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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

(Mark one)

[ X ]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended March 31, 2013
[     ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from                       to                     .

 

Commission File Number:  001-35113

 

GNC Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware	20-8536244
(State or other jurisdiction of	(I.R.S. Employer
Incorporation or organization)	Identification No.)
300 Sixth Avenue	15222
Pittsburgh, Pennsylvania	(Zip Code)
(Address of principal executive offices)

 

Registrant’s telephone number, including area code:  (412) 288-4600

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     [  X  ] Yes [    ] No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  [  X   ] Yes [    ] No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer [ X ]

Accelerated filer [   ]

Non-accelerated filer [   ]

Smaller reporting company [   ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [      ] Yes [ X ] No

 

As of April 26, 2013, there were 98,319,365 outstanding shares of Class A common stock, par value $0.001 per share (the “Class A common stock”), of GNC Holdings, Inc.

 

Table of Contents

 

TABLE OF CONTE NTS

 

 

 

		PAGE
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of March 31, 2013 (unaudited) and December 31, 2012	1
	Unaudited Consolidated Statements of Income for the three months ended March 31, 2013 and 2012	2
	Unaudited Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and 2012	2
	Unaudited Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2013 and 2012	3
	Unaudited Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012	4
	Summarized Notes to Unaudited Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	25
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	26
Item 1A.	Risk Factors	26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Mine Safety Disclosures	27
Item 5.	Other Information	27
Item 6.	Exhibits	27
Signatures		28

 

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

GNC HOLDINGS, INC. AND SUBSIDIARIES

C onsolidated B alance S heets

(in thousands, including share data)

 

		March 31,			December 31,
		2013			2012
Current assets:		(unaudited)
Cash and cash equivalents		$	176,164		$	158,541
Receivables, net		137,659			129,641
Inventories (Note 3)		510,719			491,599
Prepaids and other current assets		41,769			39,016
Total current assets		866,311			818,797
Long-term assets:
Goodwill (Note 4)		641,024			639,915
Brands (Note 4)		720,000			720,000
Other intangible assets, net (Note 4)		139,783			141,717
Property, plant and equipment, net		198,928			199,487
Other long-term assets		33,142			32,124
Total long-term assets		1,732,877			1,733,243
Total assets		$	2,599,188		$	2,552,040
Current liabilities:
Accounts payable		$	138,621		$	125,165
Current portion, long-term debt (Note 5)		3,816			3,817
Deferred revenue and other current liabilities		142,011			116,337
Total current liabilities		284,448			245,319
Long-term liabilities:
Long-term debt (Note 5)		1,093,930			1,094,745
Deferred tax liabilities, net		283,576			283,203
Other long-term liabilities		48,349			46,734
Total long-term liabilities		1,425,855			1,424,682
Total liabilities		1,710,303			1,670,001
Stockholders’ equity:
Common stock, $0.001 par value, 330,000 shares authorized:
Class A, 112,176 shares issued and 98,190 shares outstanding and 13,986 shares held in treasury at March 31, 2013 and 111,725 shares issued and 99,244 shares outstanding and 12,481 shares held in treasury at December 31, 2012		111			111
Paid-in-capital		820,964			810,094
Retained earnings		550,570			492,687
Treasury stock, at cost		(485,210)			(423,900)
Accumulated other comprehensive income		2,450			3,047
Total stockholders’ equity		888,885			882,039
Total liabilities and stockholders’ equity		$	2,599,188		$	2,552,040

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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GNC HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(unaudited)

(in thousands, except per share data)

 

		Three months ended March 31,
		2013				2012
Revenue		$		664,691		$		624,272
Cost of sales, including cost of warehousing, distribution and occupancy		408,554				383,563
Gross profit		256,137				240,709
Compensation and related benefits		79,545				80,044
Advertising and promotion		20,440				16,219
Other selling, general and administrative		31,665				31,784
Foreign currency gain		(33)				(93)
Transaction related costs		-				686
Operating income		124,520				112,069
Interest expense, net (Note 5)		11,015				10,383
Income before income taxes		113,505				101,686
Income tax expense (Note 10)		40,862				37,829
Net income		$		72,643		$		63,857
Income per share - Basic and Diluted:
Earnings per share:
Basic		$		0.73		$		0.60
Diluted		$		0.73		$		0.59
Weighted average common shares outstanding:
Basic		98,997				105,805
Diluted		99,861				107,746
Dividends declared per share:		$		0.15		$		0.11
Consolidated Statements of Comprehensive Income (unaudited) (in thousands)
		Three months ended March 31,
		2013				2012
Net income		$	72,643			$	63,857
Other comprehensive income:
Foreign currency translation adjustments		(597)				354
Other comprehensive income		(597)				354
Comprehensive income		$	72,046			$	64,211

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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GNC HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(unaudited)

(in thousands, including per share data)

 

																					Accumulated
		Common Stock																			Other			Total
		Class A					Class B					Treasury			Paid-in-			Retained			Comprehensive			Stockholders’
		Shares		Dollars			Shares		Dollars			Stock			Capital			Earnings			Income/(Loss)			Equity
Balance at December 31, 2012		99,244		$	111		-		$	-		$	(423,900)		$	810,094		$	492,687		$	3,047		$	882,039
Comprehensive income		-		-			-		-			-			-			72,643			(597)			72,046
Repurchase of treasury stock		(1,504)		-			-		-			(61,310)			-			-			-			(61,310)
Common stock dividends		-		-			-		-			-			-			(14,760)			-			(14,760)
Conversions to common stock		450		-			-		-			-			9,055			-			-			9,055
Non-cash stock-based compensation		-		-			-		-			-			1,815			-			-			1,815
Balance at March 31, 2013 (unaudited)		98,190		$	111		-		$	-		$	(485,210)		$	820,964		$	550,570		$	2,450		$	888,885
Balance at December 31, 2011		102,985		$	105		2,060		$	2		$	(65,048)		$	741,848		$	298,831		$	2,724		$	978,462
Comprehensive income		-		-			-		-			-			-			63,857			354			64,211
Conversion of Class B stock to Class A stock		2,060		2			(2,060)		(2)			-			-			-			-			-
Repurchase of treasury stock		(165)		-			-		-			(4,748)			-			-			-			(4,748)
Common stock dividends		-		-			-		-			-			-			(11,724)			-			(11,724)
Conversions to common stock		2,183		2			-		-			-			32,240			-			-			32,242
Non-cash stock-based compensation		-		-			-		-			-			1,176			-			-			1,176
Other		-		-			-		-			-			-			(1,051)			-			(1,051)
Balance at March 31, 2012 (unaudited)		107,063		$	109		-		$	-		$	(69,796)		$	775,264		$	349,913		$	3,078		$	1,058,568

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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GNC HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

 

		Three Months Ended March 31,
		2013			2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	72,643		$	63,857
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense		12,549			12,335
Amortization of debt costs		629			582
Increase in provision for inventory losses		3,993			2,797
Increase in receivables		(9,418)			(10,455)
Increase in inventory		(23,058)			(55,884)
Increase in prepaids and other current assets		(5,049)			(1,614)
Increase in accounts payable		13,256			37,473
Increase in deferred revenue and other current liabilities		27,599			19,221
Other operating activities		2,383			2,404
Net cash provided by operating activities		95,527			70,716
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures		(9,917)			(9,220)
Other investing activities		(682)			(1,388)
Net cash used in investing activities		(10,599)			(10,608)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid to shareholders		(14,728)			(11,497)
Payments on long-term debt		(943)			(415)
Proceeds from exercised stock options		4,342			12,936
Tax benefit from exercise of stock options		5,086			20,625
Repurchase of treasury stock		(61,310)			(5,885)
Other financing activities		-			(2,500)
Net cash (used in) provided by financing activities		(67,553)			13,264
Effect of exchange rate on cash and cash equivalents		248			(236)
Net increase in cash and cash equivalents		17,623			73,136
Beginning balance, cash and cash equivalents		158,541			128,438
Ending balance, cash and cash equivalents		$	176,164		$	201,574

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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NOTE 1.  NATURE OF BUSINESS

 

General Nature of Business . GNC Holdings, Inc., a Delaware corporation (“Holdings,” and collectively with its subsidiaries and, unless the context requires otherwise, its and their respective predecessors, the “Company”), is a global specialty retailer of health and wellness products, which include: vitamins, minerals and herbal supplements, sports nutrition products, diet products and other wellness products.

 

The Company is vertically integrated, as its operations consist of purchasing raw materials, formulating and manufacturing products and selling the finished products through its three segments: Retail, Franchising and Manufacturing/Wholesale. Corporate retail store operations are located in the United States, Canada and Puerto Rico, and in addition, the Company offers products domestically through GNC.com, LuckyVitamin.com and www.drugstore.com. Franchise stores are located in the United States and over 50 international countries (including distribution centers where retail sales are made). The Company operates its primary manufacturing facilities in South Carolina and distribution centers in Arizona, Pennsylvania and South Carolina. The Company manufactures the majority of its branded products, but also merchandises various third-party products. Additionally, the Company licenses the use of its trademarks and trade names.

 

The processing, formulation, packaging, labeling and advertising of the Company’s products are subject to regulation by one or more federal agencies, including the Food and Drug Administration (the “FDA”), the Federal Trade Commission, the Consumer Product Safety Commission, the United States Department of Agriculture and the Environmental Protection Agency. These activities are also regulated by various agencies of the states and localities in which the Company’s products are sold.

 

Recent Significant Transactions. In April 2011, Holdings consummated an initial public offering (the “IPO”) of 25.9 million shares of its Class A common stock, par value $0.001 per share (the “Class A common stock”), at an IPO price of $16.00 per share. Prior to the IPO, Holdings’ outstanding common stock was principally owned by Ontario Teachers’ Pension Plan Board (“OTPP”) and Ares Corporate Opportunities Fund II L.P. (“Ares”, and together with OTPP, collectively referred to as the “Sponsors”). On March 19, 2012, OTPP converted all of its shares of Class B common stock into an equal number of shares of Class A common stock. Subsequent to the IPO, certain of Holdings’ stockholders, including the Sponsors, completed the following registered offerings of Class A common stock:

 

·                   in October 2011, 23.0 million shares at $24.75 per share;

·                   in March 2012, 19.6 million shares at $33.50 per share;

·                   in August 2012,10.0 million shares at $38.42 per share; and,

·                   in November 2012, 11.7 million shares at $35.20 per share.

 

In conjunction with the August 2012 offering, the Company repurchased an additional six million shares of Class A common stock from Ares as part of a share repurchase program. As of December 31, 2012, Ares no longer owns any shares of our capital stock and OTPP owns less than 10,000 shares of our Class A common stock.

 

As of March 31, 2013, the Company had completed $61.3 million of its February 2013 approved $250.0 million share repurchase program of Class A common stock.

 

In March 2011, GNC Corporation and General Nutrition Centers, Inc., each a wholly owned subsidiary of Holdings, entered into a Credit Agreement (the “Credit Agreement”) that provided for a $1.2 billion term loan (the “Term Loan Facility”) and an $80.0 million revolving credit facility (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Senior Credit Facility”). On August 1, 2012, the Credit Agreement was amended to increase the outstanding borrowings by $200.0 million (the “Incremental Term Loan”).  In October 2012, the Credit Agreement was amended to adjust the per annum interest rate to the greater of LIBOR and 1.00%, plus an applicable margin of 2.75% (the “Repricing”).

 

NOTE 2.  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. The year-end consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”). These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s audited financial statements in Holdings’ Annual Report on Form 10-K filed for the year ended December 31, 2012. There have been no material changes to the application of significant accounting policies and significant judgments and estimates since December 31, 2012.

 

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The accompanying unaudited consolidated financial statements include all adjustments (consisting of a normal and recurring nature) that management considers necessary for a fair statement of financial information for the interim periods. Interim results are not necessarily indicative of the results that may be expected for the remainder of the year ending December 31, 2013.

 

Principles of Consolidation. The consolidated financial statements include the accounts of Holdings and all of its subsidiaries. All material intercompany transactions have been eliminated in consolidation.

 

The Company has no relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off balance sheet arrangements, or other contractually narrow or limited purposes.

 

Use of Estimates .  The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. Accordingly, these estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Some of the most significant estimates pertaining to the Company include the valuation of inventories, the allowance for doubtful accounts and income taxes. On a regular basis, management reviews its estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such reviews and if deemed appropriate, those estimates are adjusted accordingly. Actual results could differ from those estimates.

 

Transaction Related Costs.   The Company recognizes transaction related costs as expenses in the period incurred.  For the three months ended March 31, 2013, the Company incurred no transaction related costs. For the three months ended March 31, 2012, the Company incurred $0.7 million of expenses related to the March 2012 offering.

 

Recent Accounting Pronouncements

 

In February 2013, the Financial Accounting Standards Board (the “FASB”) issued an accounting standard regarding the reclassification of amounts out of accumulated other comprehensive income (“AOCI”).  This standard does not change the current requirements for reporting net income or other comprehensive income. However, the standard requires disclosure of amounts reclassified out of AOCI in its entirety, by component, on the face of the statement of operations or in the footnotes to the financial statements. Amounts that are not required to be reclassified in their entirety to net income must be cross-referenced to other disclosures that provide additional detail. This guidance is effective for fiscal years beginning after December 15, 2012. The Company adopted this guidance during the first quarter of 2013. The adoption of this guidance had no material impact on the Company’s consolidated financial statements.

 

NOTE 3.  INVENTORIES

 

The net carrying value of inventories consisted of the following:

 

		March 31,			December 31,
		2013			2012
		(unaudited)
		(in thousands)
Finished product ready for sale		$	427,837		$	415,096
Work-in-process, bulk product and raw materials		75,982			70,022
Packaging supplies		6,900			6,481
Total		$	510,719		$	491,599

 

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NOTE 4. GOODWILL AND INTANGIBLE ASSETS, NET

 

For the three months ended March 31, 2013 and 2012, the Company acquired 7 and 13 franchise stores, respectively. These acquisitions were accounted for using the purchase method of accounting and the Company recorded the acquired inventory, fixed assets, franchise rights and goodwill, with an applicable reduction to receivables and cash. For the three months ended March 31, 2013 and 2012, the total purchase price associated with these acquisitions was $1.7 million and $2.6 million, respectively, of which $1.2 million and $1.1 million, respectively, was paid in cash.

 

The following table summarizes the Company’s goodwill activity:

 

								Manufacturing/
		Retail			Franchising			Wholesale			Total
		(in thousands)
Balance at December 31, 2012		$	319,771		$	117,303		$	202,841		$	639,915
Acquired franchise stores		1,109			-			-			1,109
Balance at March 31, 2013 (unaudited)		$	320,880		$	117,303		$	202,841		$	641,024

 

Intangible assets other than goodwill consisted of the following:

 

		Retail			Franchise			Operating			Other
		Brand			Brand			Agreements			Intangibles			Total
		(in thousands)
Balance at December 31, 2012		$	500,000		$	220,000		$	132,317		$	9,400		$	861,717
Acquired franchise stores		-			-			-			186			186
Amortization expense		-			-			(1,663)			(457)			(2,120)
Balance at March 31, 2013 (unaudited)		$	500,000		$	220,000		$	130,654		$	9,129		$	859,783

 

The following table reflects the gross carrying amount and accumulated amortization for each major intangible asset:

 

		Weighted -		March 31, 2013									December 31, 2012
		Average					Accumulated			Carrying						Accumulated			Carrying
		Life		Cost			Amortization			Amount			Cost			Amortization			Amount
							(unaudited)
				(in thousands)
Brands - retail		-		$	500,000		$	-		$	500,000		$	500,000		$	-		$	500,000
Brands - franchise		-		220,000			-			220,000			220,000			-			220,000
Retail agreements		30.2		31,000			(6,512)			24,488			31,000			(6,249)			24,751
Franchise agreements		25.0		70,000			(16,917)			53,083			70,000			(16,217)			53,783
Manufacturing agreements		25.0		70,000			(16,917)			53,083			70,000			(16,217)			53,783
Other intangibles		11.4		10,600			(2,454)			8,146			10,600			(2,151)			8,449
Franchise rights		3.7		5,320			(4,337)			983			5,134			(4,183)			951
Total		24.5		$	906,920		$	(47,137)		$	859,783		$	906,734		$	(45,017)		$	861,717

 

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The following table represents future estimated amortization expense of intangible assets with finite lives at March 31, 2013:

 

		Estimated
		amortization
Years ending December 31,		expense
		(unaudited)
		(in thousands)
2013		$	6,330
2014		8,177
2015		8,034
2016		7,948
2017		7,898
Thereafter		101,396
Total		$	139,783

 

NOTE 5.  LONG-TERM DEBT / INTEREST EXPENSE

 

Long-term debt consisted of the following:

 

		March 31,			December 31,
		2013			2012
		(unaudited)
		(in thousands)
Senior Credit Facility		$	1,095,739		$	1,096,112
Mortgage		2,003			2,444
Capital leases		4			6
Total debt		1,097,746			1,098,562
Less: current maturities		(3,816)			(3,817)
Long-term debt		$	1,093,930		$	1,094,745

 

For the three months ended March 31, 2013 and 2012, interest expense was $11.0 million and $10.4 million, respectively, and consisted primarily of interest on outstanding borrowings under the Term Loan Facility. Interest under both the Term Loan Facility and the Revolving Credit Facility is based on variable rates. At both March 31, 2013 and December 31, 2012, the interest rate under the Term Loan Facility was 3.75% and the interest rate under the Revolving Credit Facility was 3.00%. The Revolving Credit Facility was undrawn and had outstanding letters of credit of $1.1 million at both March 31, 2013 and December 31, 2012.

 

As of March 31, 2013, the Company believes that it is in compliance with all covenants under the Senior Credit Facility.

 

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NOTE 6.  FINANCIAL INSTRUMENTS

 

At March 31, 2013 and December 31, 2012, the Company’s financial instruments consisted of cash and cash equivalents, receivables, franchise notes receivable, accounts payable, certain accrued liabilities and long-term debt. The carrying amount of cash and cash equivalents, receivables, accounts payable and accrued liabilities approximates their respective fair values because of the short maturities of these instruments. Based on the interest rates currently available and their underlying risk, the carrying value of the franchise notes receivable approximates their respective fair values. These fair values are reflected net of reserves for uncollectible amounts. As considerable judgment is required to determine these estimates and assumptions, changes in the assumptions or methodologies may have an effect on these estimates. The Company determined the estimated fair values of its debt by using currently available market information. The fair value of debt is classified as a Level 2 category on the fair value hierarchy, as defined in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The actual and estimated fair values of the Company’s financial instruments are as follows:

 

		March 31, 2013						December 31, 2012
		Carrying			Fair			Carrying			Fair
		Amount			Value			Amount			Value
		(unaudited)
		(in thousands)
Cash and cash equivalents		$	176,164		$	176,164		$	158,541		$	158,541
Receivables, net		137,659			137,659			129,641			129,641
Franchise notes receivable, net		8,174			8,174			7,589			7,589
Accounts payable		138,621			138,621			125,165			125,165
Long-term debt (including current portion)		1,097,746			1,105,979			1,098,562			1,101,309

 

NOTE 7.  COMMITMENTS AND CONTINGENCIES

 

Litigation

 

The Company is engaged in various legal actions, claims and proceedings resulting from the Company’s business activities arising in the normal course of business, including claims related to breach of contracts, products liabilities, intellectual property matters and employment-related matters resulting from the Company’s business activities. As with most actions such as these, an estimation of any possible and/or ultimate liability cannot always be determined. The Company continues to assess the requirement to account for additional contingencies in accordance with the standard on contingencies. If the Company is required to make a payment in connection with an adverse outcome in these matters, it could have a material impact on the Company’s business, financial condition, results of operations or cash flows.

 

As a manufacturer and retailer of nutritional supplements and other consumer products that are ingested by consumers or applied to their bodies, the Company has been and is currently subjected to various product liability claims. Although the effects of these claims to date have not been material to the Company, it is possible that current and future product liability claims could have a material adverse impact on its business or financial condition, results of operations, or cash flows. The Company currently maintains product liability insurance with a deductible/retention of $4.0 million per claim with an aggregate cap on retained loss of $10.0 million. The Company typically seeks and has obtained contractual indemnification from most parties that supply raw materials for its products or that manufacture or market products it sells. The Company also typically seeks to be added, and has been added, as an additional insured under most of such parties’ insurance policies. The Company is also entitled to indemnification by Numico for certain losses arising from claims related to products containing ephedra or Kava Kava sold prior to December 5, 2003. However, any such indemnification or insurance is limited by its terms and any such indemnification, as a practical matter, is limited to the creditworthiness of the indemnifying party and its insurer, and the absence of significant defenses by the insurers. The Company may incur material product liability claims, which could increase its costs and adversely affect its reputation, revenue and operating income.

 

Hydroxycut Claims . On May 1, 2009, the FDA issued a warning on several Hydroxycut-branded products manufactured by Iovate Health Sciences U.S.A., Inc. (“Iovate”). The FDA warning was based on 23 reports of liver injuries from consumers who claimed to have used the products between 2002 and 2009. As a result, Iovate voluntarily recalled 14 Hydroxycut-branded products.

 

Following the recall, the Company was named, among other defendants, in approximately 93 lawsuits related to Hydroxycut-branded products in 14 states.  Iovate previously accepted the Company’s tender request for defense and indemnification under its purchasing agreement with the Company and, as such, Iovate has accepted the Company’s request for defense and indemnification in the Hydroxycut matters. The Company’s ability to obtain full recovery in respect of any claims against the Company in connection with products manufactured by Iovate under the indemnity is dependent on Iovate’s insurance coverage, the creditworthiness of its insurer, and the absence of significant defenses by such insurer.  To the extent the Company is not fully compensated by Iovate’s insurer, it can seek recovery directly from Iovate.  The Company’s ability to fully recover such amounts may be limited by the creditworthiness of Iovate.

 

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As of March 31, 2013, there were 73 pending lawsuits related to Hydroxycut in which the Company has been named: 67 individual, largely personal injury claims and six putative class action cases, generally inclusive of claims of consumer fraud, misrepresentation, strict liability and breach of warranty.  In 2009, the United States Judicial Panel on Multidistrict Litigation consolidated pretrial proceedings of many of the pending actions in the Southern District of California (In re: Hydroxycut Marketing and Sales Practices Litigation, MDL No. 2087).   The parties in the consolidated class actions have reached a settlement, and the settlement has been preliminarily approved by the Court.  The parties’ motion for final approval of the settlement was heard on April 23, 2013.  The Company is not required to make any payments under the settlement.

 

As any liabilities that may otherwise arise from Hydroxycut claims against the Company are not probable or reasonably estimable at this time, no liability has been accrued in the accompanying financial statements.

 

Commitments

 

In addition to operating leases obtained in the normal course of business, the Company maintains certain purchase commitments with various vendors to ensure its operational needs are fulfilled.  As of March 31, 2013, such future purchase commitments consisted of $2.7 million.  Other commitments related to the Company’s business operations cover varying periods of time and are not significant. All of these commitments are expected to be fulfilled with no adverse consequences to the Company’s operations or financial condition.

 

Environmental Compliance

 

In March 2008, the South Carolina Department of Health and Environmental Control (the “DHEC”) requested that the Company investigate contamination associated with historical activities at its South Carolina facility. These investigations have identified chlorinated solvent impacts in soils and groundwater that extend offsite from the facility. The Company entered into a Voluntary Cleanup Contract with the DHEC regarding the matter on September 24, 2012. Pursuant to that contract, the Company is working under the DHEC’s supervision to complete additional investigations to characterize the contamination. After the Company completes the investigations to understand the extent of the chlorinated solvent impacts, the Company will develop appropriate remedial measures for DHEC approval. At this stage of the investigation, however, it is not possible to estimate the timing and extent of any remedial action that may be required, the ultimate cost of remediation, or the amount of the Company’s potential liability.

 

In addition to the foregoing, the Company is subject to numerous federal, state, local and foreign environmental and health and safety laws and regulations governing its operations, including the handling, transportation and disposal of the Company’s non-hazardous and hazardous substances and wastes, as well as emissions and discharges from its operations into the environment, including discharges to air, surface water and groundwater. Failure to comply with these laws and regulations could result in costs for remedial actions, penalties or the imposition of other liabilities.  New laws, changes in existing laws or the interpretation thereof, or the development of new facts or changes in their processes could also cause the Company to incur additional capital and operating expenditures to maintain compliance with environmental laws and regulations and environmental permits. The Company is also subject to laws and regulations that impose liability and cleanup responsibility for releases of hazardous substances into the environment without regard to fault or knowledge about the condition or action causing the liability. Under certain of these laws and regulations, such liabilities can be imposed for cleanup of previously owned or operated properties, or for properties to which substances or wastes that were sent in connection with current or former operations at its facilities. The presence of contamination from such substances or wastes could also adversely affect the Company’s ability to sell or lease its properties, or to use them as collateral for financing. From time to time, the Company has incurred costs and obligations for correcting environmental and health and safety noncompliance matters and for remediation at or relating to certain of the Company’s properties or properties at which the Company’s waste has been disposed. However, compliance with the provisions of national, state and local environmental laws and regulations has not had a material effect upon the Company’s capital expenditures, earnings, financial position, liquidity or competitive position. The Company believes it has complied with, and is currently complying with, its environmental obligations pursuant to environmental and health and safety laws and regulations and that any liabilities for noncompliance will not have a material adverse effect on its business, financial performance or cash flows. However, it is difficult to predict future liabilities and obligations, which could be material.

 

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NOTE 8.  STOCK-BASED COMPENSATION PLANS

 

The Company has outstanding stock-based compensation awards that were granted by the Compensation Committee (the “Compensation Committee”) of Holdings’ board of directors under the following two stock-based employee compensation plans:

 

·                   the GNC Holdings, Inc. 2011 Stock and Incentive Plan (the “2011 Stock Plan”) adopted in March 2011; and

 

·                   the GNC Acquisition Holdings Inc. 2007 Stock Incentive Plan adopted in March 2007 (as amended, the “2007 Stock Plan”).

 

Both plans have provisions that allow for the granting of stock options, restricted stock and other stock based awards and are available to certain eligible employees, directors, consultants or advisors as determined by the Compensation Committee.  Stock options under the plans were granted with exercise prices at or above fair market value on the date of grant, typically vesting over a four-or five-year period, and expire seven or ten years from the date of grant.

 

Up to 8.5 million shares of Class A common stock may be issued under the 2011 Stock Plan (subject to adjustment to reflect certain transactions and events specified in the 2011 Stock Plan for any award grant). If any award granted under the 2011 Stock Plan expires, terminates or is cancelled without having been exercised in full, the number of shares underlying such unexercised award will again become available for awards under the 2011 Stock Plan. The total number of shares of Class A common stock available for awards under the 2011 Stock Plan will be reduced by (i) the total number of stock options or stock appreciation rights exercised, regardless of whether any of the shares of Class A common stock underlying such awards are not actually issued to the participant as the result of a net settlement, and (ii) any shares of Class A common stock used to pay any exercise price or tax withholding obligation. In addition, the number of shares of Class A common stock that are subject to restricted stock, performance shares or other stock-based awards that are not subject to the appreciation of the value of a share of Class A common stock (“Full Share Awards”) that may be granted under the 2011 Stock Plan is limited by counting shares granted pursuant to such awards against the aggregate share reserve as 1.8 shares for every share granted. If any stock option, stock appreciation right or other stock-based award that is not a Full Share Award is cancelled, expires or terminates unexercised for any reason, the shares covered by such awards will again be available for the grant of awards under the 2011 Stock Plan. If any shares of Class A common stock that are subject to restricted stock, performance shares or other stock-based awards that are Full Share Awards are forfeited for any reason, 1.8 shares of Class A common stock for each Full Share Award forfeited will again be available for the grant of awards under the 2011 Stock Plan.

 

The Company will not grant any additional awards under the 2007 Stock Plan.  No stock appreciation rights, restricted stock, deferred stock or performance shares were granted under the 2007 Stock Plan.

 

The Company utilizes the Black Scholes model to calculate the fair value of options under both the 2011 Stock Plan and the 2007 Stock Plan. The grant-date fair value of the Company’s restricted stock awards and restricted stock units is based on the closing price of a share of the Company’s common stock on the New York Stock Exchange on the date of the grant. The resulting compensation cost is recognized in the Company’s financial statements over the vesting period. The Company recognized $1.8 million and $1.2 million of total non-cash stock-based compensation expense for the three months ended March 31, 2013 and 2012, respectively. At March 31, 2013, there was approximately $19.5 million of total unrecognized compensation cost related to non-vested stock-based compensation for all awards previously made that are expected to be recognized over a weighted average period of approximately 2.0 years. All expense for the stock-based compensation plans is recorded to paid-in-capital.

 

During the three months ended March 31, 2013, the total intrinsic value of awards exercised was $13.8 million and the total amount received by Holdings from the exercise of options was $4.3 million. The tax impact associated with the exercise of awards for the three months ended March 31, 2013 was a benefit of $4.7 million, which was recorded to paid-in-capital.

 

During the three months ended March 31, 2012, the total intrinsic value of awards exercised was $55.9 million, and the total amount received by Holdings from the exercise of options was $13.5 million. The tax impact associated with the exercise of awards for the three months ended March 31, 2012 was a benefit of $19.3 million, which was recorded to paid-in-capital.

 

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Stock Options

 

The following table sets forth a summary of stock options under all plans for the three months ended March 31, 2013:

 

							Weighted
				Weighted			Average		Aggregate
				Average			Remaining		Intrinsic
				Exercise			Contractual Term		Value (in
		Total Options		Price			(in years)		thousands)
Outstanding at December 31, 2012		3,159,542		$	18.96
Granted		10,017		42.19
Exercised		(449,872)		9.34
Forfeited		(16,667)		27.74
Outstanding at March 31, 2013		2,703,020		$	20.60		6.1		$	50,527
Exercisable at March 31, 2013		896,748		$	14.66		5.9		$	22,079

 

The weighted average fair value of options granted during the three months ended March 31, 2013 and 2012 was $12.97 and $9.89, respectively. Fair value of options vested during the three months ended March 31, 2013 and 2012 was $1.0 million and $1.7 million, respectively.

 

The Black Scholes model utilizes the following assumptions in determining a fair value: price of underlying stock, award exercise price, expected term, risk-free interest rate, expected dividend yield and expected stock price volatility over the award’s expected term. Due to the utilization of these assumptions, the existing models do not necessarily represent the definitive fair value of awards for future periods. As the IPO occurred during the second quarter of 2011, the option term has been estimated by considering both the vesting period, which typically for both plans has been four or five years, and the contractual term, which historically has been either seven or ten years. Prior to the IPO, the fair value of the Class A common stock was estimated based upon the net enterprise value of the Company, discounted to reflect the lack of liquidity and control associated with the stock.  Since the consummation of the IPO, the fair value of the Class A common stock has been based upon the closing price of the Class A common stock as reported on the New York Stock Exchange. Volatility is estimated based upon it’s the current peer group average utilized by the Company.

 

The assumptions used in the Company’s Black Scholes valuation related to stock option grants made during the three months ended March 31, 2013 were as follows:

 

Dividend yield		1.4%
Expected option life		4.8 years
Volatility factor percentage of market price		40.1%
Discount rate		0.9%

 

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Restricted Stock Awards

 

The following table sets forth a summary of restricted stock awards granted under the 2011 Stock Plan and related information for the three months ended March 31, 2013:

 

				Weighted
				Average
		Restricted		Grant-Date
		Stock		Fair Value
Outstanding at December 31, 2012		123,941		$	24.24
Granted		5,526		40.64
Forfeited		(2,225)		29.06
Outstanding at March 31, 2013		127,242		$	24.87

 

No restricted stock awards vested during the three months ended March 31, 2013.

 

Restricted Stock Units – Time Vesting and Performance Vesting

 

Under the 2011 Stock Plan, the Company granted time vesting and performance vesting restricted stock units. Time vesting restricted stock units vest over a period of three years. Performance vesting restricted stock units vest based on the passage of time and the achievement of certain criteria; based on the extent to which the targets are achieved, vested shares may range from 0% to 200% of the original share amount. The unrecognized compensation cost related to the performance vesting restricted stock units is adjusted as necessary to reflect changes in the probability that the vesting criteria will be achieved.

 

The following table sets forth a summary of restricted stock units and performance stock units granted under the 2011 Stock Plan and related information for the three months ended March 31, 2013:

 

		Time		Weighted			Performance		Weighted
		Vesting		Average			Vesting		Average
		Restricted		Grant-Date			Restricted		Grant-Date
		Stock Units		Fair Value			Stock Units		Fair Value
Outstanding at December 31, 2012		171,937		$	36.16		-		$	-
Granted		7,622		41.52			45,327		42.19
Outstanding at March 31, 2013		179,559		$	36.39		45,327		$	42.19

 

No time vesting or performance vesting shares vested during the three months ended March 31, 2013.

 

NOTE 9.  SEGMENTS

 

The Company has three reportable segments, each of which represents an identifiable component of the Company for which separate financial information is available. This information is utilized by management to assess performance and allocate assets accordingly. The Company’s management evaluates segment operating results based on several indicators. The primary key performance indicators are sales and operating income or loss for each segment. Operating income or loss, as evaluated by management, excludes certain items that are managed at the consolidated level, such as distribution and warehousing, impairments and other corporate costs. The Retail reportable segment includes the Company’s corporate store operations in the United States, Canada and Puerto Rico and its GNC.com and LuckyVitamin.com businesses. The Franchise reportable segment represents the Company’s franchise operations, both domestically and internationally. The Manufacturing/Wholesale reportable segment represents the Company’s manufacturing operations in South Carolina and the Wholesale sales business. This segment supplies the Retail and Franchise segments, along with various third parties, with finished products for sale. The Warehousing and Distribution and Corporate costs represent the Company’s administrative expenses. The accounting policies of the segments are the same as those described in the “Basis of Presentation and Summary of Significant Accounting Policies.”

 

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The following table represents key financial information of the Company’s segments:

 

		Three months ended March 31,
		2013			2012
		(unaudited)
		(in thousands)
Revenue:
Retail		$	493,467		$	469,821
Franchise		107,887			101,484
Manufacturing/Wholesale:
Intersegment revenues		65,470			66,508
Third Party		63,337			52,967
Subtotal Manufacturing/Wholesale		128,807			119,475
Subtotal segment revenues		730,161			690,780
Elimination of intersegment revenues		(65,470)			(66,508)
Total revenue		$	664,691		$	624,272
Operating income:
Retail		$	98,583		$	93,176
Franchise		38,425			34,428
Manufacturing/Wholesale		22,926			22,837
Unallocated corporate and other costs:
Warehousing and distribution costs		(16,355)			(15,795)
Corporate costs		(19,059)			(21,891)
Transaction related costs		-			(686)
Subtotal unallocated corporate and other costs		(35,414)			(38,372)
Total operating income		$	124,520		$	112,069

 

NOTE 10.  INCOME TAXES

 

The Company recognized $40.9 million of income tax expense (or 36.0% of pre-tax income) during the three months ended March 31, 2013 compared to $37.8 million (or 37.2% of pre-tax income) for the same period in 2012.

 

The Company files a consolidated U.S. federal tax return and various consolidated and separate tax returns as prescribed by the tax laws of the state, local and international jurisdictions in which it operates. The Company’s 2010 federal income tax return is currently under examination by the Internal Revenue Service. The Company has various state and local jurisdiction tax years open to examination (the earliest open period is 2004), and the Company also has certain state and local jurisdictions currently under audit. As of March 31, 2013, the Company believes that it has appropriately reserved for potential federal and state income tax exposures.

 

At both March 31, 2013 and December 31, 2012, the Company had $12.9 million of unrecognized tax benefits. As of March 31, 2013, the Company is not aware of any tax positions for which it is reasonably possible that the amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is approximately $12.9 million. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had accrued approximately $5.7 million at both March 31, 2013 and December 31, 2012 for potential interest and penalties associated with uncertain tax positions. To the extent interest and penalties are not assessed with respect to the ultimate settlement of uncertain tax positions, amounts previously accrued will be reduced and reflected as a reduction of the overall income tax provision.

 

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