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GNC > SEC Filings for GNC > Form 10-Q on 31-Oct-2013All Recent SEC Filings

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Form 10-Q for GNC HOLDINGS, INC.


31-Oct-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Item 1, "Financial Statements" in Part I of this Quarterly Report on Form 10-Q.

Forward-Looking Statements

This Quarterly Report on Form 10-Q and any documents incorporated by reference herein or therein include forward-looking statements within the meaning of federal securities laws. Forward-looking statements include statements that may relate to our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs and other information that is not historical information. Forward-looking statements can often be identified by the use of terminology such as "subject to," "believe," "anticipate," "plan," "potential," "predict," "expect," "intend," "estimate," "project," "may," "will," "should," "would," "continue," "seek," "could," "can," "think," the negatives thereof, variations thereon and similar expressions, or by discussions of strategy.

All forward-looking statements, including, without limitation, our examination of historical operating trends, are based upon our current expectations and various assumptions. We believe there is a reasonable basis for our expectations and beliefs, but they are inherently uncertain. We may not realize our expectations, and our beliefs may not prove correct. Actual results could differ materially from those described or implied by such forward-looking statements. The following uncertainties and factors, among others (including, but not limited to, those we describe under the caption "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012), could affect future performance and cause actual results to differ materially from those matters expressed in or implied by forward-looking statements:

significant competition in our industry;

unfavorable publicity or consumer perception of our products;

increases in the cost of borrowings and limitations on availability of additional debt or equity capital;

our debt levels and restrictions in our debt agreements;

incurrence of material product liability and product recall costs;

loss or retirement of key members of management;

costs of compliance and our failure to comply with new and existing governmental regulations governing our products, including, but not limited to, proposed dietary supplement legislation and regulations;

changes in our tax obligations;

costs of litigation and the failure to successfully defend lawsuits and other claims against us;

failure of our franchisees to conduct their operations profitably and limitations on our ability to terminate or replace under-performing franchisees;

economic, political and other risks associated with our international operations;

failure to keep pace with the demands of our customers for new products and services;

limitations of or disruptions in our manufacturing system or losses of manufacturing certifications;

limitations of or disruptions in our distribution network;

lack of long-term experience with human consumption of ingredients in some of our products;

increases in the frequency and severity of insurance claims, particularly claims for which we are self-insured;

failure to adequately protect or enforce our intellectual property rights against competitors;

changes in raw material costs and pricing of our products;


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failure to successfully execute our growth strategy, including any delays in our planned future growth, any inability to expand our franchise operations or attract new franchisees, any inability to expand our company-owned retail operations, any inability to grow our international footprint, or any inability to expand our e-commerce business;

changes in applicable laws relating to our franchise operations;

damage or interruption to our information systems;

risks and costs associated with data loss, credit card fraud and identity theft;

impact of current economic conditions on our business;

natural disasters, unusually adverse weather conditions, pandemic outbreaks, boycotts and geo-political events; and

failure to maintain effective internal controls.

Consequently, forward-looking statements should be regarded solely as our current plans, estimates and beliefs. You should not place undue reliance on forward-looking statements. We cannot guarantee future results, events, levels of activity, performance or achievements. We do not undertake and specifically decline any obligation to update, republish or revise forward-looking statements to reflect future events or circumstances or to reflect the occurrences of unanticipated events.

Business Overview

We are a global specialty retailer of health and wellness products. We derive our revenues principally from product sales through our company-owned stores and online through GNC.com and LuckyVitamin.com, domestic and international franchise activities and sales of products manufactured in our facilities to third parties. We sell products through a worldwide network of more than 8,400 locations operating under the GNC brand name.

In April 2011, we consummated an initial public offering (the "IPO") of 25.9 million shares of Holdings Class A common stock, par value $0.001 per share (the "Class A common stock"), at an IPO price of $16.00 per share. Subsequent to the IPO, certain of Holdings' stockholders 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, we repurchased an additional six million shares of Class A common stock from one of our stockholders as part of a share repurchase program.

As of September 30, 2013, we have completed $238.4 million of the February 2013 approved $250.0 million share repurchase program of Class A common stock. The IPO, the offerings, and the repurchase of the six million shares of Class A common stock are collectively herein referred to as the "Offerings."

In March 2011, GNC Corporate 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"). In August 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").

On October 2, 2013, we acquired A1 Sports Limited (d/b/a Discount Supplements), the leading multi-brand sports nutrition e-commerce retailer in the United Kingdom. We expect the acquisition of Discount Supplements to have an immaterial impact on operating income during 2013.


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Executive Overview

In 2013, we have continued to focus on achieving our five principal corporate goals: growing company-owned domestic retail earnings, growing company-owned domestic retail square footage, growing our international footprint, expanding our e-commerce business and further leveraging the GNC brand. These goals are designed to drive both short-term and long-term financial results. Our efforts led to the following results for the three months ended September 30, 2013 compared to the same period in 2012:

Our company-owned domestic same store sales increased by 6.7%, which includes a 31.7% increase from our GNC.com business.

We increased our company-owned domestic store count by 32 net new stores during the third quarter of 2013.

Our retail segment sales increased by 9.5%, and operating income increased 7.3%.

Total franchising revenue grew 9.3%, and operating income increased 14.6%.

Domestic franchising revenue grew 10.1%, and we added 15 net new domestic franchise stores during the third quarter of 2013.

International franchise revenue grew 8.2%, and we added 29 net new international franchise stores during the third quarter of 2013.

We increased our sales in our wholesale/manufacturing segment by 2.4% through our wholesale distribution channels and increased third-party sales, and operating income increased 7.5%.

We generated 8.7% of total revenue growth which drove a 13.3% increase in total operating income.

For the nine months ended September 30, 2013, we generated net cash from operating activities of $215.4 million, repurchased $238.4 million in common stock, and paid $43.3 million in common stock dividends.

Revenues and Operating Performance from our Segments

We measure our operating performance primarily through revenues and operating income from our three segments, Retail, Franchise and Manufacturing/Wholesale, and through the management of unallocated costs from our warehousing, distribution and corporate segments, as follows:

Retail: Retail revenues are generated by sales to consumers at our company-owned stores and online through our websites, GNC.com and LuckyVitamin.com. Although we believe that our retail and franchise businesses are not seasonal in nature, historically we have experienced, and expect to continue to experience, a variation in our net sales and operating results from quarter to quarter. Our industry is expected to grow at an annual average rate of approximately 7% through 2020. As a leader in our industry, we expect our organic retail revenue to grow faster than the projected industry growth as a result of our disproportionate market share, scale economies in purchasing and advertising, strong brand awareness and vertical integration.

         Franchise: Franchise revenues are generated primarily by:



(1)       product sales to our franchisees;

(2)       royalties on franchise retail sales; and

(3)       franchise fees, which we charge for initial franchise awards, renewals

and transfers of franchises.

Although we do not anticipate the number of our domestic franchise stores to grow substantially, we expect to achieve domestic franchise store revenue growth consistent with projected industry growth, which we expect to generate from royalties on franchise retail sales and product sales to our existing franchisees. As a result of our efforts to expand our international presence and provisions in our international franchising agreements requiring franchisees to open additional stores, we have increased our international store base in recent periods and expect to continue to increase the number of our international franchise stores over the next five years. We believe this will result in additional franchise fees associated with new store openings and increased revenues from product sales to, and royalties from, new franchisee stores. Since our international franchisees pay royalties to us in U.S. dollars, any strengthening of the U.S. dollar relative to our franchisees' local currency may offset some of the growth in royalty revenue.


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Manufacturing/Wholesale: Manufacturing/Wholesale revenues are generated by: sales of manufactured products to third parties, generally for third-party private label brands; the sale of our proprietary and third-party products to and through Rite Aid and www.drugstore.com; and the sale of our proprietary products to PetSmart and Sam's Club. We also record license fee revenue from the opening of franchise store-within-a-store locations within Rite Aid stores. Our revenues generated by our manufacturing and wholesale operations are subject to our available manufacturing capacity.

A significant portion of our business infrastructure is comprised of fixed operating costs. Our vertically integrated distribution network, manufacturing capacity, and our ability to outsource production can support higher sales volume. With the continued growth in each of our operating segments, the Company has announced that it will be adding a fourth domestic distribution center. This distribution center will be located near Indianapolis, Indiana and will provide distribution capacity for the foreseeable future.

The following trends and uncertainties in our industry could affect our operating performance as follows:

broader consumer awareness of health and wellness issues and rising healthcare costs may increase the use of the products we offer and positively affect our operating performance;

interest in, and demand for, condition-specific products based on scientific research may positively affect our operating performance if we can timely develop and offer such condition-specific products;

the effects of favorable and unfavorable publicity on consumer demand with respect to the products we offer may have similarly favorable or unfavorable effects on our operating performance;

a lack of long-term experience with human consumption of ingredients in some of our products could create uncertainties with respect to the health risks, if any, related to the consumption of such ingredients and negatively affect our operating performance;

increased costs associated with complying with new and existing governmental regulation may negatively affect our operating performance; and

a decline in disposable income available to consumers may lead to a reduction in consumer spending and negatively affect our operating performance.

Results of Operations

The following information presented for the three and nine months ended September 30, 2013 and 2012 was prepared by management, is unaudited and was derived from our unaudited consolidated financial statements and accompanying notes. In the opinion of management, all adjustments necessary for a fair statement of our financial position and operating results for such periods and as of such dates have been included.

As discussed in Note 9, "Segments," to our unaudited consolidated financial statements, we evaluate segment operating results based on several indicators. The primary key performance indicators are revenues and operating income or loss for each segment. Revenues and operating income or loss, as evaluated by management, exclude certain items that are managed at the consolidated level, such as warehousing and transportation costs, impairments and other corporate costs. The following discussion compares the revenues and the operating income or loss by segment, as well as those items excluded from the segment totals.

Same store sales growth reflects the percentage change in same store sales in the period presented compared to the prior year period. Same store sales are calculated on a daily basis for each store and exclude the net sales of a store for any period if the store was not open during the same period of the prior year. We also include internet sales, as generated only through GNC.com and www.drugstore.com, in our domestic retail company-owned domestic same store sales calculation. When a store's square footage has been changed as a result of reconfiguration or relocation in the same mall or shopping center, the store continues to be treated as a same store. If, during the period presented, a store was closed, relocated to a different mall or shopping center, or converted to a franchise store or a company-owned store, sales from that store up to and including the closing day or the day immediately preceding the relocation or conversion are included as same store sales as long as the store was open during the same period of the prior year. We exclude from the calculation sales during the period presented that occurred on or after the date of relocation to a different mall or shopping center or the date of a conversion.


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Results of Operations



(Dollars in millions and percentages expressed as a percentage of total net
revenue)



                                  Three Months Ended September 30,              Nine Months Ended September 30,
                                      2013                  2012                  2013                    2012
                                                                    (unaudited)
Revenues:
Retail                        $      487.3    72.1%    $ 445.0    71.6%    $   1,483.3    73.6%    $  1,373.5    73.7%
Franchise                            118.9    17.6%      108.8    17.5%          337.3    16.7%         313.8    16.8%
Manufacturing / Wholesale             69.4    10.3%       67.8    10.9%          196.0     9.7%         177.7     9.5%
Total net revenues                   675.6   100.0%      621.6   100.0%        2,016.6   100.0%       1,865.0   100.0%

Operating expenses:
Cost of sales, including
warehousing, distribution
and occupancy costs                  421.6    62.4%      386.4    62.2%        1,250.6    62.0%       1,149.6    61.6%
Compensation and related
benefits                              79.3    11.7%       78.7    12.7%          239.9    11.9%         237.1    12.7%
Advertising and promotion             16.7     2.5%       15.7     2.5%           53.5     2.6%          45.3     2.4%
Other selling, general and
administrative expenses               29.9     4.4%       26.6     4.3%           92.2     4.6%          84.8     4.6%
Transaction related costs                -     0.0%        0.9     0.1%              -     0.0%           1.6     0.1%
Amortization expense                   2.1     0.3%        2.1     0.3%            6.3     0.3%           6.4     0.3%
Foreign currency gain                    -     0.0%          -     0.0%          (0.1)     0.0%         (0.1)     0.0%
Total operating expenses             549.6    81.3%      510.4    82.1%        1,642.4    81.4%       1,524.7    81.7%

Operating income:
Retail                                92.6    13.7%       86.3    13.9%          291.5    14.5%         277.0    14.9%
Franchise                             41.6     6.2%       36.3     5.8%          116.7     5.8%         103.0     5.5%
Manufacturing / Wholesale             28.4     4.2%       26.5     4.3%           76.9     3.8%          73.2     3.9%
Unallocated corporate and
other costs:
Warehousing and
distribution costs                  (17.5)    -2.6%     (16.2)    -2.7%         (50.7)    -2.5%        (47.6)    -2.5%
Corporate costs                     (19.1)    -2.8%     (20.8)    -3.3%         (60.2)    -3.0%        (63.7)    -3.4%
Transaction related costs                -     0.0%      (0.9)    -0.1%              -     0.0%         (1.6)    -0.1%
Subtotal unallocated
corporate and other costs,
net                                 (36.6)    -5.4%     (37.9)    -6.1%        (110.9)    -5.5%       (112.9)    -6.0%
Total operating income               126.0    18.7%      111.2    17.9%          374.2    18.6%         340.3    18.3%
Interest expense, net                 11.3                12.1                    33.4                   32.9
Income before income taxes           114.7                99.1                   340.8                  307.4
Income tax expense                    41.7                36.9                   123.4                  114.6
Net income                    $       73.0             $  62.2             $     217.4             $    192.8

Note: The numbers in the above table have been rounded to millions. All calculations related to the Results of Operations for the year-over-year comparisons were derived from unrounded data and could occasionally differ immaterially if you were to use the table above for these calculations.


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Comparison of the Three Months Ended September 30, 2013 and 2012

Revenues

Our consolidated net revenues increased $54.0 million, or 8.7%, to $675.6 million for the three months ended September 30, 2013 compared to $621.6 million for the same period in 2012. The increase was the result of increased sales in each of our segments.

Retail. Revenue in our Retail segment increased $42.3 million, or 9.5%, to $487.3 million for the three months ended September 30, 2013 compared to $445.0 million for the same period in 2012. Domestic retail revenue increased $38.3 million due to the opening of new stores, which accounted for approximately $10.8 million of the increase, and a 6.7% increase in our same store sales, which includes an increase in sales from GNC.com of $7.7 million, or 31.7%, to $31.9 million for the three months ended September 30, 2013, compared to $24.2 million for the same period in 2012. The nationwide rollout of Member Pricing included the giveaway of free Gold Cards, which negatively impacted same store sales. In addition, sales from LuckyVitamin.com contributed $2.0 million to the increase in revenue. Canadian sales increased by $2.0 million in U.S. dollars for the three months ended September 30, 2013 compared to the same period in 2012. Our company-owned store base increased by 143 domestic stores to 3,129 at September 30, 2013 compared to 2,986 at September 30, 2012, due to new store openings and franchise store acquisitions. Our Canadian store base increased by five stores to 170 at September 30, 2013 compared to 165 at September 30, 2012.

Franchise. Revenues in our Franchise segment increased $10.1 million, or 9.3%, to $118.9 million for the three months ended September 30, 2013 compared to $108.8 million for the same period in 2012. Domestic franchise revenues increased $6.2 million primarily due to higher product sales. Our domestic franchise same store sales increased by 5.9% for the three months ended September 30, 2013 compared to the same period in 2012. There were 984 domestic franchise stores at September 30, 2013 compared to 935 stores at September 30, 2012. International revenue increased by $3.9 million, or 8.2%, for the three months ended September 30, 2013, compared to the same period in 2012, primarily as a result of higher product sales. Our franchisees have reported an 11.6% same store sales increase this year, on a local currency basis. Our international franchise store base increased by 244 stores to 1,955 at September 30, 2013 compared to 1,711 at September 30, 2012.

Manufacturing/Wholesale. Revenues in our Manufacturing/Wholesale segment, which includes third-party sales from our manufacturing facilities in South Carolina, as well as wholesale sales to Rite Aid, PetSmart, Sam's Club and www.drugstore.com, increased $1.6 million, or 2.4%, to $69.4 million for the three months ended September 30, 2013 compared to $67.8 million for the same period in 2012. For the three months ended September 30, 2013, third party contract manufacturing sales from our South Carolina manufacturing plant increased by $3.2 million, or 9.2%, compared to the same period in 2012. Wholesale revenue decreased $1.5 million, or 4.6%, due to timing of purchase orders and shipments with key wholesale customers.

Cost of Sales

Cost of sales, which includes product costs, costs of warehousing and distribution and occupancy costs, increased $35.2 million, or 9.1%, to $421.6 million for the three months ended September 30, 2013 compared to $386.4 million for the same period in 2012. Cost of sales, as a percentage of net revenue, was 62.4% and 62.2% for the three months ended September 30, 2013 and 2012, respectively. The higher cost of sales percentage for the three months ended September 30, 2013 was due to planned pricing investments with the rollout of Member Pricing.

Selling, General and Administrative ("SG&A") Expenses

SG&A expenses, including compensation and related benefits, advertising and promotion expense, other SG&A expenses including amortization expense and transaction related costs, increased $4.0 million, or 3.2%, to $128.0 million for the three months ended September 30, 2013 compared to $124.0 million for the same period in 2012. These expenses, as a percentage of net revenue, were 18.9% for the three months ended September 30, 2013 compared to 20.0% for the three months ended September 30, 2012.

Compensation and related benefits. Compensation and related benefits increased $0.6 million, or 0.7%, to $79.3 million for the three months ended September 30, 2013 compared to $78.7 million for the same period in 2012. The increase in compensation and related benefits was primarily due to support for our increased store base and sales volume.

Advertising and promotion. Advertising and promotion expenses increased $1.0 million, or 6.7%, to $16.7 million for the three months ended September 30, 2013 compared to $15.7 million for the same period in 2012. Advertising expense, as a percentage of net revenue, was 2.5% for both the three months ended September 30, 2013 and 2012.


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Other SG&A. Other SG&A expenses, including amortization expense, increased $3.3 million, or 11.3%, to $32.0 million for the three months ended September 30, 2013 compared to $28.7 million for the same period in 2012. This increase was to support increased sales in each of our segments.

Transaction related costs. We did not incur any transaction related costs for the three months ended September 30, 2013. For the three months ended September 30, 2012, we incurred $0.9 million related to the August 2012 offering and the Incremental Term Loan.

Operating Income

As a result of the foregoing, consolidated operating income increased $14.8 million, or 13.3%, to $126.0 million for the three months ended September 30, 2013 compared to $111.2 million for the same period in 2012. Operating income, as a percentage of net revenue, was 18.6% and 17.9% for the three months ended September 30, 2013 and 2012, respectively.

Retail. Operating income increased $6.3 million, or 7.3%, to $92.6 million for the three months ended September 30, 2013 compared to $86.3 million for the same period in 2012. The increase in operating income was driven by the same store sales increase offset by planned investments in marketing and pricing with the nationwide rollout of Member Pricing.

Franchise. Operating income increased $5.3 million, or 14.6%, to $41.6 million for the three months ended September 30, 2013 compared to $36.3 million for the same period in 2012. The increase was due to increased wholesale product sales and royalty income.

Manufacturing/Wholesale. Operating income increased $1.9 million, or 7.5%, to . . .

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