**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 THESECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended **September 30, 2010**

 

[    ]              TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

 

For the transition period from                    to                     .

 

Commission File Number: **333-144396**

 

**GENERAL NUTRITION CENTERS, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                             | ** ** | **72-1575168**      |
|------------------------------------------|------------|---------------------|
| (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**

 

 Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.     [ ** ** ] Yes [ **X** ] No

 

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

 

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, a non-accelerated filer or a smallerreporting 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 [  ]       Accelerated filer  [   ]      Non-accelerated filer[ **X** ]     Smallerreporting company [  ]

 

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

 

Asof November 4, 2010, 100 shares of common stock, par value $0.01 per share(the “Common Stock”), of General Nutrition Centers, Inc. wereoutstanding.  All shares of our CommonStock are held by GNC Corporation.

 

----

 

**TABLE OF CONTENTS**

 
| ** **            |                                                                                                                                                 | **PAGE** |
|-----------------------|------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| ** **            | ** **                                                                                                                                           |     |
| ** **            | **PART I - FINANCIAL INFORMATION**                                                                                                              |     |
| ** **            | ** **                                                                                                                                           |     |
| **Explanatory Note.** |                                                                                                                                                 |
| ** **            | ** **                                                                                                                                           |     |
| **Item 1.**           | **Financial Statements.**                                                                                                                            |     |
|                  |                                                                                                                                                 |     |
|                  | Consolidated  Balance Sheets as of September 30, 2010 (unaudited) and  December 31, 2009.                                                  | 1        |
|                  |                                                                                                                                                 |     |
|                  | Unaudited  Consolidated Statements of Operations for the three and nine months ended  September 30, 2010 and 2009.                                   | 2        |
|                  |                                                                                                                                                 |     |
|                  | Unaudited Consolidated Statement of Stockholder’s  Equity and Comprehensive Income for the nine months ended September 30,  2010 and 2009. | 3        |
|                  |                                                                                                                                                 |     |
|                  | Unaudited Consolidated Statements of Cash Flows for  the nine months ended September 30, 2010 and 2009.                                         | 4        |
|                  |                                                                                                                                                 |     |
|                  | Summarized Notes to Unaudited Consolidated Financial  Statements.                                                                                    | 5        |
|                  |                                                                                                                                                 |     |
| **Item 2.**           | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations.**                                                     | 26       |
|                  |                                                                                                                                                 |     |
| **Item 3.**           | **Quantitative  and Qualitative Disclosures About Market Risk.**                                                                                     | 38       |
|                  |                                                                                                                                                 |     |
| **Item 4.**           | **Controls and  Procedures.**                                                                                                                        | 39       |
| ** **            | ** **                                                                                                                                           |     |
|                  |                                                                                                                                                 |     |
| ** **            | **PART II  - OTHER INFORMATION**                                                                                                                |     |
|                  |                                                                                                                                                 |     |
| **Item 1.**           | **Legal Proceedings.**                                                                                                                               | 40       |
|                  |                                                                                                                                                 |     |
| **Item 1A.**          | **Risk Factors.**                                                                                                                                    | 40       |
|                  |                                                                                                                                                 |     |
| **Item 2.**           | **Unregistered  Sales of Equity Securities and Use of Proceeds.**                                                                                    | 40       |
|                  |                                                                                                                                                 |     |
| **Item 3.**           | **Defaults Upon  Senior Securities.**                                                                                                                | 40       |
|                  |                                                                                                                                                 |     |
| **Item 4.**           | **Removed and Reserved.**                                                                                                                            | 40       |
|                  |                                                                                                                                                 |     |
| **Item 5.**           | **Other Information.**                                                                                                                               | 40       |
|                  |                                                                                                                                                 |     |
| **Item 6.**           | **Exhibits.**                                                                                                                                        | 40       |
|                  |                                                                                                                                                 |     |
| **Signatures**        | 41                                                                                                                                                   |
|                       |                                                                                                                                                      |          |  |

 

----

 

**PART I - FINANCIAL INFORMATION**

**Item 1. Financial Statements.**

 

**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**Consolidated BalanceSheets**

**(in thousands, except share data)**

 

 
| ** **                                                                                 | ** ** | **September 30,** | ** ** | ** ** | **December 31,** | ** **    | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------|------------|------------|-----------------------|---------------|------------|
| ** **                                                                                 | ** ** | **2010**               | ** ** | ** ** | **2009 ***       | ** **    | ** ** |
| **Current assets:**                                                                   | ** ** | **(unaudited)**        | ** ** | ** ** | ** **            | ** **    | ** ** |
| Cash and cash equivalents                                                                  |       |   $          | 121,704    |       |                  |   $ | 75,089     |   |   |
| Receivables, net                                                                           |       | 105,781                |       |       | 94,355                |          |       |
| Inventories, net (Note 3)                                                                  |       | 396,788                |       |       | 370,492               |          |       |
| Prepaids and other current assets                                                          |       | 33,639                 |       |       | 42,219                |          |       |
| Total current assets                                                                       |       | 657,912                |       |       | 582,155               |          |       |
|                                                                                       |       |                   |       |       |                  |          |       |
| Long-term assets:                                                                          |       |                   |       |       |                  |          |       |
| Goodw ill (Note 4)                                                                         |       | 624,920                |       |       | 624,753               |          |       |
| Brands (Note 4)                                                                            |       | 720,000                |       |       | 720,000               |          |       |
| Other intangible assets, net (Note 4)                                                      |       | 148,873                |       |       | 154,370               |          |       |
| Property, plant and equipment, net                                                         |       | 192,816                |       |       | 199,581               |          |       |
| Deferred financing fees, net                                                               |       | 15,216                 |       |       | 18,411                |          |       |
| Other long-term assets                                                                     |       | 4,781                  |       |       | 4,332                 |          |       |
| Total long-term assets                                                                     |       | 1,706,606              |       |       | 1,721,447             |          |       |
|                                                                                       |       |                   |       |       |                  |          |       |
| Total assets                                                                               |       |   $          | 2,364,518  |       |                  |   $ | 2,303,602  |   |   |
|                                                                                       |       |                   |       |       |                  |          |       |
| Current liabilities:                                                                       |       |                   |       |       |                  |          |       |
| Accounts payable                                                                           |       |   $          | 99,380     |       |                  |   $ | 95,904     |   |   |
| Accrued payroll and related liabilities                                                    |       | 26,918                 |       |       | 22,277                |          |       |
| Accrued interest (Note 5)                                                                  |       | 5,576                  |       |       | 14,552                |          |       |
| Current portion, long-term debt (Note 5)                                                   |       | 1,565                  |       |       | 1,724                 |          |       |
| Deferred revenue and other current liabilities                                             |       | 77,905                 |       |       | 65,130                |          |       |
| Total current liabilities                                                                  |       | 211,344                |       |       | 199,587               |          |       |
|                                                                                       |       |                   |       |       |                  |          |       |
| Long-term liabilities:                                                                     |       |                   |       |       |                  |          |       |
| Long-term debt (Note 5)                                                                    |       | 1,057,208              |       |       | 1,058,085             |          |       |
| Deferred tax liabilities, net                                                              |       | 291,798                |       |       | 288,894               |          |       |
| Other long-term liabilities                                                                |       | 31,425                 |       |       | 39,520                |          |       |
| Total long-term liabilities                                                                |       | 1,380,431              |       |       | 1,386,499             |          |       |
|                                                                                       |       |                   |       |       |                  |          |       |
| Total liabilities                                                                          |       | 1,591,775              |       |       | 1,586,086             |          |       |
|                                                                                       |       |                   |       |       |                  |          |       |
| Stockholder's equity:                                                                      |       |                   |       |       |                  |          |       |
| Common stock, $0.01 par value, 1,000 shares authorized, 100  shares issued and outstanding |       |                   |       |       |                  |          |       |
| Paid-in-capital                                                                            |       | 597,308                |       |       | 594,932               |          |       |
| Retained earnings                                                                          |       | 179,744                |       |       | 129,783               |          |       |
| Accumulated other comprehensive loss                                                       |       | (4,309                 | )          |       | (7,199                | )             |       |
| Total stockholder's equity                                                                 |       | 772,743                |       |       | 717,516               |          |       |
|                                                                                       |       |                   |       |       |                  |          |       |
| Total liabilities and stockholder's equity                                                 |       |   $          | 2,364,518  |       |                  |   $ | 2,303,602  |   |   |

 

*Footnotes summarized from the Audited Financial Statements

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

1

----

 

**GENERAL NUTRITION CENTERS, INC. AND SUBSIDIARIES**

**ConsolidatedStatements of Operations**

**(unaudited)**

**(in thousands)**

 

 
|                                                                       | ** ** | **Three  months ended** | ** ** | ** ** | **Nine  months ended** | ** **    |
|----------------------------------------------------------------------------|------------|-------------------------|------------|------------|------------------------|---------------|
|                                                                       | ** ** | **September  30,**      | ** ** | ** ** | **September  30,**     | ** **    | ** ** | **September  30,** | ** ** | ** ** | **September  30,** | ** ** |
|                                                                       | ** ** | **2010**                | ** ** | ** ** | **2009**               | ** **    | ** ** | **2010** | ** ** | ** ** | **2009** | ** ** |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
| Revenue                                                                    |       |   $           | 465,746    |       |                   |   $ | 430,798 |   |   |   $ | 1,386,669 |   |   |   $ | 1,303,111   |   |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
| Cost of sales, including costs of warehousing, distribution and  occupancy |       | 302,667                 |       |       | 282,606                |          |   | 894,035 |   |   | 849,241   |   |
| Gross profit                                                               |       | 163,079                 |       |       | 148,192                |          |   | 492,634 |   |   | 453,870   |   |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
| Compensation and related benefits                                          |       | 69,174                  |       |       | 65,470                 |          |   | 204,566 |   |   | 196,321   |   |
| Advertising and promotion                                                  |       | 10,643                  |       |       | 11,043                 |          |   | 40,219 |   |   | 40,177   |   |
| Other selling, general and administrative                                  |       | 24,115                  |       |       | 24,272                 |          |   | 74,373 |   |   | 74,006   |   |
| Foreign currency (gain) loss                                               |       | (92                     | )          |       | 6                      |          |   | (149 | ) |   | (27)  |   |
| Operating income                                                           |       | 59,239                  |       |       | 47,401                 |          |   | 173,625 |   |   | 143,393   |   |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
| Interest expense, net (Note 5)                                             |       | 16,340                  |       |       | 16,874                 |          |   | 49,286 |   |   | 53,017   |   |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
| Income before income taxes                                                 |       | 42,899                  |       |       | 30,527                 |          |   | 124,339 |   |   | 90,376   |   |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
| Income tax expense (Note 11)                                               |       | 16,114                  |       |       | 11,002                 |          |   | 45,994 |   |   | 33,440   |   |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
|                                                                       |       |                    |       |       |                   |          |   |   |   |   |   |   |
| Net income                                                                 |       |   $           | 26,785     |       |                   |   $ | 19,525 |   |   |   $ | 78,345 |   |   |   $ | 56,936   |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

2

----

 

 

 

**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**Consolidated Statementof Stockholder’s Equity and Comprehensive Income**

**(in thousands, except share data)**

 
| ** **                                                                                              | ** **   | **Common Stock** | ** **   | ** **  | ** **   | **Retained**        | ** **   | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholder’s** | ** **        |
|---------------------------------------------------------------------------------------------------------|--------------|-----------------------|--------------|-------------|--------------|---------------------|--------------|---------------------------------------|------------|-------------------------------|-------------------|
| ** **                                                                                              | ** **   | **Shares**            | ** **   | **Dollars** | ** **   | **Paid-in-Capital** | ** **   | **Earnings**                          | ** ** | **Income/(Loss)**             | ** **        | **Equity** | ** ** |
| ** **                                                                                              | ** **   | ** **            | ** **   | ** **  | ** **   | ** **          | ** **   | ** **                            | ** ** | ** **                    | ** **        | ** ** | ** ** |
| ** **                                                                                              | ** **   | ** **            | ** **   | ** **  | ** **   | ** **          | ** **   | ** **                            | ** ** | ** **                    | ** **        | ** ** | ** ** |
| **Balance at December 31, 2009**                                                                   | ** **   | **100**               | ** **   | **$**       | **-**        | ** **          | **$**        | **594,932 **                     | ** ** | **$**                         | **129,783**       | ** ** | **$** | **(7,199)** | ** ** | **$** | **717,516 ** | ** ** |
|                                                                                                    |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| *Comprehensive income:*                                                                                 |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| Net income                                                                                              | ** **   | **-**                 |         | -           |         | -              |         | 78,345                                |       | -                        |              | 78,345  |   |
| Unrealized gain on derivatives designated and qualified  as cash flow hedges, net of tax of $1,367 |         | -                     |         | -           |         | -              |         | -                                |       | 2,389                    |              | 2,389  |   |
| Foreign currency translation adjustments                                                                | ** **   | -                     | ** **   | -           | ** **   | -              | ** **   | -                                |       | 501                      |              | 501  |   |
| *Comprehensive income*                                                                                  | *** *** |                  | *** *** |        | *** *** |                | *** *** |                                  |       |                          | * *          | *81,235 * | * * |
|                                                                                                    |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| Non-cash stock-based compensation                                                                       | ** **   | -                     |         | -           |         | 2,376          |         | -                                |       | -                        |              | 2,376  |   |
| Dividend payment                                                                                        | ** **   | -                     |         | -           |         | -              |         | (28,384)                              |       | -                        |              | (28,384) |   |
|                                                                                                    |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| **Balance at September 30, 2010  (unaudited)**                                                     | ** **   | **100**               | ** **   | **$**       | **-**        | ** **          | **$**        | **597,308 **                     | ** ** | **$**                         | **179,744 ** | ** ** | **$** | **(4,309)** | ** ** | **$** | **772,743 ** | ** ** |
| ** **                                                                                              | ** **   | ** **            | ** **   | ** **  | ** **   | ** **          | ** **   | ** **                            | ** ** | ** **                    | ** **        | ** ** | ** ** |
| ** **                                                                                              | ** **   | ** **            | ** **   | ** **  | ** **   | ** **          | ** **   | ** **                            | ** ** | ** **                    | ** **        | ** ** | ** ** |
| **Balance at December 31, 2008**                                                                   | ** **   | **100**               | ** **   | **$**       | **-**        | ** **          | **$**        | **592,355 **                     | ** ** | **$**                         | **73,764 **  | ** ** | **$** | **(14,057)** | ** ** | **$** | **652,062 ** | ** ** |
|                                                                                                    |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| *Comprehensive income:*                                                                                 |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| Net income                                                                                              | ** **   | -                     |         | -           |         | -              |         | 56,936                           |       | -                        |              | 56,936  |   |
| Unrealized gain on derivatives designated and qualified  as cash flow hedges, net of tax of $753   |         | -                     |         | -           |         | -              |         | -                                |       | 1,316                    |              | 1,316  |   |
| Foreign currency translation adjustments                                                                | ** **   | -                     | ** **   | -           | ** **   | -              | ** **   | -                                |       | 3,451                    |              | 3,451  |   |
| *Comprehensive income*                                                                                  | *** *** |                  | *** *** |        | *** *** |                | *** *** |                                  |       |                          | * *          | *61,703 * | * * |
|                                                                                                    |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| Return of capital to GNC Corporation                                                                    | ** **   | -                     |         | -           |         | (278)               |         | -                                |       | -                        |              | (278) |   |
| Non-cash stock-based compensation                                                                       | ** **   | -                     |         | -           |         | 2,062          |         | -                                |       | -                        |              | 2,062  |   |
| Dividend payment                                                                                        | ** **   | -                     |         | -           |         | -              |         | (13,600)                              |       | -                        |              | (13,600) |   |
|                                                                                                    |         |                  |         |        |         |                |         |                                  |       |                          |              |   |   |
| **Balance at September 30, 2009  (unaudited)**                                                     | ** **   | **100**               | ** **   | **$**       | **-**        | ** **          | **$**        | **594,139 **                     | ** ** | **$**                         | **117,100 ** | ** ** | **$** | **(9,290)** | ** ** | **$** | **701,949 ** | ** ** |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

3

----

 

**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**ConsolidatedStatements of Cash Flows**

**(unaudited)**

**(in thousands)**

 
| ** **                                                                         | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,  2010**    | ** ** | **September 30,  2009** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          |       |                            |       |   |   |
| Net income                                                                         |       | $                               | 78,345     |   | $ | 56,936 |   |
|                                                                               |       |                            |       |   |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                            |       |   |   |
| Depreciation expense                                                               |       | 27,939                          |       | 27,327 |   |
| Amortization of intangible assets                                                  |       | 5,914                           |       | 7,308 |   |
| Amortization of deferred financing fees                                            |       | 3,195                           |       | 3,053 |   |
| Amortization of original issue discount                                            |       | 304                             |       | 277 |   |
| Increase in provision for inventory losses                                         |       | 10,877                          |       | 8,278 |   |
| Non-cash stock-based compensation                                                  |       | 2,376                           |       | 2,062 |   |
| Decrease in provision for losses on accounts receivable                            |       | (858)                           |       | (2,173) |   |
| Decrease (increase) in net deferred taxes                                          |       | (1,381)                         |       | 10,970 |   |
|                                                                               |       |                            |       |   |   |
| Changes in assets and liabilities:                                                 |       |                            |       |   |   |
| Increase in receivables                                                            |       | (10,707)                        |       | (6,762) |   |
| Increase in inventory, net                                                         |       | (36,770)                        |       | (19,298) |   |
| Increase in franchise note receivables, net                                        |       | (392)                           |       | (31) |   |
| Increase in accrued income taxes                                                   |       | 11,525                          |       | 8,928 |   |
| Decrease in other assets                                                           |       | 1,429                           |       | 7,486 |   |
| Increase (decrease) in accounts payable                                            |       | 3,398                           |       | (21,025) |   |
| Decrease in interest payable                                                       |       | (8,976)                         |       | (9,475) |   |
| Increase in accrued liabilities                                                    |       | 11,336                          |       | 3,987 |   |
| **Net cash provided by operating activities**                                      |       | 97,554                          |       | 77,848 |   |
| ** **                                                                         |       |                            |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          |       |                            |       |   |   |
| Capital expenditures                                                               |       | (20,969)                        |       | (20,448) |   |
| Franchise store conversions                                                        |       | 67                              |       | 231 |   |
| Store acquisition costs                                                            |       | (345)                           |       | (1,791) |   |
| **Net cash used in investing activities**                                          |       | (21,247)                        |       | (22,008) |   |
| ** **                                                                         |       |                            |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          |       |                            |       |   |   |
| Return of capital to Parent company                                                |       | -                               |       | (278) |   |
| Dividend payment                                                                   |       | (28,384)                        |       | (13,600) |   |
| Debt financing fees                                                                |       | -                               |       | (45) |   |
| Payments on long-term debt                                                         |       | (1,341)                         |       | (19,973) |   |
| **Net cash used in financing activities**                                          |       | (29,725)                        |       | (33,896) |   |
|                                                                               |       |                            |       |   |   |
| Effect of exchange rate on cash                                                    |       | 33                              |       | 308 |   |
| Net increase in cash                                                               |       | 46,615                          |       | 22,252 |   |
| Beginning balance, cash                                                            |       | 75,089                          |       | 42,307 |   |
| Ending balance, cash                                                               |       | $                               | 121,704    |   | $ | 64,559 |   |

 

The accompanying notes are an integral part of theconsolidated financial statements.

 

4

----

 

**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIALSTATEMENTS (UNAUDITED)**

 

**NOTE 1. NATURE OF BUSINESS**

 

***GeneralNature of Business****.* General Nutrition Centers, Inc. (“GNC” or the “Company”),a Delaware corporation, is a leading specialty retailer of nutritionalsupplements, which include: vitamins, minerals and herbal supplements (“VMHS”),sports nutrition products, diet products and other wellness products.

 

The Company’sorganizational structure is vertically integrated as the operations consist ofpurchasing raw materials, formulating and manufacturing products and sellingthe finished products through its retail, franchising andmanufacturing/wholesale segments. The Company operates primarily in threebusiness segments: Retail, Franchising, and Manufacturing/Wholesale.  Corporate retail store operations are locatedin North America and Puerto Rico and in addition the Company offers productsdomestically through www.gnc.com. Franchise stores are physically located in the United States and 45international countries. The Company operates its primary manufacturingfacilities in South Carolina and distribution centers in Arizona, Pennsylvaniaand South Carolina.  The Companymanufactures the majority of its branded products, but also merchandisesvarious third-party products. Additionally, the Company licenses the use of itstrademarks and trade names.

 

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

 

***Mergerof the Company.*** On February 8, 2007, GNC Parent Corporation enteredinto an Agreement and Plan of Merger with GNC Acquisition Inc. and its parentcompany, GNC Acquisition Holdings Inc. (“Parent”), pursuant to which GNCAcquisition Inc. agreed to merge with and into GNC Parent Corporation, with GNCParent Corporation as the surviving corporation and a wholly owned subsidiaryof Parent (the “Merger”).  Immediatelyfollowing the Merger, GNC Parent Corporation was converted into a Delawarelimited liability company and renamed GNC Parent LLC.  The purchase equity contribution was made byAres Corporate Opportunities Fund II, L.P. (“ACOF”) and Ontario Teachers’Pension Plan Board (“OTPP”) (collectively, the “Sponsors”), together withadditional institutional investors and certain management of the Company.  The transaction closed on March 16, 2007and was accounted for under the purchase method of accounting.  The transaction occurred between unrelatedparties and no common control existed. The Merger consideration (excluding acquisition costs of $13.7 million)totaled $1.65 billion, including the repayment of existing debt and otherliabilities, and was funded with a combination of equity contributions and theissuance of new debt.  The Mergeragreement requires payments to former shareholders and option holders in lieuof income tax payments made for utilizing net operating losses created as aresult of the Merger.  No such paymentswere made during the nine months ended September 30, 2010 or September 30,2009.

 

5

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**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

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

 

Theaccompanying unaudited consolidated financial statements and footnotes havebeen prepared by the Company in accordance with accounting principles generallyaccepted in the United States of America (“U.S. GAAP”) and with theinstructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of theinformation and related footnotes that would normally be required by U.S. GAAP forcomplete financial reporting.  Theseunaudited consolidated financial statements should be read in conjunction withthe Company’s audited consolidated financial statements in the Company’s AnnualReport on Form 10-K filed for the year ended December 31, 2009 (the “Form 10-K”).  The Company’s reporting period is based on acalendar year.

 

The accountingpolicies of the Company are consistent with the policies disclosed in theCompany’s audited financial statements for the year ended December 31,2009.  There have been no materialchanges to the application of critical accounting policies and significantjudgments and estimates since December 31, 2009.

 

Theaccompanying unaudited consolidated financial statements include alladjustments (consisting of a normal and recurring nature) that managementconsiders necessary for a fair statement of financial information for theinterim periods.  Interim results are notnecessarily indicative of the results that may be expected for the remainder ofthe year ending December 31, 2010.

 

***Principlesof Consolidation.*** The consolidated financial statements include the accountsof the Company, all of its subsidiaries and a variable interest entity.  All material intercompany transactions havebeen eliminated in consolidation.

 

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

 

***Useof Estimates****.* The preparation offinancial statements in conformity with U.S. GAAP requires management to makeestimates and assumptions. Accordingly, these estimates and assumptions affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements, and thereported amounts of revenues and expenses during the reporting period.  Some of the most significant estimatespertaining to the Company include the valuation of inventories, the allowancefor doubtful accounts, income tax valuation allowances and the recoverabilityof long-lived assets.  On a regularbasis, management reviews its estimates utilizing currently availableinformation, changes in facts and circumstances, historical experience andreasonable assumptions.  After suchreviews and if deemed appropriate, those estimates are adjusted accordingly.  Actual results could differ from thoseestimates.

 

***Cashand Cash Equivalents*****.**The Company considers cash and cash equivalents to includeall cash and liquid deposits and investments with a maturity of three months orless.  The majority of payments due frombanks for third-party credit cards process within 24-48 hours, except fortransactions occurring on a Friday, which are generally processed the followingMonday. All credit card transactions are classified as cash, and the amountsdue from these transactions totaled $2.1 million at both September 30,2010 and December 31, 2009.

 

Bookoverdrafts of $9.8 million and $0.7 million as of September 30, 2010 and December 31,2009, respectively, represent checks issued that had not been presented forpayment to the banks and are classified as accounts payable in the Company’sconsolidated balance sheet.  The Companytypically funds these overdrafts through normal collections of funds ortransfers from bank balances at other financial institutions.  Under the terms of the Company’s facilitieswith its banks, the respective financial institutions are not obligated tohonor the book overdraft balances as of September 30, 2010 and December 31,2009, or any balance on any given date.

 

6

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**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

***FinancialInstruments and Derivatives*****.** As part of theCompany’s financial risk management program, it uses certain derivativefinancial instruments.  The Company doesnot enter into derivative transactions for speculative purposes and holds noderivative instruments for trading purposes. The Company uses derivative financial instruments to reduce its exposureto market risk for changes in interest rates primarily in respect to its longterm debt obligations.  The Company triesto manage its interest rate risk in order to balance its exposure to both fixedand floating rates while minimizing its borrowing costs.  Floating-to-fixedinterest rate swap agreements, designated as cash flow hedges of interest raterisk, are entered into from time to time to hedge the Company’s exposure tointerest rate changes on a portion of the Company’s floating rate debt. Theseinterest rate swap agreements convert a portion of its floating rate debt tofixed rate debt. Interest rate floors designated as cash flow hedges involvethe receipt of variable-rate amounts from a counterparty if interest rates fallbelow the strike rate on the contract in exchange for an upfront premium. The Companyrecords the fair value of these contracts as an asset or a liability, asapplicable, in the balance sheet.  Theeffective portions of changes in the fair value of derivatives designated andthat qualify as cash flow hedges are recorded in accumulated othercomprehensive income, net of tax.  Theineffective portions, if any, are recorded in interest expense in the currentperiod. As of September 30, 2010, the Company has not recorded any hedgeineffectiveness in earnings related to its cash flow hedges.

 

Derivativesdesignated as hedging instruments have been recorded in the consolidatedbalance sheet at fair value as follows:

 
| ** **              | ** ** | ** **                           | ** ** | **Fair Value**              | ** ** |
|-------------------------|------------|--------------------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **Balance Sheet Location** | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
| ** **              | ** ** | ** **                           | ** ** | **(unaudited)**                  | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **                           | ** ** | **(in thousands)**          | ** ** |
| Interest  Rate Products |       | Other current  liabilities           |       | $                                | (7,232)    |   | $ | - |   |
| Interest  Rate Products |       | Other  long-term liabilities         |       | $                                | (3,691)    |   | $ | (14,679) |   |

 

 

The Companyhas interest rate swap agreements outstanding that effectively convert anaggregate $550.0 million of debt from floating to fixed interest rates.  One of these agreements includes an embeddedderivative contract with a purchased interest rate floor that effectivelyconverts $150.0 million of the Senior Toggle Notes from a floating to a fixedrate. The floor is intended to replicate the optionality present in theoriginal debt agreement, providing an equivalent offset in the interestpayments. The Company did not enter into any new swap agreements during thefirst nine months of 2010. Each of the four outstanding agreements maturesbetween April 2011 and September 2012.

 

Amountsreported in accumulated other comprehensive income related to derivatives willbe reclassified to interest expense as interest payments are made on theCompany’s variable-rate debt. During the next twelve months, the Companyestimates that an additional $9.6 million will be reclassified as an increaseto interest expense.

 

7

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**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

Components of gains and lossesfor the three months ended September 30, 2010 and 2009 are as follows:

 

 
| **Derivatives in Cash  Flow Hedging  Relationships** | ** ** | **Amount of Gain or  (Loss) Recognized in  OCI on Derivative  (Effective Portion)** | ** **    | **Location of Gain or (Loss)  Reclassified from  Accumulated OCI into  Income (Effective Portion)** | ** **                 | **Amount of Gain or (Loss)  Reclassified from  Accumulated OCI into  Income (Effective Portion)** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|---------------|--------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                          | ** ** | **(unaudited)  (in thousands)**                                                                                        | ** **    | ** **                                                                                                                                       | ** **                 |
|                                                                |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| **2010**                                                            |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
|                                                                |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| Interest  Rate Products                                             |       | $                                                                                                                           |  (1,988) |                                                                                                                                             | Interest  income (expense) |                                                                                                                                           | $          |  (3,344) |   |
|                                                                |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| **2009**                                                            |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
|                                                                |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| Interest  Rate Products                                             |       | $                                                                                                                           |  (5,219) |                                                                                                                                             | Interest  income (expense) |                                                                                                                                           | $          |  (3,381) |   |

 

 

Components ofgains and losses for the nine months ended September 30, 2010 and 2009 areas follows:

 

 
| **Derivatives in Cash  Flow Hedging  Relationships** | ** ** | **Amount of Gain or  (Loss) Recognized in  OCI on Derivative  (Effective Portion)** | ** **    | **Location of Gain or (Loss)  Reclassified from  Accumulated OCI into  Income (Effective Portion)** | ** **                 | **Amount of Gain or (Loss)  Reclassified from  Accumulated OCI into  Income (Effective Portion)** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|---------------|--------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                          | ** ** | **(unaudited)  (in thousands)**                                                                                             |          |                                                                                                                                             |                       |
| ** **                                                          |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| **2010**                                                            |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
|                                                                |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| Interest  Rate Products                                             |       | $                                                                                                                           |  (7,262) |                                                                                                                                             | Interest  income (expense) |                                                                                                                                           | $          |  (11,018) |   |
|                                                                |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| **2009**                                                            |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
|                                                                |       |                                                                                                                        |          |                                                                                                                                             |                       |                                                                                                                                           |       |
| Interest  Rate Products                                             |       | $                                                                                                                           |  (6,307) |                                                                                                                                             | Interest  income (expense) |                                                                                                                                           | $          |  (8,376) |   |

 

 

Under the Company’s agreements with its derivative counterparty, if theCompany defaults on any of its indebtedness, including default whererepayment of the indebtedness has not been accelerated by thelender, then the Company could also be declared in default on itsderivative obligations.

 

As of September 30,2010, the settlement value of derivatives in a net liability position relatedto these agreements was $13.5 million, including accrued interest of $2.2million but excluding adjustments for nonperformance risk.

 

8

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**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

**Recently Issued Accounting Pronouncements**

 

As of September 30, 2010, there were no developmentsrelated to recently issued accounting standards, including the expected datesof adoption and estimated effects on the Company’s consolidated financialstatements, in addition to those disclosed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009.

 

 

**NOTE 3. INVENTORIES, NET**

 

 

Inventories at each respective periodconsisted of the following:

 
| ** **                                       | ** ** | **September 30, 2010** | ** **    |
|--------------------------------------------------|------------|----------------------------------|---------------|
|                                             |       |                             |          |   | ** ** | **Net Carrying** | ** ** |
|                                             | ** ** | **Gross cost**                   | ** **    | **Reserves (a)** | ** ** | **Value** | ** ** |
|                                             |       |                             | ** **    | **(unaudited)** |   |   |   |
|                                             |       |                             | ** **    | **(in thousands)** |   |   |   |
| Finished  product ready for sale                 |       | $                                |  331,179 |   | $ |  (8,293) |   | $ |  322,886 |   |
| Work-in-process,  bulk product and raw materials |       | 68,827                           |          | (1,471) |   | 67,356 |   |
| Packaging  supplies                              |       | 6,546                            |          | -  |   | 6,546 |   |
|                                             |       | $                                |  406,552 |   | $ |  (9,764) |   | $ |  396,788 |   |
|                                             |       |                             |          |   |   |   |   |
|                                             |       | ** **                       |          |
|                                             |       | **December 31, 2009**       |          |
|                                             |       |                             |          |   | ** ** | **Net Carrying** | ** ** |
|                                             | ** ** | **Gross cost**                   | ** **    | **Reserves (a)** | ** ** | **Value** | ** ** |
|                                             |       |                             | ** **    | **(in thousands)** |   |   |   |
| Finished  product ready for sale                 |       | $                                |  319,688 |   | $ |  (8,266) |   | $ |  311,422 |   |
| Work-in-process,  bulk product and raw materials |       | 54,803                           |          | (1,288) |   | 53,515 |   |
| Packaging  supplies                              |       | 5,555                            |          | -  |   | 5,555 |   |
|                                             |       | $                                |  380,046 |   | $ |  (9,554) |   | $ |  370,492 |   |

 

(a)   Reservesprimarily consist of amounts recorded for obsolescence.

 

**NOTE 4. GOODWILL AND INTANGIBLE ASSETS, NET**

 

Goodwillrepresents the excess of purchase price over the fair value of identifiable netassets of acquired entities.  Inaccordance with the standard on intangibles and goodwill, goodwill andintangible assets with indefinite useful lives are not amortized, but insteadare tested for impairment at least annually. Other intangible assets with finite lives are amortized on astraight-line or declining balance basis over periods not exceeding 35 years.

 

For the ninemonths ended September 30, 2010, the Company acquired 17 franchisestores.  These acquisitions wereaccounted for utilizing the acquisition method of accounting and the Companyrecorded the acquired inventory, fixed assets, franchise rights and goodwill,with an applicable reduction to receivables and cash. The total purchase priceassociated with these acquisitions was $1.4 million, of which $0.3 million waspaid in cash.

 

9

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**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

The followingtable summarizes the Company’s goodwill activity from December 31, 2009 toSeptember 30, 2010:

 
| ** **                                      | ** ** | **Retail** | ** **    | **Franchising**         | ** ** | **Manufacturing/  Wholesale** | ** ** | **Total** | ** **    |
|-------------------------------------------------|------------|------------|---------------|-------------------------|------------|-------------------------------|------------|-----------|---------------|
| ** **                                      | ** ** | ** ** | ** **    | **(in thousands)** | ** ** | ** **                    | ** ** |
| Balance  at December 31, 2009              |       | $          |  304,609 |                    | $          |  117,303                 |       | $         |  202,841 |   | $ |  624,753 |   |
| Acquired  franchise stores                      |       | 167        |          | -                       |       | -                             |       | 167       |          |
| Balance  at September 30, 2010 (unaudited) |       | $          |  304,776 |                    | $          |  117,303                 |       | $         |  202,841 |   | $ |  624,920 |   |

 

 

 

The followingtable summarizes the Company’s intangible asset activity from December 31,2009 to September 30, 2010:

 

 
| ** **                                      | ** ** | ** **              | ** **      | **Retail** | ** ** | **Franchise** | ** ** | **Operating**  | ** **    | **Franchise** | ** ** | ** **          | ** ** |
|-------------------------------------------------|------------|-------------------------|-----------------|------------|------------|---------------|------------|----------------|---------------|---------------|------------|---------------------|------------|
| ** **                                      | ** ** | **Gold Card**      | ** **      | **Brand**  | ** ** | **Brand**     | ** ** | **Agreements** | ** **    | **Rights**    | ** ** | **Total**           | ** ** |
| ** **                                      | ** ** | **(in thousands)** | ** **      |
| Balance  at December 31, 2009              |       | $                       |  375  |       | $          |  500,000 |       | $              |  220,000 |          | $          |  153,076  |       | $ |  919  |   | $ |  874,370  |   |
| Acquired  franchise stores                      |       | -                  |            | -          |       | -             |       | -         |          | 417      |       | 417            |       |
| Amortization  expense                           |       | (375)                   |            | -          |       | -             |       | (5,140)        |          | (399)         |       | (5,914)             |       |
| Balance  at September 30, 2010 (unaudited) |       | $                       |  -    |       | $          |  500,000 |       | $              |  220,000 |          | $          |  147,936  |       | $ |  937  |   | $ |  868,873  |   |

 

 

The followingtable reflects the gross carrying amount and accumulated amortization for eachmajor intangible asset:

 
| ** **                | ** ** | **Estimated**     | ** ** | **September 30, 2010** | ** **    | **December 31, 2009** | ** ** |
|---------------------------|------------|-------------------|------------|----------------------------------|---------------|---------------------------------|------------|
| ** **                | ** ** | **Life**          | ** ** | ** **                       | ** **    | **Accumulated**                 | ** ** | **Carrying** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| ** **                | ** ** | **in years** | ** ** | **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 |   |
| Gold  card - retail       |       | 3                 |       | 3,500                            |          | (3,500)                         |       | - |   | 3,500 |   | (3,354) |   | 146 |   |
| Gold  card - franchise    |       | 3                 |       | 5,500                            |          | (5,500)                         |       | - |   | 5,500 |   | (5,271) |   | 229 |   |
| Retail  agreements        |       | 25-35             |       | 31,000                           |          | (3,880)                         |       | 27,120 |   | 31,000 |   | (3,090) |   | 27,910 |   |
| Franchise  agreements     |       | 25                |       | 70,000                           |          | (9,917)                         |       | 60,083 |   | 70,000 |   | (7,817) |   | 62,183 |   |
| Manufacturing  agreements |       | 25                |       | 70,000                           |          | (9,917)                         |       | 60,083 |   | 70,000 |   | (7,817) |   | 62,183 |   |
| Other  intangibles        |       | 5                 |       | 1,150                            |          | (500)                           |       | 650 |   | 1,150 |   | (350) |   | 800 |   |
| Franchise  rights         |       | 1-5               |       | 3,478                            |          | (2,541)                         |       | 937 |   | 3,061 |   | (2,142) |   | 919 |   |
|                      |       |              |       | $                                |  904,628 |                            | $          |  (35,755) |   | $ |  868,873 |   | $ |  904,211 |   | $ |  (29,841) |   | $ | 874,370 |   |

 

10

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

The following table represents future estimated amortization expense ofother intangible assets, net, with definite lives at September 30, 2010:

 
| ** **                                       | ** ** | **Estimated**      | ** ** |
|--------------------------------------------------|------------|--------------------|------------|
|                                             | ** ** | **amortization**   | ** ** |
| **   Years  ending December 31,** | ** ** | **expense**        | ** ** |
|                                             | ** ** | **(unaudited)**    | ** ** |
|                                             | ** ** | **(in thousands)** | ** ** |
|  2010                                       |       | 1,846              |       |
|  2011                                       |       | 7,266              |       |
|  2012                                       |       | 7,081              |       |
|  2013                                       |       | 6,973              |       |
|  2014                                       |       | 6,690              |       |
|  Thereafter                                 |       | 119,017            |       |
|  Total                                      |       | $                  | 148,873    |   |
|                                                  |            |                    |            |  |

 

**NOTE5.  LONG-TERM DEBT / INTEREST EXPENSE**

 

 

Long-term debt at each respective period consisted of the following:

 
|                             | ** ** | **September 30,**  | ** ** | ** ** | **December 31,** | ** ** | ** ** |
|----------------------------------|------------|--------------------|------------|------------|------------------|------------|------------|
|                             | ** ** | **2010**           | ** ** | ** ** | **2009**         | ** ** | ** ** |
|                             | ** ** | **(unaudited)**    |       |       |             |       |       |
|                             |       | **(in thousands)** |       |       |
|                             |       |               |       |       |             |       |       |
| 2007 Senior Credit Facility      |       | $                  | 644,382    |       |             | $          | 644,619    |   |   |
| Senior Toggle Notes              |       | 298,264            |       |       | 297,959          |       |       |
| 10.75% Senior Subordinated Notes |       | 110,000            |       |       | 110,000          |       |       |
| Mortgage                         |       | 6,089              |       |       | 7,184            |       |       |
| Capital leases                   |       | 38                 |       |       | 47               |       |       |
| Less: current maturities         |       | (1,565             | )          |       | (1,724           | )          |       |
| Total                            |       | $                  | 1,057,208  |       |             | $          | 1,058,085  |   |   |

 

The Company’s net interest expense for each respective period is asfollows:

 

 
|                              |   | **Three months ended** | ** **   | ** ** | **Nine months ended** |       |         |
|-----------------------------------|--------|------------------------|--------------|------------|-----------------------|------------|--------------|
|                              |   | **September 30,**      | ** **   | ** ** | **September 30,**     | ** ** | ** **   | **September 30,** | ** ** | ** ** | **September 30,** |   |   |
|                              |   | **2010**               | ** **   | ** ** | **2009**              | ** ** | ** **   | **2010** | ** ** | ** ** | **2009** |   |   |
|                              |   | **(unaudited)**        |         |       |
|                              |   | **(in thousands)**     |         |       |
|                              |   |                   |         |       |                  |       |         |   |   |   |   |   |   |
| 2007 Senior Credit Facility       |   |                   |         |       |                  |       |         |   |   |   |   |   |   |
| Term Loan                         |   | $                      |  7,241  |       |                  | $          |  7,823  |   |   | $ |  22,024 |   |   | $ |  24,971 |   |   |
| Revolver                          |   | 111                    |         |       | 113                   |       |         | 335 |   |   | 378 |   |   |
| Senior Toggle Notes               |   | 4,874                  |         |       | 4,716                 |       |         | 14,583 |   |   | 15,050 |   |   |
| 10.75% Senior Subordinated Notes  |   | 2,957                  |         |       | 2,956                 |       |         | 8,869 |   |   | 8,868 |   |   |
| Deferred financing fees           |   | 1,071                  |         |       | 1,026                 |       |         | 3,195 |   |   | 3,053 |   |   |
| Mortgage                          |   | 110                    |         |       | 135                   |       |         | 341 |   |   | 423 |   |   |
| OID amortization                  |   | 103                    |         |       | 95                    |       |         | 304 |   |   | 277 |   |   |
| Interest expense (income) - other |   | (127                   | )            |       | 10                    |       |         | (365 | ) |   | (3 | ) |   |
| Interest expense, net             |   | $                      |  16,340 |       |                  | $          |  16,874 |   |   | $ |  49,286 |   |   | $ | 53,017 |   |   |
|                                   |        |                        |              |            |                       |            |              |  |  |  |  |  |  |  |  |  |  |  |

 

11

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

Accrued interest at eachrespective period consisted of the following:

 
| ** **                       | ** ** | **September  30,** |       | **December 31,** |       |
|----------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                       | ** ** | **2010**           | ** ** | **2009**         | ** ** |
| ** **                       | ** ** | ** **         | ** ** | ** **       | ** ** |
| ** **                       | ** ** | **(unaudited)**    | ** ** | ** **       | ** ** |
| ** **                       | ** ** | ** **         | ** ** | ** **       | ** ** |
| ** **                       | ** ** | **(in thousands)** | ** ** |
| ** **                       | ** ** | ** **         | ** ** | ** **       | ** ** |
| 2007 Senior Credit Facility      |       | $                  | 4,189      |             | $          | 5,350 |   |
| Senior Toggle Notes              |       | 862                |       | 5,720            |       |
| 10.75% Senior Subordinated Notes |       | 525                |       | 3,482            |       |
| Total                            |       | $                  | 5,576      |             | $          | 14,552 |   |

 

 

Interest on the 2007 Senior Credit Facility and theSenior Toggle Notes is based on variable rates. At both September 30, 2010 and December 31, 2009 the interestrate for the 2007 Senior Credit Facility was 2.5%.  At September 30, 2010 and December 31,2009 the interest rate for the Senior Toggle Notes was 5.8%.

 

 

**NOTE6.  FINANCIAL INSTRUMENTS**

 

At September 30, 2010 and December 31,2009, the Company’s financial instruments consisted of cash and cashequivalents, receivables, franchise notes receivable, accounts payable, certainaccrued liabilities and long-term debt. The carrying amounts of cash and cashequivalents, receivables, accounts payable and accrued liabilities approximatetheir fair value because of the short maturity of these instruments.  Based on current interest rates and theirunderlying risk, the carrying value of the franchise notes receivableapproximate their fair value. These fair values are reflected net of reserves,which are recognized according to Company policy.  The Company determined the estimated fairvalues of its debt by using currently available market information andestimates and assumptions where appropriate. Accordingly, as considerable judgment is required to determine theseestimates, changes in the assumptions or methodologies may have an effect onthese estimates.  The actual andestimated fair values of the Company’s financial instruments are as follows:

 

 
|                                        | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|--------------------|------------|------------------|------------|
|                                        | ** ** | **2010**           | ** ** | **2009**         | ** ** |
|                                        | ** ** | **Carrying**       | ** ** | **Fair**         | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
|                                        | ** ** | **Amount**         | ** ** | **Value**        | ** ** | **Amount** | ** ** | **Value** | ** ** |
|                                        | ** ** | ** **         | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                        | ** ** | **(unaudited)**    | ** ** | ** **       | ** ** | ** ** | ** ** |
|                                        | ** ** | **(in thousands)** | ** ** |
| Cash and cash  equivalents                  |       | $                  | 121,704    |             | $          | 121,704 |   | $ | 75,089 |   | $ | 75,089 |   |
| Receivables                                 |       | 105,781            |       | 105,781          |       | 94,355 |   | 94,355 |   |
| Franchise notes  receivable                 |       | 3,624              |       | 3,624            |       | 3,364 |   | 3,364 |   |
| Accounts payable                            |       | 99,380             |       | 99,380           |       | 95,904 |   | 95,904 |   |
| Long term debt  (including current portion) |       | 1,058,773          |       | 1,003,307        |       | 1,059,809 |   | 977,718 |   |
|                                        |       |               |       |             |       |   |   |   |   |
|                                             |            |                    |            |                  |            |  |  |  |  |  |  |  |  |

 

12

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**NOTE 7.  COMMITMENTS AND CONTINGENCIES**

 

**Litigation**

 

The Company is engaged in various legal actions,claims and proceedings arising in the normal course of business, includingclaims related to breach of contracts, product liabilities, intellectualproperty matters and employment-related matters resulting from the Company’sbusiness activities.  As with manyactions such as these, an estimation of any possible and/or ultimate liabilitycannot always be determined.  The Companycontinues to assess the requirement to account for additional contingencies inaccordance with the standard on contingencies. An adverse outcome in these matterscould have a material impact on the Company’s financial condition and operatingresults.

 

As a manufacturer and retailerof nutritional supplements and other consumer products that are ingested byconsumers or applied to their bodies, the Company has been and is currentlysubjected to various product liability claims. Although the effects of theseclaims to date have not been material to the Company, it is possible thatcurrent and future product liability claims could have a material adverseimpact on its business or financial condition. The Company currently maintainsproduct liability insurance with a deductible/retention of $3.0 million perclaim with an aggregate cap on retained loss of $10.0 million. The Companytypically seeks and has obtained contractual indemnification from most partiesthat supply raw materials for its products or that manufacture or marketproducts it sells. The Company also typically seeks to be added, and has beenadded, as an additional insured under most of such parties’ insurancepolicies.  The Company is also entitledto indemnification by Numico for certain losses arising from claims related toproducts containing ephedra or Kava Kava sold prior to December 5, 2003.However, any such indemnification or insurance is limited by its terms and anysuch indemnification, as a practical matter, is limited to the creditworthinessof the indemnifying party and its insurer, and the absence of significantdefenses by the insurers. The Company may incur material products liabilityclaims, which could increase its costs and adversely affect its reputation,revenues and operating income.

 

*Hydroxycut Claims.*On May 1, 2009, the FDA issued a warning on severalHydroxycut-branded products manufactured by Iovate Health Sciences U.S.A., Inc.(“Iovate”).  The FDA warning was based on23 reports of liver injuries from consumers who claimed to have used theproducts between 2002 and 2009. As a result, Iovate voluntarily recalled14 Hydroxycut-branded products. As described in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009, following the recall, GNC was named,among other defendants, in several lawsuits related to Hydroxycut (note thatprior to May 1, 2009, GNC was a co-defendant in one Hydroxycut case (seethe “*Ciavarra Claim*” described inthe Company’s Annual Report on Form 10-K for the year ended December 31,2009)).  Iovate previously accepted GNC’stender request for defense and indemnification under its purchasing agreementwith GNC and, as such, Iovate has accepted GNC’s request for defense andindemnification in the new Hydroxycut matters. GNC’s ability to obtain full recovery in respect of any claims againstGNC in connection with products manufactured by Iovate under the indemnity isdependent on Iovate’s insurance coverage, the creditworthiness of its insurer,and the absence of significant defenses by such insurer.  To the extent GNC is not fully compensated byIovate’s insurer, it can seek recovery directly from Iovate.  GNC’s ability to fully recover such amountsmay be limited by the creditworthiness of Iovate.

 

As of October 21, 2010, GNC has been named inapproximately 43 personal injury actions in 13 states claiming injuries fromuse and consumption of Hydroxycut-branded products.  During the third quarter of 2010, 6 suchpersonal injury actions naming GNC were filed. In addition, as described in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009, GNC has been named in six activeputative class actions that generally include claims of consumer fraud,misrepresentation, strict liability, and breach of warranty related toHydroxycut-branded products.  By courtorder dated October 6, 2009, the United States Judicial Panel onMultidistrict Litigation consolidated pretrial proceedings of many of thepending actions (including the GNC class actions).  Any liabilities that may arise from thesematters are not probable or reasonably estimable at this time.

 

*Pro-Hormone/AndrostenedioneCases.* As described in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2009, theCompany is currently defending six lawsuits relating to the sale by GNC ofcertain nutritional products alleged to contain the ingredients commonly knownas Androstenedione, Androstenediol, Norandrostenedione, and Norandrostenediol(collectively, “Andro Products”).  Ineach of the six

 

13

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

cases, plaintiffs sought, or are seeking, to certifya class and obtain damages on behalf of the class representatives and all thosesimilarly-situated who purchased from the Company certain nutritionalsupplements alleged to contain one or more Andro Products.  Any liabilities that may arise from these mattersare not probable or reasonably estimable at this time.

 

*California Wage and Break Claim*.  As described in theCompany’s Annual Report on Form 10-K for the year ended December 31,2009, on November 4, 2008, 98 plaintiffs filed individual claims againstthe Company.  Each of the plaintiffs hadpreviously been a member of a purported class in a lawsuit filed against theCompany in 2007 and resolved in September 2009.  The plaintiffs allege that they were notprovided all of the rest and meal periods to which they were entitled underCalifornia law, and further allege that the Company failed to pay them splitshift and overtime compensation to which they were entitled under Californialaw.  Discovery in this case is ongoingand the Company is vigorously defending these matters.  Any liabilities that may arise from thesematters are not probable or reasonably estimable at this time.

 

*Othercases.* The Company is currentlydefending other lawsuits relating to personal injury claims, product labelingand employee-related matters.  Anyliabilities that may arise from these matters are not probable or reasonablyestimable at this time.

 

 

**Environmental Compliance**

 

In March 2008, the South Carolina Department ofHealth and Environmental Control (“DHEC”) requested that the Companyinvestigate its South Carolina facility for a possible source or sources ofcontamination detected on an adjoining property.  The Company has commenced the investigationat the facility as requested by DHEC. After several phases of the investigation the possible source or sourcesof contamination have not been sufficiently identified.  The Company is continuing suchinvestigation.  The proceedings in thismatter have not yet progressed to a stage where it is possible to estimate thetiming and extent of any remedial action that may be required, the ultimatecost of remediation, or the amount of the Company’s potential liability.

 

In addition to the foregoing, theCompany is subject to numerous federal, state, local, and foreign environmentaland health and safety laws and regulations governing its operations, includingthe handling, transportation, and disposal of the Company’s non-hazardous andhazardous substances and wastes, as well as emissions and discharges from itsoperations into the environment, including discharges to air, surface water, andgroundwater. Failure to comply with such laws and regulations could result incosts for remedial actions, penalties, or the imposition of otherliabilities.  New laws, changes inexisting laws or the interpretation thereof, or the development of new facts orchanges in their processes could also cause the Company to incur additionalcapital and operating expenditures to maintain compliance with environmentallaws and regulations and environmental permits. The Company also is subject to laws and regulations that imposeliability and cleanup responsibility for releases of hazardous substances intothe environment without regard to fault or knowledge about the condition oraction causing the liability. Under certain of these laws and regulations, suchliabilities can be imposed for cleanup of previously owned or operatedproperties, or for properties to which substances or wastes that were sent inconnection with current or former operations at its facilities. The presence ofcontamination from such substances or wastes could also adversely affect theCompany’s ability to sell or lease its properties, or to use them as collateralfor financing. From time to time, the Company has incurred costs andobligations for correcting environmental and health and safety noncompliancematters and for remediation at or relating to certain of its properties orproperties at which its waste has been disposed.  The Company believes it has complied with,and is currently complying with, its environmental obligations pursuant toenvironmental and health and safety laws and regulations in all materialrespects, and that any liabilities for noncompliance will not have a materialadverse effect on its business or financial performance. However, it isdifficult to predict future liabilities and obligations, which could bematerial.

 

***Contingencies***

 

Due to the nature of the Company’sbusiness operations having a presence in multiple taxing jurisdictions, theCompany periodically receives inquiries and/or audits from various taxingauthorities.  Any probable and reasonablyestimable liabilities that may arise from these inquiries have been accrued andreflected in the accompanying financial statements.

 

14

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**GENERAL NUTRITIONCENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

 

**NOTE8.  STOCK-BASED COMPENSATION PLANS**

 

**StockOptions**

 

In 2007, the Board of Directors of Parent (the “Board”)and Parent’s stockholders approved and adopted the GNC Acquisition HoldingsInc. 2007 Stock Incentive Plan (the “Plan”). The purpose of the Plan is toenable Parent to attract and retain highly qualified personnel who willcontribute to the success of the Company. The Plan provides for the granting of stock options, restricted stock,and other stock-based awards.  The Planis available to certain eligible employees, directors, consultants or advisorsas determined by the Compensation Committee of the Board (the “CompensationCommittee”).  The total number of sharesof Parent’s Class A common stock reserved and available for the Plan is10.4 million shares.  Stock options underthe Plan generally are granted with exercise prices at or above fair marketvalue, typically vest over a four or five-year period and expire ten years fromthe date of grant.  The CompensationCommittee has used a valuation methodology in which the fair market value ofthe common stock is based on the Company’s business enterprise value and, insituations deemed appropriate by the Compensation Committee, may be discountedto reflect the lack of marketability associated with the common stock.  No stock appreciation rights, restrictedstock, deferred stock or performance shares have been granted under the Plan.

 

The Company utilizes theBlack-Scholes model to calculate the fair value of options under the standardon stock compensation.  The resultingcompensation cost is recognized in the Company’s financial statements over theoption vesting period.  At September 30,2010, the net unrecognized compensation cost was $7.1 million and is expectedto be recognized over a weighted average period of approximately 2.2 years.

 

 

The following table outlines the Parent’s stock option activity:

 
|                               |       |              | ** ** | **Weighted**       | ** ** |
|------------------------------------|------------|-------------------|------------|--------------------|------------|
|                               |       |              | ** ** | **Average**        | ** ** |
|                               | ** ** | **Total Options** | ** ** | **Exercise Price** | ** ** |
| ** **                         | ** ** | ** **        | ** ** | ** **         | ** ** |
| Outstanding at December  31, 2009  |       | 9,263,640         |       | $                  |  7.27 |   |
|  Granted                      |       | 680,000           |       | 12.58              |       |
|  Exercised                    |       | (13,876)          |       | 7.91               |       |
|  Forfeited                    |       | (433,325)         |       | 7.87               |       |
|  Expired                      |       | (33,251)          |       | 6.49               |       |
| Outstanding at  September 30, 2010 |       | 9,463,188         |       | $                  |  7.63 |   |
|                               |       |              |       |               |       |
| Exercisable at  September 30, 2010 |       | 4,843,811         |       | $                  |  6.71 |   |

 

The standard on stock compensation requires that thecost resulting from all share-based payment transactions be recognized in thefinancial statements. Stock-based compensation expense for the nine monthsended September 30, 2010 and 2009 was $2.4 million and $2.1 million,respectively.

 

At September 30, 2010, the weighted averageremaining contractual life of outstanding options was 6.8 years.  At September 30, 2010, the weightedaverage remaining contractual life of exercisable options was 6.2 years.  The weighted average fair value of optionsgranted during 2010 was $2.64.

 

The Black-Scholes model utilizes the followingassumptions in determining a fair value: price of underlying stock, optionexercise price, expected option term, risk-free interest rate, expecteddividend yield, and expected stock price volatility over the option’s expectedterm. As the Company has had minimal exercises of stock options since theinception of the Plan, the option term has been estimated by considering boththe vesting period, which is typically four or five years, and the contractualterm of ten years. As the Company’s underlying stock is not publicly traded onan open market, the Company utilized its current peer group average to estimatethe expected volatility. The assumptions used in the Company’s Black-Scholesvaluation related to stock option grants made during the nine months ended September 30,2010 were as follows:

 

15

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 
|                                         | ** ** | **September 30,** | ** ** |
|----------------------------------------------|------------|-------------------|------------|
|                                         | ** ** | **2010**          | ** ** |
|                                         | ** ** | **(unaudited)**   | ** ** |
| Dividend yield                               |       | 0.00%             |       |
| Expected option life                         |       | 7.5 years         |       |
| Volatility factor percentage of market price |       | 31.5%  -33.0%     |       |
| Discount rate                                |       | 2.49% - 3.28%     |       |

 

As the Black-Scholes model utilizes certain estimatesand assumptions, the existing models do not necessarily represent thedefinitive fair value of options for future periods.

 

 

**NOTE9.  SEGMENTS**

 

The Company has three reportable segments, each ofwhich represents an identifiable component of the Company for which separatefinancial information is available.  Thisinformation is utilized by management to assess performance and allocate assetsaccordingly.  The Company’s managementevaluates segment operating results based on several indicators.  The primary key performance indicators aresales and operating income or loss for each segment.  Operating income or loss, as evaluated bymanagement, excludes certain items that are managed at the consolidated level,such as distribution and warehousing, impairments and other corporatecosts.  The following table representskey financial information for each of the Company’s reportable segments,identifiable by the distinct operations and management of each: Retail,Franchising, and Manufacturing/Wholesale. The Retail reportable segment includes the Company’s corporate storeoperations in the United States, Canada and its www.gnc.com business.  The Franchise reportable segment representsthe Company’s franchise operations, both domestically and internationally.  The Manufacturing/Wholesale reportablesegment represents the Company’s manufacturing operations in South Carolina andthe Wholesale sales business.  Thissegment supplies the Retail and Franchise segments, along with various thirdparties, with finished products for sale. The Warehousing and Distribution Costs, Corporate Costs, and OtherUnallocated Costs represent the Company’s administrative expenses. Theaccounting policies of the segments are the same as those described in Note 2, “Basisof Presentation and Summary of Significant Accounting Policies”.

 

16

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

 
| ** **                                      | ** ** | **Three months ended** | ** ** | **Nine months ended** |       |
|-------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **September 30,**      | ** ** | **September**         | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                      | ** ** | **2010**               | ** ** | **2009**              | ** ** | **2010** |   | **2009** |   |
| ** **                                      | ** ** | **(unaudited)**        |       |
| ** **                                      | ** ** | **(in thousands)**     |       |
| **Revenue:**                                    |       |                   |       |                  |       |   | ** ** |   | ** ** |
| Retail                                          |       | $                      | 338,231    |                  | $          | 311,933 |   | $ | 1,031,899 |   | $ | 962,587 |   |
| Franchise                                       |       | 76,980                 |       | 67,355                |       | 222,625 |   | 201,063 |   |
| Manufacturing/Wholesale:                        |       |                   |       |                  |       |   |   |   |   |
| Intersegment (1)                                |       | 55,821                 |       | 51,452                |       | 154,428 |   | 149,470 |   |
| Third Party                                     |       | 50,535                 |       | 51,510                |       | 132,145 |   | 139,461 |   |
| Sub total Manufacturing/Wholesale               |       | 106,356                |       | 102,962               |       | 286,573 |   | 288,931 |   |
| Sub total segment revenues                      |       | 521,567                |       | 482,250               |       | 1,541,097 |   | 1,452,581 |   |
| Intersegment elimination (1)                    |       | (55,821)               |       | (51,452)              |       | (154,428) |   | (149,470) |   |
| **Total revenue**                               |       | $                      | 465,746    |                  | $          | 430,798 |   | $ | 1,386,669 |   | $ | 1,303,111 |   |
| ** **                                      |       |                   |       |                  |       |   |   |   |   |
| **Operating income:**                           |       |                   |       |                  |       |   |   |   |   |
| Retail                                          |       | $                      | 47,670     |                  | $          | 37,251 |   | $ | 147,248 |   | $ | 123,277 |   |
| Franchise                                       |       | 26,329                 |       | 22,486                |       | 71,660 |   | 61,243 |   |
| Manufacturing/Wholesale                         |       | 17,901                 |       | 18,854                |       | 51,140 |   | 54,072 |   |
| Unallocated corporate and other costs:          |       |                   |       |                  |       |   |   |   |   |
| Warehousing and distribution costs              |       | (13,784)               |       | (13,441)              |       | (41,450) |   | (40,458) |   |
| Corporate costs                                 |       | (18,877)               |       | (17,749)              |       | (54,973) |   | (54,741) |   |
| Sub total unallocated corporate and other costs |       | (32,661)               |       | (31,190)              |       | (96,423) |   | (95,199) |   |
| **Total operating income**                      |       | $                      | 59,239     |                  | $          | 47,401 |   | $ | 173,625 |   | $ | 143,393 |   |

 

(1) Intersegment revenues areeliminated from consolidated revenue.

 

 

**NOTE 10. SUPPLEMENTAL GUARANTOR INFORMATION**

 

As of September 30, 2010 the Company’s debtincluded its 2007 Senior Credit Facility, Senior Toggle Notes and 10.75% SeniorSubordinated Notes.  The 2007 SeniorCredit Facility has been guaranteed by the Company’s direct parent, GNCCorporation, and the Company’s existing and future direct and indirect materialdomestic subsidiaries.  The Senior ToggleNotes are general non collateralized obligations of the Company, areeffectively subordinated to the Company’s 2007 Senior Credit Facility to theextent of the value of the collateral securing the 2007 Senior Credit Facilityand are senior in right of payment to all existing and future subordinatedobligations of the Company, including its 10.75% Senior SubordinatedNotes.  The Senior Toggle Notes areunconditionally guaranteed on a non collateralized basis by all of the Company’sexisting and future direct and indirect material domestic subsidiaries.  The 10.75% Senior Subordinated Notes aregeneral non collateralized obligations and are guaranteed on a seniorsubordinated basis by the Company’s existing and future direct and indirectmaterial domestic subsidiaries and rank junior in right of payment to theCompany’s 2007 Senior Credit Facility and Senior Toggle Notes.  The guarantors are the same for the 2007Senior Credit Facility, Senior Toggle Notes and 10.75% Senior SubordinatedNotes.  Non-guarantor subsidiariesinclude the Company’s direct and indirect foreign subsidiaries.  Each subsidiary guarantor is 100% owned,directly or indirectly, by the Company. The guarantees are full and unconditional and joint and several.  Investments in subsidiaries are accounted forunder the equity method of accounting.

 

Presented below are condensed consolidating financialstatements of the Company as the parent/issuer, and the combined guarantor andnon-guarantor subsidiaries as of September 30, 2010, December 31,2009, and the three and nine months ended September 30, 2010 and2009.  Intercompany balances andtransactions have been eliminated.

 

17

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

 

**Supplemental Condensed Consolidating Balance Sheets**

 
|                                                  |       |               | ** ** | **Combined**     | ** ** | **Combined**      |       |             |       |             |       |
|-------------------------------------------------------|------------|--------------------|------------|------------------|------------|-------------------|------------|------------------|------------|------------------|------------|
| ** **                                            | ** ** | **Parent/**        | ** ** | **Guarantor**    |       | **Non-Guarantor** |       |             |       |             |       |
| **September 30, 2010**                                | ** ** | **Issuer**         | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                  |       | **(unaudited)**    |       |
|                                                  |       | **(in thousands)** |       |
|                                                  |       |               |       |             |       |              |       |             |       |             |       |
| Current assets                                        |       |               |       |             |       |              |       |             |       |             |       |
| Cash and cash equivalents                             |       | $                  | 114,554    |             | $          | 3,953             |       | $                | 3,197      |             | $          | - |   | $ | 121,704 |   |
| Receivables, net                                      |       | 1,827              |       | 103,318          |       | 636               |       | -                |       | 105,781          |       |
| Intercompany receivables                              |       | 83,740             |       | -                |       | -                 |       | (83,740)         |       | -                |       |
| Inventories, net                                      |       | -                  |       | 366,494          |       | 30,294            |       | -                |       | 396,788          |       |
| Prepaids and other current assets                     |       | 13,464             |       | 13,656           |       | 6,519             |       | -                |       | 33,639           |       |
| Total current assets                                  |       | 213,585            |       | 487,421          |       | 40,646            |       | (83,740)         |       | 657,912          |       |
|                                                  |       |               |       |             |       |              |       |             |       |             |       |
| Goodwill                                              |       | -                  |       | 624,452          |       | 468               |       | -                |       | 624,920          |       |
| Brands                                                |       | -                  |       | 720,000          |       | -                 |       | -                |       | 720,000          |       |
| Property, plant and equipment, net                    |       | 6,899              |       | 157,706          |       | 28,211            |       | -                |       | 192,816          |       |
| Investment in subsidiaries                            |       | 1,633,003          |       | (8,011)          |       | -                 |       | (1,624,992)      |       | -                |       |
| Other assets                                          |       | 25,952             |       | 151,699          |       | -                 |       | (8,781)          |       | 168,870          |       |
| Total assets                                          |       | $                  | 1,879,439  |             | $          | 2,133,267         |       | $                | 69,325     |             | $          | (1,717,513) |   | $ | 2,364,518 |   |
|                                                  |       |               |       |             |       |              |       |             |       |             |       |
| Current liabilities                                   |       |               |       |             |       |              |       |             |       |             |       |
| Current liabilities                                   |       | $                  | 38,876     |             | $          | 159,853           |       | $                | 12,615     |             | $          | - |   | $ | 211,344 |   |
| Intercompany payables                                 |       | -                  |       | 64,244           |       | 19,496            |       | (83,740)         |       | -                |       |
| Total current liabilities                             |       | 38,876             |       | 224,097          |       | 32,111            |       | (83,740)         |       | 211,344          |       |
|                                                  |       |               |       |             |       |              |       |             |       |             |       |
| Long-term debt                                        |       | 1,052,646          |       | 23               |       | 13,320            |       | (8,781)          |       | 1,057,208        |       |
| Deferred tax liabilities                              |       | (370)              |       | 292,533          |       | (365)        |       | -                |       | 291,798          |       |
| Other long-term liabilities                           |       | 15,544             |       | 13,974           |       | 1,907             |       | -                |       | 31,425           |       |
| Total liabilities                                     |       | 1,106,696          |       | 530,627          |       | 46,973            |       | (92,521)         |       | 1,591,775        |       |
| Total stockholder's equity (deficit)                  |       | 772,743            |       | 1,602,640        |       | 22,352            |       | (1,624,992)      |       | 772,743          |       |
| Total  liabilities and stockholder's equity (deficit) |       | $                  | 1,879,439  |             | $          | 2,133,267         |       | $                | 69,325     |             | $          | (1,717,513) |   | $ | 2,364,518 |   |

 

18

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** **

**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIALSTATEMENTS (UNAUDITED)**

 

**Supplemental Condensed Consolidating Balance Sheets**

 
|                                                  |       |          | ** ** | ** ** | **Combined**     | ** **    | ** ** | **Combined**        |       |          |             |       |       |             |       |       |
|-------------------------------------------------------|------------|---------------|------------|------------|------------------|---------------|------------|---------------------|------------|---------------|------------------|------------|------------|------------------|------------|------------|
|                                                  | ** ** | **Parent/**   | ** ** | ** ** | **Guarantor**    | ** **    | ** ** | **Non-Guarantor**   |       |          |             |       |       |             |       |       |
| **December 31, 2009**                                 | ** ** | **Issuer**    | ** ** | ** ** | **Subsidiaries** | ** **    | ** ** | **Subsidiaries**    | ** ** | ** **    | **Eliminations** | ** ** | ** ** | **Consolidated** | ** ** | ** ** |
|                                                  |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
|                                                  |       |          |       |       |             | ** **    | ** ** | **(in  thousands)** |       |          |             |       |       |             |       |       |
|                                                  |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Current assets                                        |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Cash and cash equivalents                             |       |   $ | 77,797     |       |             |   $ | (4,801     | )                   |       |   $ | 2,093            |       |       |   $    | -          |       |   |   $ | 75,089 |   |   |
| Receivables, net                                      |       | 895           |       |       | 92,273           |          |       | 1,187               |       |          | -                |       |       | 94,355           |       |       |
| Intercompany receivables                              |       | 139,168       |       |       | -                |          |       | -                   |       |          | (139,168         | )          |       | -                |       |       |
| Inventories, net                                      |       | -             |       |       | 339,975          |          |       | 30,517              |       |          | -                |       |       | 370,492          |       |       |
| Prepaids and other current assets                     |       | 19,308        |       |       | 14,409           |          |       | 8,502               |       |          | -                |       |       | 42,219           |       |       |
| Total current assets                                  |       | 237,168       |       |       | 441,856          |          |       | 42,299              |       |          | (139,168         | )          |       | 582,155          |       |       |
|                                                  |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Goodwill                                              |       | -             |       |       | 624,285          |          |       | 468                 |       |          | -                |       |       | 624,753          |       |       |
| Brands                                                |       | -             |       |       | 720,000          |          |       | -                   |       |          | -                |       |       | 720,000          |       |       |
| Property, plant and equipment, net                    |       | 7,409         |       |       | 163,882          |          |       | 28,290              |       |          | -                |       |       | 199,581          |       |       |
| Investment in subsidiaries                            |       | 1,550,708     |       |       | (7,687           | )             |       | -                   |       |          | (1,543,021       | )          |       | -                |       |       |
| Other assets                                          |       | 28,876        |       |       | 157,018          |          |       | -                   |       |          | (8,781           | )          |       | 177,113          |       |       |
| Total assets                                          |       |   $ | 1,824,161  |       |             |   $ | 2,099,354  |                |       |   $ | 71,057           |       |       |   $    | (1,690,970 | )          |   |   $ | 2,303,602 |   |   |
|                                                  |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Current liabilities                                   |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Current liabilities                                   |       |   $ | 34,129     |       |             |   $ | 154,435    |                |       |   $ | 11,023           |       |       |   $    | -          |       |   |   $ | 199,587 |   |   |
| Intercompany payables                                 |       | -             |       |       | 113,359          |          |       | 25,809              |       |          | (139,168         | )          |       | -                |       |       |
| Total current liabilities                             |       | 34,129        |       |       | 267,794          |          |       | 36,832              |       |          | (139,168         | )          |       | 199,587          |       |       |
|                                                  |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Long-term debt                                        |       | 1,052,341     |       |       | 32               |          |       | 14,493              |       |          | (8,781           | )          |       | 1,058,085        |       |       |
| Deferred tax liabilities                              |       | (4,754        | )          |       | 294,087          |          |       | (439                | )          |          | -                |       |       | 288,894          |       |       |
| Other long-term liabilities                           |       | 24,929        |       |       | 14,129           |          |       | 462                 |       |          | -                |       |       | 39,520           |       |       |
| Total liabilities                                     |       | 1,106,645     |       |       | 576,042          |          |       | 51,348              |       |          | (147,949         | )          |       | 1,586,086        |       |       |
| Total stockholder's equity (deficit)                  |       | 717,516       |       |       | 1,523,312        |          |       | 19,709              |       |          | (1,543,021       | )          |       | 717,516          |       |       |
| Total  liabilities and stockholder's equity (deficit) |       |   $ | 1,824,161  |       |             |   $ | 2,099,354  |                |       |   $ | 71,057           |       |       |   $    | (1,690,970 | )          |   |   $ | 2,303,602 |   |   |

 

19

----

 

**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

 

**Supplemental Condensed Consolidating Statements of Operations**

 
|                                                                       |       |          | ** ** | ** ** | **Combined**     | ** **    | ** ** | **Combined**        |       |          |             |       |       |             |       |       |
|----------------------------------------------------------------------------|------------|---------------|------------|------------|------------------|---------------|------------|---------------------|------------|---------------|------------------|------------|------------|------------------|------------|------------|
|                                                                       | ** ** | **Parent/**   | ** ** | ** ** | **Guarantor**    | ** **    | ** ** | **Non-Guarantor**   |       |          |             |       |       |             |       |       |
| **Three months ended September 30, 2010**                                  | ** ** | **Issuer**    | ** ** | ** ** | **Subsidiaries** | ** **    | ** ** | **Subsidiaries**    | ** ** | ** **    | **Eliminations** | ** ** | ** ** | **Consolidated** | ** ** | ** ** |
|                                                                       |       |          |       |       |             | ** **    | ** ** | ** **          |       |          |             |       |       |             |       |       |
|                                                                       |       |          |       |       |             | ** **    | ** ** | **(unaudited)**     |       |          |             |       |       |             |       |       |
|                                                                       |       |          |       |       |             | ** **    | ** ** | **(in  thousands)** |       |          |             |       |       |             |       |       |
| Revenue                                                                    |       |   $ | -          |       |             |   $ | 442,734    |                |       |   $ | 26,450           |       |       |   $    | (3,438     | )          |   |   $ | 465,746 |   |   |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Cost of sales, including costs of warehousing, distribution and  occupancy |       | -             |       |       | 286,088          |          |       | 20,017              |       |          | (3,438           | )          |       | 302,667          |       |       |
| Gross profit                                                               |       | -             |       |       | 156,646          |          |       | 6,433               |       |          | -                |       |       | 163,079          |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Compensation and related benefits                                          |       | 11,930        |       |       | 52,877           |          |       | 4,367               |       |          | -                |       |       | 69,174           |       |       |
| Advertising and promotion                                                  |       | -             |       |       | 10,488           |          |       | 155                 |       |          | -                |       |       | 10,643           |       |       |
| Other selling, general and administrative                                  |       | 7,544         |       |       | 16,578           |          |       | (7                  | )          |          | -                |       |       | 24,115           |       |       |
| Subsidiary (income) expense                                                |       | (27,196       | )          |       | 107              |          |       | -                   |       |          | 27,089           |       |       | -                |       |       |
| Other (income) expense                                                     |       | (18,649       | )          |       | 17,750           |          |       | 807                 |       |          | -                |       |       | (92              | )          |       |
| Operating income (loss)                                                    |       | 26,371        |       |       | 58,846           |          |       | 1,111               |       |          | (27,089          | )          |       | 59,239           |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Interest expense, net                                                      |       | 883           |       |       | 15,182           |          |       | 275                 |       |          | -                |       |       | 16,340           |       |       |
| Income (loss) before income taxes                                          |       | 25,488        |       |       | 43,664           |          |       | 836                 |       |          | (27,089          | )          |       | 42,899           |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Income tax (benefit) expense                                               |       | (1,297        | )          |       | 17,239           |          |       | 172                 |       |          | -                |       |       | 16,114           |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Net income (loss)                                                          |       |   $ | 26,785     |       |             |   $ | 26,425     |                |       |   $ | 664              |       |       |   $    | (27,089    | )          |   |   $ | 26,785 |   |   |

 

 

**Supplemental Condensed Consolidating Statements of Operations**

 
|                                                                       |       |          | ** ** | ** ** | **Combined**     | ** **    | ** ** | **Combined**        |       |          |             |       |       |             |       |       |
|----------------------------------------------------------------------------|------------|---------------|------------|------------|------------------|---------------|------------|---------------------|------------|---------------|------------------|------------|------------|------------------|------------|------------|
|                                                                       | ** ** | **Parent/**   | ** ** | ** ** | **Guarantor**    | ** **    | ** ** | **Non-Guarantor**   |       |          |             |       |       |             |       |       |
| **Nine months ended September 30, 2010**                                   | ** ** | **Issuer**    | ** ** | ** ** | **Subsidiaries** | ** **    | ** ** | **Subsidiaries**    | ** ** | ** **    | **Eliminations** | ** ** | ** ** | **Consolidated** | ** ** | ** ** |
|                                                                       |       |          |       |       |             | ** **    | ** ** | ** **          |       |          |             |       |       |             |       |       |
|                                                                       |       |          |       |       |             | ** **    | ** ** | **(unaudited)**     |       |          |             |       |       |             |       |       |
|                                                                       |       |          |       |       |             | ** **    | ** ** | **(in  thousands)** |       |          |             |       |       |             |       |       |
| Revenue                                                                    |       |   $ | -          |       |             |   $ | 1,314,091  |                |       |   $ | 82,767           |       |       |   $    | (10,189    | )          |   |   $ | 1,386,669 |   |   |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Cost of sales, including costs of warehousing, distribution and  occupancy |       | -             |       |       | 843,217          |          |       | 61,007              |       |          | (10,189          | )          |       | 894,035          |       |       |
| Gross profit                                                               |       | -             |       |       | 470,874          |          |       | 21,760              |       |          | -                |       |       | 492,634          |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Compensation and related benefits                                          |       | 33,030        |       |       | 158,485          |          |       | 13,051              |       |          | -                |       |       | 204,566          |       |       |
| Advertising and promotion                                                  |       | -             |       |       | 39,436           |          |       | 783                 |       |          | -                |       |       | 40,219           |       |       |
| Other selling, general and administrative                                  |       | 23,443        |       |       | 50,545           |          |       | 385                 |       |          | -                |       |       | 74,373           |       |       |
| Subsidiary (income) expense                                                |       | (81,794       | )          |       | 324              |          |       | -                   |       |          | 81,470           |       |       | -                |       |       |
| Other (income) expense                                                     |       | (53,677       | )          |       | 49,749           |          |       | 3,779               |       |          | -                |       |       | (149             | )          |       |
| Operating income (loss)                                                    |       | 78,998        |       |       | 172,335          |          |       | 3,762               |       |          | (81,470          | )          |       | 173,625          |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Interest expense, net                                                      |       | 2,622         |       |       | 45,840           |          |       | 824                 |       |          | -                |       |       | 49,286           |       |       |
| Income (loss) before income taxes                                          |       | 76,376        |       |       | 126,495          |          |       | 2,938               |       |          | (81,470          | )          |       | 124,339          |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Income tax (benefit) expense                                               |       | (1,969        | )          |       | 47,167           |          |       | 796                 |       |          | -                |       |       | 45,994           |       |       |
|                                                                       |       |          |       |       |             |          |       |                |       |          |             |       |       |             |       |       |
| Net income (loss)                                                          |       |   $ | 78,345     |       |             |   $ | 79,328     |                |       |   $ | 2,142            |       |       |   $    | (81,470    | )          |   |   $ | 78,345 |   |   |

 

20

----

 

**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTESTO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

 

**Supplemental Condensed Consolidating Statements of Operations**

** **
| ** **                                                         |   | ** **    | ** ** |   | ** **       | ** **    |       | ** **              | ** ** |          | ** **       | ** ** |   | ** **       | ** ** |   |
|--------------------------------------------------------------------|--------|---------------|------------|--------|------------------|---------------|------------|-------------------------|------------|---------------|------------------|------------|--------|------------------|------------|--------|
| ** **                                                         |   | ** **    | ** ** |   | **Combined**     | ** **    |       | **Combined**            | ** ** |          | ** **       | ** ** |   | ** **       | ** ** |   |
| ** **                                                         |   | **Parent/**   | ** ** |   | **Guarantor**    | ** **    |       | **Non-Guarantor**       | ** ** |          | ** **       | ** ** |   | ** **       | ** ** |   |
| **Three months ended September 30, 2009** |   | **Issuer**    | ** ** |   | **Subsidiaries** | ** **    |       | **Subsidiaries**        | ** ** |          | **Eliminations** | ** ** |   | **Consolidated** | ** ** |   |
|                                                               |   |          |       |   |             | ** **    | ** ** | ** **              |       |          |             |       |   |             |       |   |
| ** **                                                         |   | ** **    | ** ** |   | ** **       | ** **    |       | **(unaudited)**         | ** ** |          | ** **       | ** ** |   | ** **       | ** ** |   |
| ** **                                                         |   | ** **    | ** ** |   | ** **       | ** **    |       | **(in thousands)** | ** ** |          | ** **       | ** ** |   | ** **       | ** ** |   |
| Revenue                                                            |   |   $ | -          |   |             |   $ | 409,634    |                    |       |   $ | 26,343           |       |   |   $    | (5,179     | )      |   |   $ | 430,798 |   |   |
|                                                               |   |          |       |   |             |          |       |                    |       |          |             |       |   |             |       |   |
| Cost of sales, including costs of warehousing,                     |   |          |       |   |             |          |       |                    |       |          |             |       |   |             |       |   |
| distribution and occupancy                                         |   | -             |       |   | 268,609          |          |       | 19,176                  |       |          | (5,179           | )          |   | 282,606          |       |   |
| Gross profit                                                       |   | -             |       |   | 141,025          |          |       | 7,167                   |       |          | -                |       |   | 148,192          |       |   |
|                                                               |   |          |       |   |             |          |       |                    |       |          |             |       |   |             |       |   |
| Compensation and related benefits                                  |   | 9,897         |       |   | 51,442           |          |       | 4,131                   |       |          | -                |       |   | 65,470           |       |   |
| Advertising and promotion                                          |   | -             |       |   | 10,925           |          |       | 118                     |       |          | -                |       |   | 11,043           |       |   |
| Other selling, general and administrative                          |   | 8,382         |       |   | 15,885           |          |       | 5                       |       |          | -                |       |   | 24,272           |       |   |
| Subsidiary (income) expense                                        |   | (20,789       | )          |   | 236              |          |       | -                       |       |          | 20,553           |       |   | -                |       |   |
| Other (income) expense                                             |   | (17,407       | )          |   | 16,452           |          |       | 961                     |       |          | -                |       |   | 6                |       |   |
| Operating income (loss)                                            |   | 19,917        |       |   | 46,085           |          |       | 1,952                   |       |          | (20,553          | )          |   | 47,401           |       |   |
|                                                               |   |          |       |   |             |          |       |                    |       |          |             |       |   |             |       |   |
| Interest expense, net                                              |   | 982           |       |   | 15,595           |          |       | 297                     |       |          | -                |       |   | 16,874           |       |   |
| Income (loss) before income taxes                                  |   | 18,935        |       |   | 30,490           |          |       | 1,655                   |       |          | (20,553          | )          |   | 30,527           |       |   |
|                                                               |   |          |       |   |             |          |       |                    |       |          |             |       |   |             |       |   |
| Income tax (benefit) expense                                       |   | (590          | )          |   | 11,084           |          |       | 508                     |       |          | -                |       |   | 11,002           |       |   |
|                                                               |   |          |       |   |             |          |       |                    |       |          |             |       |   |             |       |   |
| Net income (loss)                                                  |   |   $ | 19,525     |   |             |   $ | 19,406     |                    |       |   $ | 1,147            |       |   |   $    | (20,553    | )      |   |   $ | 19,525 |   |   |

 

 

**Supplemental Condensed Consolidating Statements of Operations**

 
| ** **                                                        | ** ** | ** **    | ** ** | ** ** | **Combined**     | ** **    | ** ** | **Combined**            | ** ** | ** **    | ** **       | ** ** | ** ** | ** **       | ** ** | ** ** |
|-------------------------------------------------------------------|------------|---------------|------------|------------|------------------|---------------|------------|-------------------------|------------|---------------|------------------|------------|------------|------------------|------------|------------|
| ** **                                                        | ** ** | **Parent/**   | ** ** | ** ** | **Guarantor**    | ** **    | ** ** | **Non-Guarantor**       | ** ** | ** **    | ** **       | ** ** | ** ** | ** **       | ** ** | ** ** |
| **Nine months ended September 30, 2009** | ** ** | **Issuer**    | ** ** | ** ** | **Subsidiaries** | ** **    | ** ** | **Subsidiaries**        | ** ** | ** **    | **Eliminations** | ** ** | ** ** | **Consolidated** | ** ** | ** ** |
|                                                              |       |          |       |       |             | ** **    | ** ** | ** **              |       |          |             |       |       |             |       |       |
| ** **                                                        | ** ** | ** **    | ** ** | ** ** | ** **       | ** **    | ** ** | **(unaudited)**         | ** ** | ** **    | ** **       | ** ** | ** ** | ** **       | ** ** | ** ** |
| ** **                                                        | ** ** | ** **    | ** ** | ** ** | ** **       | ** **    | ** ** | **(in thousands)** | ** ** | ** **    | ** **       | ** ** | ** ** | ** **       | ** ** | ** ** |
| Revenue                                                           |       |   $ | -          |       |             |   $ | 1,238,791  |                    |       |   $ | 75,784           |       |       |   $    | (11,464    | )          |   |   $ | 1,303,111 |   |   |
|                                                              |       |          |       |       |             |          |       |                    |       |          |             |       |       |             |       |       |
| Cost of sales, including costs of warehousing,                    |       |          |       |       |             |          |       |                    |       |          |             |       |       |             |       |       |
| distribution and occupancy                                        |       | -             |       |       | 807,078          |          |       | 53,627                  |       |          | (11,464          | )          |       | 849,241          |       |       |
| Gross profit                                                      |       | -             |       |       | 431,713          |          |       | 22,157                  |       |          | -                |       |       | 453,870          |       |       |
|                                                              |       |          |       |       |             |          |       |                    |       |          |             |       |       |             |       |       |
| Compensation and related benefits                                 |       | 30,639        |       |       | 153,818          |          |       | 11,864                  |       |          | -                |       |       | 196,321          |       |       |
| Advertising and promotion                                         |       | -             |       |       | 39,571           |          |       | 606                     |       |          | -                |       |       | 40,177           |       |       |
| Other selling, general and administrative                         |       | 25,516        |       |       | 48,345           |          |       | 145                     |       |          | -                |       |       | 74,006           |       |       |
| Subsidiary (income) expense                                       |       | (60,434       | )          |       | 681              |          |       | -                       |       |          | 59,753           |       |       | -                |       |       |
| Other (income) expense                                            |       | (53,546       | )          |       | 50,702           |          |       | 2,817                   |       |          | -                |       |       | (27              | )          |       |
| Operating income (loss)                                           |       | 57,825        |       |       | 138,596          |          |       | 6,725                   |       |          | (59,753          | )          |       | 143,393          |       |       |
|                                                              |       |          |       |       |             |          |       |                    |       |          |             |       |       |             |       |       |
| Interest expense, net                                             |       | 2,746         |       |       | 49,384           |          |       | 887                     |       |          | -                |       |       | 53,017           |       |       |
| Income (loss) before income taxes                                 |       | 55,079        |       |       | 89,212           |          |       | 5,838                   |       |          | (59,753          | )          |       | 90,376           |       |       |
|                                                              |       |          |       |       |             |          |       |                    |       |          |             |       |       |             |       |       |
| Income tax (benefit) expense                                      |       | (1,857        | )          |       | 33,560           |          |       | 1,737                   |       |          | -                |       |       | 33,440           |       |       |
|                                                              |       |          |       |       |             |          |       |                    |       |          |             |       |       |             |       |       |
| Net income (loss)                                                 |       |   $ | 56,936     |       |             |   $ | 55,652     |                    |       |   $ | 4,101            |       |       |   $    | (59,753    | )          |   |   $ | 56,936 |   |   |

 

21

----

 

**GENERAL NUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

 

**Supplemental Condensed Consolidating Statements of Cash Flows**

 
|                                                                             |       |                | ** ** | ** ** | **Combined**     | ** **    | ** ** | **Combined**      |       |          |             |       |       |
|----------------------------------------------------------------------------------|------------|---------------------|------------|------------|------------------|---------------|------------|-------------------|------------|---------------|------------------|------------|------------|
|                                                                             | ** ** | **Parent/**         | ** ** | ** ** | **Guarantor**    | ** **    | ** ** | **Non-Guarantor** |       |          |             |       |       |
| **Nine months ended September 30, 2010**                                         | ** ** | **Issuer**          | ** ** | ** ** | **Subsidiaries** | ** **    | ** ** | **Subsidiaries**  | ** ** | ** **    | **Consolidated** | ** ** | ** ** |
|                                                                             |       | ** **          |       |
|                                                                             |       | **(unaudited)**     |       |
|                                                                             |       | **(in  thousands)** |       |
| **NET  CASH PROVIDED BY OPERATING ACTIVITIES:**                                  |       |   $       | -          |       |             |   $ | 93,591     |              |       |   $ | 3,963            |       |       |   $ | 97,554 |   |   |
|                                                                             |       |                |       |       |             |          |       |              |       |          |             |       |       |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                       |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Capital expenditures                                                             |       | (2,389              | )          |       | (16,783          | )             |       | (1,797            | )          |          | (20,969          | )          |       |
| Investment/distribution                                                          |       | 67,767              |       |       | (67,767          | )             |       | -                 |       |          | -                |       |       |
| Other investing                                                                  |       | -                   |       |       | (278             | )             |       | -                 |       |          | (278             | )          |       |
| **Net cash provided by (used in) investing  activities**     |       | 65,378              |       |       | (84,828          | )             |       | (1,797            | )          |          | (21,247          | )          |       |
|                                                                             |       |                |       |       |             |          |       |              |       |          |             |       |       |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                       |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Dividend payment                                                                 |       | (28,384             | )          |       | -                |          |       | -                 |       |          | (28,384          | )          |       |
| Other financing                                                                  |       | (237                | )          |       | (9               | )             |       | (1,095            | )          |          | (1,341           | )          |       |
| **Net cash used in financing activities**                                        |       | (28,621             | )          |       | (9               | )             |       | (1,095            | )          |          | (29,725          | )          |       |
|                                                                             |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Effect of exchange rate on cash                                                  |       | -                   |       |       | -                |          |       | 33                |       |          | 33               |       |       |
|                                                                             |       |                |       |       |             |          |       |              |       |          |             |       |       |
| **Net increase in cash**                                                         |       | 36,757              |       |       | 8,754            |          |       | 1,104             |       |          | 46,615           |       |       |
|                                                                             |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Beginning balance, cash                                                          |       | 77,797              |       |       | (4,801           | )             |       | 2,093             |       |          | 75,089           |       |       |
|                                                                             |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Ending balance, cash                                                             |       |   $       | 114,554    |       |             |   $ | 3,953      |              |       |   $ | 3,197            |       |       |   $ | 121,704 |   |   |

 

22

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**GENERAL NUTRITION CENTERS, INC.AND SUBSIDIARIES**

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS (UNAUDITED)**

 

 

**Supplemental Condensed Consolidating Statements of Cash Flows**

 
|                                                     |       |                | ** ** | ** ** | **Combined**     | ** **    | ** ** | **Combined**      |       |          |             |       |       |
|----------------------------------------------------------|------------|---------------------|------------|------------|------------------|---------------|------------|-------------------|------------|---------------|------------------|------------|------------|
|                                                     | ** ** | **Parent/**         | ** ** | ** ** | **Guarantor**    | ** **    | ** ** | **Non-Guarantor** |       |          |             |       |       |
| **Nine months ended September 30, 2009**                 | ** ** | **Issuer**          | ** ** | ** ** | **Subsidiaries** | ** **    | ** ** | **Subsidiaries**  | ** ** | ** **    | **Consolidated** | ** ** | ** ** |
|                                                     |       |                | ** ** | ** ** | ** **       |          |       |              |       |          |             |       |       |
|                                                     |       | **(unaudited)**     |       |
|                                                     |       | **(in  thousands)** |       |
| **NET  CASH PROVIDED BY OPERATING ACTIVITIES:**          |       |   $       | -          |       |             |   $ | 74,730     |              |       |   $ | 3,118            |       |       |   $ | 77,848 |   |   |
|                                                     |       |                |       |       |             |          |       |              |       |          |             |       |       |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**               |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Capital expenditures                                     |       | (1,821              | )          |       | (15,920          | )             |       | (2,707            | )          |          | (20,448          | )          |       |
| Investment/distribution                                  |       | 99,486              |       |       | (99,486          | )             |       | -                 |       |          | -                |       |       |
| Other investing                                          |       | -                   |       |       | (1,560           | )             |       | -                 |       |          | (1,560           | )          |       |
| **Net cash provided by (used in) investing  activities** |       | 97,665              |       |       | (116,966         | )             |       | (2,707            | )          |          | (22,008          | )          |       |
|                                                     |       |                |       |       |             |          |       |              |       |          |             |       |       |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**               |       |                |       |       |             |          |       |              |       |          |             |       |       |
| GNC Corporation investment in                            |       |                |       |       |             |          |       |              |       |          |             |       |       |
| General  Nutrition Centers, Inc                          |       | (278                | )          |       | -                |          |       | -                 |       |          | (278             | )          |       |
| Dividend payment                                         |       | (13,600             | )          |       | -                |          |       | -                 |       |          | (13,600          | )          |       |
| Financing fees                                           |       | (45                 | )          |       | -                |          |       | -                 |       |          | (45              | )          |       |
| Other financing                                          |       | (18,945             | )          |       | (5               | )             |       | (1,023            | )          |          | (19,973          | )          |       |
| **Net cash used in financing activities**                |       | (32,868             | )          |       | (5               | )             |       | (1,023            | )          |          | (33,896          | )          |       |
|                                                     |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Effect of exchange rate on cash                          |       | -                   |       |       | -                |          |       | 308               |       |          | 308              |       |       |
|                                                     |       |                |       |       |             |          |       |              |       |          |             |       |       |
| **Net increase (decrease) in cash**                      |       | 64,797              |       |       | (42,241          | )             |       | (304              | )          |          | 22,252           |       |       |
|                                                     |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Beginning balance, cash                                  |       | -                   |       |       | 40,077           |          |       | 2,230             |       |          | 42,307           |       |       |
|                                                     |       |                |       |       |             |          |       |              |       |          |             |       |       |
| Ending balance, cash                                     |       |   $       | 64,797     |       |             |   $ | (2,164     | )                 |       |   $ | 1,926            |       |       |   $ | 64,559 |   |   |

 

**NOTE 11.  INCOME TAXES**

 

The Companyfiles a consolidated U.S. federal tax return and various consolidated andseparate tax returns as prescribed by the tax laws of the state, local, andinternational jurisdictions in which it and its subsidiaries operate.  TheCompany has been audited by the Internal Revenue Service (the “IRS”) throughits March 15, 2007 tax year.  TheCompany has various state, local, and international jurisdiction tax years opento examination (the earliest open period is 2003), and is also currently underaudit in certain state and local jurisdictions. As of September 30, 2010,the Company believes that it has appropriately reserved for any potentialfederal, state, local, and international income tax exposures.

 

TheCompany recorded additional unrecognized tax benefits of approximately $0.9million during the nine months ended September 30, 2010, exclusive of $0.9million settled.  The additionalunrecognized tax benefits recorded during the nine months ended September 30,2010 are principally related to the continuation of previously taken taxpositions.  As of September 30, 2010and December 31, 2009, the Company had $6.7 million and $6.8 million,respectively, of unrecognized tax benefits. As of September 30, 2010, the Company is not aware of any taxpositions for which it is reasonably possible that the amounts of unrecognizedtax benefits will significantly increase or decrease within the next 12 months.The amount of unrecognized tax benefits that, if recognized, would affect theeffective tax rate is $6.7 million.  TheCompany recognizes accrued interest and penalties related to unrecognized taxbenefits in income tax expense. The Company had accrued approximately $2.5million and $2.2 million, respectively, for September 30, 2010 and December 31,2009 in potential interest and penalties associated with uncertain taxpositions.  To the extent interest andpenalties are not assessed with respect to the ultimate settlement of uncertaintax positions, amounts previously accrued will be reduced and reflected as areduction of the overall income tax provision.

 

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**GENERALNUTRITION CENTERS, INC. AND SUBSIDIARIES**

**NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**NOTE 12.   FAIR VALUE MEASUREMENT**

 

The Company adopted the standard on fair valuemeasurements and disclosures under the new Codification as of January 1,2008. This standard defines fair value, establishes a consistent framework formeasuring fair value, and expands disclosures for each major asset andliability category measured at fair value on either a recurring or nonrecurringbasis. The standard clarifies that fair value is an exit price, representingthe amount that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants. As such, fairvalue is a market-based measurement that should be determined based onassumptions that market participants would use in pricing an asset orliability. As a basis for considering such assumptions, the standardestablishes a three-tier fair value hierarchy which prioritizes the inputs usedin measuring fair value as follows:

 
|   | Level 1  - | observable  inputs such as quoted prices in active markets for identical assets and  liabilities;                                                                                                                                                                                     |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                                                                                                                                                  |
|   | Level 2  - | observable  inputs such as quoted prices for similar assets or liabilities in active  markets, quoted prices for identical or similar assets or liabilities in  markets that are not active, other inputs that are observable, or can be  corroborated by observable market data; and |
|   |       |                                                                                                                                                                                                                                                                                  |
|   | Level 3  - | unobservable  inputs for which there are little or no market data, which require the  reporting entity to develop its own assumptions.                                                                                                                                                |

 

The following table presents the Company’s financialassets and liabilities that were accounted for at fair value on a recurringbasis as of September 30, 2010 by level within the fair value hierarchy:

 
|                        | ** ** | **Fair  Value Measurements Using** |                            |
|-----------------------------|------------|------------------------------------|---------------------------------|
|                        |       | Level 1                            |                            | Level 2 |   | Level 3 |   |
|                        |       |                               | ** **                      | **(unaudited)** |   |   |   |
|                        |       |                               | ** **                      | ** ** |   |   |   |
|                        |       |                               | ** **                      | **(in  thousands)** |   |   |   |
|                        |       |                               |                            |   |   |   |   |
| Other current liabilities   |       |   $                      | -      |   |   $ | 7,232  |   |   $ | -      |   |
|                        |       |                               |                            |   |   |   |   |
| Other long-term liabilities |       |   $                      | 2,612                      |   |   $ | 3,691  |   |   $ | -      |   |

 

The following table presents the Company’s financial assets andliabilities that were accounted for at fair value on a recurring basis as ofDecember 31, 2009 by level within the fair value hierarchy:

 
|                        | ** ** | **Fair  Value Measurements Using** |                            |
|-----------------------------|------------|------------------------------------|---------------------------------|
|                        |       | Level 1                            |                            | Level 2 |   | Level 3 |   |
|                        |       |                               | ** **                      | **(in  thousands)** |   |   |   |
|                        |       |                               |                            |   |   |   |   |
| Other current liabilities   |       |   $                      | -      |   |   $ | -      |   |   $ | -      |   |
|                        |       |                               |                            |   |   |   |   |
| Other long-term liabilities |       |   $                      | 2,337                      |   |   $ | 14,679  |   |   $ | -      |   |

 

Thefollowing is a description of the valuation methodologies used for these items,as well as the general classification of such items pursuant to the fair valuehierarchy of the standard on fair value measurements and disclosures:

 

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**GENERAL NUTRITION CENTERS, INC. ANDSUBSIDIARIES**

**NOTES TO THE CONSOLIDATED FINANCIALSTATEMENTS (UNAUDITED)**

 

*Other Current Liabilities and Other Long-term Liabilities*. Otherlong-term liabilities classified as Level 1 consist of liabilities related tothe Company’s non-qualified deferred compensation plan. The liabilities relatedto this plan are adjusted based on changes in the fair value of the underlyingemployee-directed investment choices. Since the employee-directed investmentchoices are exchange traded equity indexes with quoted prices in activemarkets, the liabilities are classified as Level 1 on the fair value hierarchy.Other current liabilities and other long-term liabilities classified as Level 2consist of the Company’s interest rate swaps. The derivatives are pay-fixed,receive-variable interest rate swaps based on a LIBOR rate. Fair value is basedon a model-derived valuation using the LIBOR rate, which is an observable inputin an active market. Therefore, the Company’s derivative is classified as Level2 on the fair value hierarchy.

 

Inaddition to the above table, the Company’s financial instruments also consistof cash and cash equivalents, accounts receivable, accounts payable andlong-term debt.  The Company did notelect to value its long-term debt with the fair value option in accordance withthe standard on financial instruments. The Company believes that the recorded values of all of its otherfinancial instruments approximate their fair values because of their nature andrespective durations.

 

**NOTE 13. RELATED PARTY TRANSACTIONS**

 

*Management Services Agreement.*  In connection with the Merger, the Companyentered into a Management Services Agreement with Parent.  Under the terms of the agreement, Parentprovides the Company and its subsidiaries with certain services in exchange foran annual fee of $1.5 million, as well as customary fees for services renderedin connection with certain major financial transactions, plus reimbursement ofexpenses and a tax gross-up relating to a non-tax deductible portion of thefee.  The Company provides customaryindemnifications to Parent and its affiliates and those providing services onits behalf.  In addition, uponconsummation of the Merger, the Company incurred an aggregate fee of $10.0million, plus reimbursement of expenses, payable to Parent for servicesrendered in connection with the Merger. For each of the nine months ended September 30, 2010 and 2009, $1.1million was paid pursuant to this agreement.

 

*Credit Facility. *Uponconsummation of the Merger, the Company entered into a $735.0 million creditagreement, under which various funds affiliated with one of the Company’ssponsors, ACOF, are lenders.  As of September 30,2010, certain affiliates of ACOF held approximately $62.1 million of term loansunder the Company’s 2007 Senior Credit Facility.

 

*Lease Agreements. *GeneralNutrition Centres Company, a wholly owned subsidiary of the Company, is partyto 20 lease agreements, as lessee, with Cadillac Fairview Corporation, aslessor, with respect to properties located in Canada (the “Lease Agreements”).  Cadillac Fairview Corporation is a direct,wholly owned subsidiary of OTPP, one of the principal stockholders ofParent.  For the nine months ended September 30,2010 and 2009, the Company paid $2.1 million and $1.8 million, respectively,under the Lease Agreements.  Each leasewas negotiated in the ordinary course of business on an arm’s length basis.

 

*Product Purchases*.  The Company purchases certain fish oil andprobiotics products manufactured by Lifelong Nutrition, Inc. (“Lifelong”)for resale under the Company’s proprietary brand name WELLbeING. CarmenFortino, who serves as one of the directors of the Company and its Parent, isthe Managing Director, a member of the Board of Directors and a stockholder ofLifelong.  For the nine months ended September 30,2010 and 2009, the Company made $1.9 million and $2.7 million, respectively, inproduct purchases from Lifelong, excluding purchases pursuant to the LifelongAgreement (as defined below).

 

*Product Development and Distribution Agreement*.  On June 3, 2010, General NutritionCorporation, a wholly owned subsidiary of the Company, and Lifelong enteredinto a Product Development and Distribution Agreement (the “Lifelong Agreement”),pursuant to which General Nutrition Corporation and Lifelong will develop abranded line of supplements to be manufactured by Lifelong.  As described above, Mr. Fortino is theManaging Director, a member of the Board of Directors and a stockholder ofLifelong.  Products manufactured under theLifelong Agreement and sold in the Company’s stores will be purchased by theCompany from Lifelong; products sold outside of the Company’s stores will besubject to certain revenue sharing arrangements.  For the nine months ended September 30,2010, the Company made $1.2 million in product purchases from Lifelong underthe Lifelong Agreement.

 

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**Item 2.   Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations should be read in conjunction with Item 1, “Financial Statements” inPart I of this quarterly report on Form 10-Q.

 

**Forward-Looking Statements**

 

Thediscussion in this section contains forward-looking statements that involverisks and uncertainties.  Forward-lookingstatements 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 beidentified by the use of terminology such as “subject to,” “believe,” “anticipate,”“plan,” “expect,” “intend,” “estimate,” “project,” “may,” “will,” “should,” “would,”“could,” “can,” the negatives thereof, variations thereon and similarexpressions, or by discussions of strategy.

 

Allforward-looking statements, including, without limitation, our examination ofhistorical operating trends, are based upon our current expectations andvarious assumptions. We believe there is a reasonable basis for ourexpectations and beliefs, but they are inherently uncertain. We may not realizeour expectations, and our beliefs may not prove correct. Actual results coulddiffer materially from those described or implied by such forward-lookingstatements. Factors that may materially affect such forward-looking statementsinclude, among others:

 

·                            significantcompetition in our industry;

 

·                            unfavorablepublicity or consumer perception of our products;

 

·                            increases inthe cost of borrowings and limitations on availability of additional debt orequity capital;

 

·                            our debtlevels and restrictions in our debt agreements;

 

·                            theincurrence of material product liability and product recall costs;

 

·                            loss orretirement of key members of management;

 

·                            costs ofcompliance and our failure to comply with new and existing governmentalregulations including, but  not limitedto, tax regulations;

 

·                            costs oflitigation and the failure to successfully defend lawsuits and other claimsagainst us;

 

·                            the failureof our franchisees to conduct their operations profitably and limitations onour ability to terminate or  replaceunder-performing franchisees;

 

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

 

·                            our failureto keep pace with the demands of our customers for new products and services;

 

·                            disruptionsin our manufacturing system or losses of manufacturing certifications;

 

·                            disruptionsin our distribution network;

 

·                            the lack oflong-term experience with human consumption of ingredients in some of ourproducts;

 

·                            increases inthe frequency and severity of insurance claims, particularly claims for whichwe are self-insured;

 

·                            the failureto adequately protect or enforce our intellectual property rights againstcompetitors;

 

·                            changes inraw material costs and pricing of our products;

 

26

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·         failure tosuccessfully execute our growth strategy, including any delays in our plannedfuture growth, testing and development of our new store formats, any inabilityto expand out franchise operations or attract new franchisees, or any inabilityto expand our company-owned retail operations;

 

·         changes inapplicable laws relating to our franchise operations;

 

·         damage orinterruption to our information systems;

 

·         the impactof current economic conditions on our business;

 

·         naturaldisasters, unusually adverse weather conditions, pandemic outbreaks, boycottsand geo-political events; and

 

·         our failureto maintain effective internal controls.

 

Wecaution that these forward-looking statements, and those described elsewhere inthis report, involve material risks and uncertainties and are subject to changebased on factors beyond our control as discussed within Item 1A of Part IIof this Quarterly Report on Form 10-Q and Item 1A of our Annual Report on Form 10-Kfor the year ended December 31, 2009. Consequently, forward-looking statements should be regarded solely asour current plans, estimates, and beliefs. You should not place undue relianceon forward-looking statements. We cannot guarantee future results, events,levels of activity, performance, or achievements. We do not undertake andspecifically decline any obligation to update, republish, or reviseforward-looking statements to reflect future events or circumstances or toreflect the occurrences of unanticipated events.

 

**Business Overview**

 

We are a leading global specialty retailer of nutritional supplements,which include VMHS, sports nutrition products, diet products, and otherwellness products. We derive our revenues principally from product salesthrough our company-owned stores and online through www.gnc.com, franchiseactivities, and sales of products manufactured in our facilities to thirdparties. We sell products through a worldwide network of more than 7,100locations operating under the GNC brand name.

 

***Revenuesand Operating Performance from our Business Segments***

 

We measure our operating performance primarily throughrevenues and operating income from our three business segments, Retail,Franchise, and Manufacturing/Wholesale, and through the management ofunallocated costs from our warehousing, distribution and corporate segments, asfollows:

 

·           Retailrevenues are generated by sales to consumers at our company-owned stores andonline through www.gnc.com. Although we believe that our retail and franchisebusinesses are not seasonal in nature, historically we have experienced, andexpect to continue to experience, a substantial variation in our net sales andoperating results from quarter to quarter, with the first half of the yearbeing stronger than the second half of the year. As a leader in our industry,we expect our retail revenue growth to be consistent with projected industrygrowth as a result of our disproportionate market share, scale economies inpurchasing and advertising, strong brand awareness, and vertical integration.

 

·            Franchiserevenues are generated primarily from:

 

(1)             productsales to our franchisees;

 

(2)             royalties onfranchise retail sales; and

 

(3)             franchisefees, which are charged for initial franchise awards, renewals, and transfersof franchises.

 

Since we do notanticipate the number of our domestic franchised stores to grow substantially,we expect our domestic franchise revenue growth will be consistent with projectedindustry growth and will be generated by royalties on franchise retail salesand product sales to our existing franchisees. As a result of our efforts toexpand our international presence, we expect to increase the

 

27

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number of our internationalfranchised stores over the next five years which we believe will result in additionalfranchise fees associated with new store openings and increased revenues fromproduct sales to new franchisees. As international franchise trends continue toimprove, we also anticipate that franchise revenue from international operationswill be driven by increased product sales to our franchisees.  Since our international franchisees payroyalties to us in U.S. dollars, any strengthening of the U.S. dollar relativeto our franchisees’ local currency may offset some of the growth in royaltyrevenue.

 

·           Manufacturing/wholesalerevenues are generated through sales of manufactured products to third parties,generally for third-party private label brands, and the sale of our proprietaryand third-party products to and through Rite Aid and www.drugstore.com, and thesale of our proprietary products to and through PetSmart. License fee revenuefrom the opening of GNC franchised store-within-a-store locations within RiteAid stores is also recorded in this segment. Our revenues generated by our manufacturing and wholesale operations aresubject to our available manufacturing capacity.

 

A significant portion of our business infrastructure iscomprised of fixed operating costs. Our vertically integrated distributionnetwork and manufacturing capacity can support higher sales volume withoutsignificant incremental costs. We therefore expect our operating expenses togrow at a lesser rate than our revenues, resulting in significant operatingleverage in our business.

 

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

 

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

 

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

 

·    the effects of favorable andunfavorable publicity on consumer demand with respect to the products we offermay have similarly favorable or unfavorable effects on our operatingperformance;

 

·    alack of long-term experience with human consumption of ingredients insome of our products could create uncertainties with respect to the healthrisks, if any, related to the consumption of such ingredients and negativelyaffect our operating performance;

 

·    increasedcosts associated with complying with new and existing governmentalregulation may negatively affect our operating performance; and

 

·    a decline in disposable incomeavailable to consumers may lead to a reduction in consumer spending andnegatively affect our performance.

 

**Executive Overview**

 

The third quarter of 2010 continued the recent trendsof the business, led by the domestic retail unit posting its 21st consecutive quarterof positive same store sales growth, and the retail and franchise businessesdriving higher revenue and operating income.

 

Thefirst nine months of 2010 resulted in revenue growth of 6.4%, operating incomegrowth of 21.1%, and net income growth of 37.6% compared to the same period in2009. Operating income growth resulted from higher sales and margins in ourretail and franchise segments and effective cost controls on unallocatedexpenses. Net income growth resulted primarily from higher operating income andlower interest expense.

 

Revenuegrowth occurred primarily in our domestic retail segment and has been drivenprimarily by increases in the sports nutrition category, resulting from boththird party and proprietary new product introductions. In addition, we haveexperienced significant growth in our www.gnc.com business primarily as aresult of our redesigned website.  Ourdomestic retail comparable store sales increased 5.5% in the first nine monthsof 2010 as compared to the same period in 2009. Included in this increase is a 24.5% increase in our www.gnc.combusiness.  This sales increase, alongwith increased margins, contributed greatly to the overall retail segmentoperating income increase of 19.4% in the first nine months of 2010 compared tothe same period in 2009.

 

28

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Inthe first nine months of 2010, our franchise segment continued to demonstratethe trends observable in 2009, with the domestic franchise businessexperiencing increasing product sales despite a lower store base.  The international franchise businesscontinued to grow, and reflected higher wholesale product sales as a result ofan increased store base and same store sales growth.  We added 94 net new international stores inthe first nine months of 2010.  Thecombined franchise segment revenue grew 10.7%, and operating income grew 17.0%in the first nine months of 2010 over the same period in 2009.

 

In the first nine months of 2010, our manufacturingsegment experienced reduced sales in contract manufacturing compared with thefirst nine months of 2009, partially offset by higher product sales to Rite Aidand www.drugstore.com.  The reduction in thecontract manufacturing business reflects a transition period during which weare moving from low margin commodity contracts to higher margin, specialtyproduct contracts.

 

Inthe first quarter of 2010, we announced an alliance with The Gatorade Company (“Gatorade”),a division of PepsiCo, to launch G Series Pro – a new sports drink variantof Gatorade’s recently launched G Series. In the second quarter of 2010, G Series Pro was distributed throughan exclusive co-marketing and co-distribution collaboration between Gatoradeand us, utilizing our network of more than 5,500 outlets nationwide.

 

Inthe second quarter, GNC and PetSmart announced the launch of a line of dietarysupplements designed for dogs and cats. This new line, which recognizes theunique dietary needs of pets, is made exclusively for PetSmart and was launchedat PetSmart and www.petsmart.com in the fall of 2010. 

 

Webelieve that the strength of our company and its leadership position in thehealth and wellness sector provide significant future opportunities tocapitalize on favorable demographics and consumer trends.  In our experience, and as our results inrecent months show, our customers have continued to focus on their personalhealth and well-being during economic downturns; nonetheless, a continueddownturn or an uncertain outlook in the economy may materially and adverselyaffect our business and financial results.

 

Ourresults depend on a number of factors impacting consumer spending, including,but not limited to, general economic and business conditions, consumerconfidence, consumer debt levels, availability of consumer credit, and thelevel of customer traffic within malls and other shopping environments.  Consumer purchases of products, includingours and those of our partners, may decline during recessionary periods.

 

Ifconsumer purchases of products decline, we could be impacted in the followingways:

 

·                  retail sales at ourcompany stores and through our website could decline;

 

·                  demand for ourbranded products produced at our manufacturing plant could decline;

 

·                  demand for productsproduced for distributors and other retailers / wholesalers could diminish;

 

·                  our domesticfranchisees may choose not to renew their franchise licenses, which in turnwould lower our franchise product revenue; and

 

·                  our internationalfranchisees may experience decreased revenue resulting in lower royalties andproduct revenue to us; additionally, a strengthening of the U.S. dollar mayimpact us, as our international franchisees purchase inventory from and payroyalties to us in U.S. dollars.

 

InMay 2009, the FDA warned consumers to stop using certain Hydroxycutproducts, produced by Iovate Health Sciences, Inc., which were sold in ourstores.  Iovate issued a voluntaryrecall, with which we immediately fully complied.  Sales of the recalled Hydroxycut productsamounted to approximately $57.8 million, or 4.7% of our retail sales in 2008and $18.8 million, or 4.2% of our retail sales in the first four months of2009.  We provided refunds or gift cardsto consumers who returned these products to our stores.  In the second quarter of 2009, we experienceda reduction in sales and margin due to the recall as a result of acceptingreturns of products from customers and a loss of sales as a Hydroxycutreplacement product was not available. Through December 31, 2009, we had refunded approximately $3.5million to our retail customers and approximately $1.6 million to our wholesalecustomers for Hydroxycut product returns. A significant majority of the retail refunds occurred in our secondquarter of 2009; the wholesale refunds were recognized in the early part of thethird quarter of 2009.  All returns ofproduct by our customers were recognized as a reduction in sales in the periodwhen the return occurred.  At the end of September 2009, Iovatelaunched new reformulated Hydroxycut products that we began to sell in ourstores.  Although post-recall sales ofthe new reformulated Hydroxycut have trailed pre-recall levels, strong sales inour core sports, vitamins and herbs products, along with other new third partydiet products, helped to mitigate the decrease in sales from the Hydroxycutproduct line.

 

29

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In the near term,we expect to concentrate on our primary strategies, focusing particularly on:

 

·      drivingtop-line performance in each of our business segments by attracting newcustomers through product innovation and the introduction of new,scientifically backed products, improved product assortment, effectivemarketing campaigns designed to increase traffic at our and our franchisees’stores and awareness of the GNC brand, and price competitiveness;

 

·      investing inkey infrastructure areas for future growth, including e-commerce andinternational development; and

 

·      generatingefficiencies and cost savings in the everyday operations of the business thatwill allow us to leverage profit margins on revenue growth.

 

We will continue toseek improvements in each of the business segments and position ourselves forlong term growth.

 

**Related Parties**

 

For the nine months ended September 30,2010 and 2009, we had related party transactions with ACOF and OTPP and theiraffiliates. For further discussion of these transactions, see Item 13, “CertainRelationships and Related Transactions and Director Independence” and the “RelatedParty Transactions” note in our Annual Report on Form 10-K for the yearended December 31, 2009.

 

**Results of Operations**

 

The following information presentedfor the three and nine months ended September 30, 2010 and 2009 wasprepared by management and is unaudited. In the opinion of management, all adjustments necessary for a fairstatement of our financial position and operating results for such periods andas of such dates have been included.

 

As discussed in the “Segments” noteto our consolidated financial statements, we evaluate segment operating resultsbased on several indicators. The primary key performance indicators arerevenues and operating income or loss for each segment. Revenues and operatingincome or loss, as evaluated by management, exclude certain items that aremanaged at the consolidated level, such as warehousing and transportationcosts, impairments, and other corporate costs. The following discussioncompares the revenues and the operating income or loss by segment, as well asthose items excluded from the segment totals.

 

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**Results of Operations**

(Dollars in millions and percentages expressed as a percentage oftotal net revenues)

 
| ** **                                                              | ** ** | **Three Months Ended** | ** **     | **Nine Months Ended** |
|-------------------------------------------------------------------------|------------|----------------------------------|----------------|---------------------------------|
| ** **                                                              | ** ** | **September 30,  2010**     | ** **     | **September 30,  2009**    | ** ** | **September 30,  2010** | ** ** | **September 30,  2009** |
| ** **                                                              | ** ** | **(unaudited)**                  |
| **Revenues:**                                                           |       |                             |           |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retail                                                                  |       | $                                | 338.2          |                            |   | 72.6% |   |   | $ |  312.0 |   |   | 72.4% |   |   | $ | 1,031.9 |   |   | 74.4% |   |   | $ | 962.6 |   |   | 73.9% |   |
| Franchise                                                               |       | 77.0                             |           |                            | 16.5% |   |   | 67.3 |   |   | 15.6% |   |   | 222.6 |   |   | 16.1% |   |   | 201.0 |   |   | 15.4% |   |
| Manufacturing / Wholesale                                               |       | 50.5                             |           |                            | 10.9% |   |   | 51.5 |   |   | 12.0% |   |   | 132.2 |   |   | 9.5% |   |   | 139.5 |   |   | 10.7% |   |
| **Total net revenues**                                                  | ** ** | **465.7**                        | ** **     | ** **                      | **100.0%** | ** ** | ** ** | **430.8** | ** ** | ** ** | **100.0%** | ** ** | ** ** | **1,386.7** | ** ** | ** ** | **100.0%** | ** ** | ** ** | **1,303.1** | ** ** | ** ** | **100.0%** | ** ** |
| ** **                                                              |       |                             |           |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Operating expenses:**                                                 |       |                             |           |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of sales, including warehousing, distribution and occupancy  costs |       | 302.7                            |           |                            | 65.0% |   |   | 282.6 |   |   | 65.6% |   |   | 894.0 |   |   | 64.5% |   |   | 849.2 |   |   | 65.2% |   |
| Compensation and related benefits                                       |       | 69.2                             |           |                            | 14.9% |   |   | 65.5 |   |   | 15.2% |   |   | 204.6 |   |   | 14.8% |   |   | 196.3 |   |   | 15.1% |   |
| Advertising and promotion                                               |       | 10.6                             |           |                            | 2.3% |   |   | 11.0 |   |   | 2.6% |   |   | 40.2 |   |   | 2.9% |   |   | 40.2 |   |   | 3.1% |   |
| Other selling, general and administrative expenses                      |       | 22.2                             |           |                            | 4.7% |   |   | 22.0 |   |   | 5.1% |   |   | 68.5 |   |   | 4.9% |   |   | 66.7 |   |   | 5.1% |   |
| Amortization expense                                                    |       | 1.9                              |           |                            | 0.4% |   |   | 2.3 |   |   | 0.5% |   |   | 5.9 |   |   | 0.4% |   |   | 7.3 |   |   | 0.5% |   |
| Foreign currency (gain) loss                                            |       | (0.1                             | )              |                            | 0.0% |   |   | -     |   |   | 0.0% |   |   | (0.1 | ) |   | 0.0% |   |   | -     |   |   | 0.0% |   |
| **Total operating expenses**                                            | ** ** | **406.5**                        | ** **     | ** **                      | **87.3%** | ** ** | ** ** | **383.4** | ** ** | ** ** | **89.0%** | ** ** | ** ** | **1,213.1** | ** ** | ** ** | **87.5%** | ** ** | ** ** | **1,159.7** | ** ** | ** ** | **89.0%** | ** ** |
| ** **                                                              |       |                             |           |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Operating income:**                                                   |       |                             |           |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retail                                                                  |       | 47.7                             |           |                            | 10.2% |   |   | 37.3 |   |   | 8.7% |   |   | 147.3 |   |   | 10.6% |   |   | 123.3 |   |   | 9.5% |   |
| Franchise                                                               |       | 26.3                             |           |                            | 5.7% |   |   | 22.5 |   |   | 5.2% |   |   | 71.7 |   |   | 5.2% |   |   | 61.2 |   |   | 4.7% |   |
| Manufacturing / Wholesale                                               |       | 17.9                             |           |                            | 3.8% |   |   | 18.9 |   |   | 4.4% |   |   | 51.1 |   |   | 3.7% |   |   | 54.1 |   |   | 4.1% |   |
| Unallocated corporate and other costs:                                  |       |                             |           |                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Warehousing and distribution costs                                      |       | (13.8                            | )              |                            | -3.0% |   |   | (13.5 | ) |   | -3.2% |   |   | (41.5 | ) |   | -3.0% |   |   | (40.5 | ) |   | -3.1% |   |
| Corporate costs                                                         |       | (18.9                            | )              |                            | -4.0% |   |   | (17.8 | ) |   | -4.1% |   |   | (55.0 | ) |   | -3.9% |   |   | (54.7 | ) |   | -4.2% |   |
| Subtotal unallocated corporate and other costs, net                     |       | (32.7                            | )              |                            | -7.0% |   |   | (31.3 | ) |   | -7.3% |   |   | (96.5 | ) |   | -6.9% |   |   | (95.2 | ) |   | -7.3% |   |
| **Total operating income**                                              | ** ** | **59.2**                         | ** **     | ** **                      | **12.7%** | ** ** | ** ** | **47.4** | ** ** | ** ** | **11.0%** | ** ** | ** ** | **173.6** | ** ** | ** ** | **12.6%** | ** ** | ** ** | **143.4** | ** ** | ** ** | **11.0%** | ** ** |
| Interest expense, net                                                   |       | 16.3                             |           |                            |   |   |   | 16.9 |   |   |   |   |   | 49.3 |   |   |   |   |   | 53.0 |   |   |   |   |
| **Income before income taxes**                                          | ** ** | **42.9**                         |           |                            |   | ** ** | ** ** | **30.5** |   |   |   | ** ** | ** ** | **124.3** |   |   |   | ** ** | ** ** | **90.4** |   |   |   |   |
| Income tax expense                                                      |       | 16.1                             |           |                            |   |   |   | 11.0 |   |   |   |   |   | 46.0 |   |   |   |   |   | 33.5 |   |   |   |   |
| **Net income**                                                          | ** ** | **$**                            | ** 26.8** |                            |   |   | ** ** | ** ** | **$** | ** 19.5** |   |   |   | ** ** | ** ** | **$** | **78.3** |   |   |   | ** ** | ** ** | **$** | **56.9** |   |   |   |   |

 

**Note:** The numbers in the above table have been rounded tomillions.  All calculations related tothe Results of Operations for the year-over-year comparisons were derived fromunrounded data and could occasionally differ immaterially if you were to usethe table above for these calculations.

 

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***Comparison of the ThreeMonths Ended September 30, 2010 and 2009***

 

***Revenues***

 

Our consolidated net revenuesincreased $34.9 million, or 8.1%, to $465.7 million for the three months ended September 30,2010 compared to $430.8 million for the same period in 2009.  The increase was the result of increasedsales in our Retail and Franchise segments, partially offset by a decline inour Manufacturing/Wholesale segment.

 

*Retail.*Revenues in our Retail segment increased $26.2 million, or8.4%, to $338.2 million for the three months ended September 30, 2010compared to $312.0 million for the same period in 2009. Domestic retail revenue increased $20.4 million as a resultof an increase in our same store sales and $5.8 million from our non-same storesales.  Included in the increase from2009 to 2010 was an increase in sales of $2.6 million through www.gnc.com. Salesincreases occurred primarily in the sports nutrition product category.  Our domestic company-owned same store salesimproved for the quarter by 7.1%. Canadarevenue decreased $1.5 million in local currency as a result of a decrease inour same store sales and increased $0.1 million in local currency from ournon-same store sales. In the third quarter of 2010, ourCanadian company-owned stores had a same store sales decline of 6.2% in localcurrency.  This decline was more thanoffset by the weakening of the U.S. dollar from 2009 to 2010.  Our company-owned store base increased by 62domestic stores to 2,702 compared to 2,640 at September 30, 2009,primarily due to new store openings and franchise store acquisitions.  Our Canadian store base increased to 169 at September 30,2010 compared to 166 at September 30, 2009.

 

*Franchise.*Revenues in our Franchise segmentincreased $9.7 million, or 14.3%, to $77.0 million for the three months ended September 30,2010 compared to $67.3 million for the same period in 2009. Domestic franchiserevenue increased by $3.2 million compared to the same period in 2009,primarily due to higher wholesale revenues and fees.  There were 897 stores at September 30,2010 compared to 919 stores at September 30, 2009.   International franchise revenue increased by$6.5 million, primarily the result of increases in product sales and royalties.Our international franchise store base increased by 144 stores to 1,401 at September 30,2010 compared to 1,257 at September 30, 2009.

 

*Manufacturing/Wholesale.*  Revenues in our Manufacturing/Wholesalesegment, which includes third-party sales from our manufacturing facilities inSouth Carolina, as well as wholesale sales to Rite Aid, PetSmart, andwww.drugstore.com, decreased $1.0 million, or 1.9%, to $50.5 million for thethree months ended September 30, 2010 compared to $51.5 million for thesame period in 2009. Third party sales from the South Carolina manufacturing plantdecreased by $5.3 million, partially offset by an increase in wholesale revenueof $4.3 million.

 

***Cost of Sales***

 

Consolidated cost of sales, whichincludes product costs, costs of warehousing and distribution and occupancycosts, increased $20.1 million, or 7.1%, to $302.7 million for the three monthsended September 30, 2010 compared to $282.6 million for the same period in2009.  Consolidated cost of sales, as apercentage of net revenue, was 65.0% and 65.6% for the three months ended September 30,2010 and 2009, respectively.  Theincrease in cost of sales was primarily due to higher sales volumes and storecounts.

 

***Selling, General andAdministrative******(“SG&A”)******Expenses***

 

Our consolidated SG&A expenses, includingcompensation and related benefits, advertising and promotion expense, otherselling, general and administrative expenses, and amortization expense,increased $3.1 million, or 3.1%, to $103.9 million, for the three months ended September 30,2010 compared to $100.8 million for the same period in 2009.  These expenses, as a percentage of netrevenue, were 22.3% for the three months ended September 30, 2010 comparedto 23.4% for the three months ended September 30, 2009.

 

*Compensation and related benefits.*  Compensation and related benefits increased$3.7 million, or 5.7%, to $69.2 million for the three months ended September 30,2010 compared to $65.5 million for the same period in 2009. Increases occurredin (1) base wages of $1.8 million to support our increased store base andsales volume; (2) health insurance expenses of $0.5 million; and (3) incentives,non cash compensation, and severance of $1.4 million.

 

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*Advertising and promotion.* Advertising and promotion expenses decreased $0.4 million, or 3.6%, to$10.6 million for the three months ended September 30, 2010 compared to$11.0 million during the same period in 2009.

 

*Other SG&A.* Other SG&A expenses, including amortization expense, decreased $0.2million, or 0.7%, to $24.1 million for the three months ended September 30,2010 compared to $24.3 million for the same period in 2009.  This decrease was due to decreases indepreciation and amortization expense of $0.9 million and other selling costsof $0.5 million. These were offset by increases in third party salescommissions of $0.7 million and banking fees of $0.5 million.

 

***ForeignCurrency (Gain) Loss***

 

Foreigncurrency (gain) loss for the three months ended September 30, 2010 and2009 resulted primarily from accounts payable activity with our Canadiansubsidiary.

 

***Operating Income***

 

As a result of the foregoing,consolidated operating income increased $11.8 million, or 25.0%, to $59.2million for the three months ended September 30, 2010 compared to $47.4million for the same period in 2009. Operating income, as a percentage of net revenue, was 12.7% and 11.0%for the three months ended September 30, 2010 and 2009, respectively.

 

*Retail.*Operating income increased $10.4million, or 28.0%, to $47.7 million for the three months ended September 30,2010 compared to $37.3 million for the same period in 2009. The increase wasdue to higher dollar margins on increased sales offset by increases inoccupancy and other selling expenses.

 

*Franchise.*Operating income increased $3.8 million, or 17.1%, to $26.3million for the three months ended September 30, 2010 compared to $22.5million for the same period in 2009.  Theincrease was due to increased wholesale product sales and increased royaltyincome.

 

*Manufacturing/Wholesale.*Operatingincome decreased $1.0 million, or 5.1%, to $17.9 million for the three monthsended September 30, 2010 compared to $18.9 million for the same period in2009 as declines in third party sales from our South Carolina manufacturingoperations were partially offset by wholesale sales.

 

*Warehousingand Distribution Costs.*Unallocated warehousing anddistribution costs increased $0.3 million, or 2.6%, to $13.8 million for thethree months ended September 30, 2010 compared to $13.5 million for thethree months ended September 30, 2009.

 

*Corporate Costs.*Corporate overheadcosts increased $1.1 million, or 6.4%, to $18.9 million for the three monthsended September 30, 2010 compared to $17.8 million for the same period in2009. This increase was due to increases in compensation expenses offset bydecreases in other selling, general and administrative expenses.

 

***Interest Expense***

 

Interestexpense decreased $0.6 million, or 3.2%, to $16.3 million for the three monthsended September 30, 2010 compared to $16.9 million for the same period in2009. This decrease was primarily attributable to decreases in interest rateson our variable rate debt in 2010 as compared to 2009 along with a reduction inoutstanding debt of approximately $6.3 million from the prior year period.

 

***Income Tax Expense***

 

We recognized $16.1 million ofincome tax expense (or 37.6% of pre-tax income) during the three months ended September 30,2010 compared to $11.0 million (or 36.0% of pre-tax income) for the same periodof 2009.

 

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*** ***

***Net Income***

 

As a result of the foregoing,consolidated net income increased $7.3 million to $26.8 million for the threemonths ended September 30, 2010 compared to $19.5 million for the sameperiod in 2009.

 

***Comparison of theNine Months Ended September 30, 2010 and 2009***

 

***Revenues***

 

Our consolidated net revenuesincreased $83.6 million, or 6.4%, to $1,386.7 million for the nine months endedSeptember 30, 2010 compared to $1,303.1 million for the same period in2009.  The increase was the result ofincreased sales in our Retail and Franchise segments, partially offset by adecline in our Manufacturing/Wholesale segment.

 

*Retail.*Revenues in our Retail segment increased $69.3 million, or7.2%, to $1,031.9 million for the nine months ended September 30, 2010 comparedto $962.6 million for the same period in 2009. Domestic retail revenue increased $49.2 million as a result of anincrease in our same store sales and $13.2 million from our non-same storesales.  Included in the increase from2009 to 2010 was an increase in sales of $8.5 million through www.gnc.com. Salesincreases occurred primarily in the sports nutrition and vitaminscategories.  Our domestic company-ownedsame store sales, including our internet sales, improved by 5.5% for the ninemonths ended September 30, 2010 compared to the same period in 2009.  Canadarevenue decreased $3.8 million in local currency as a result of a decrease inour same store sales and increased $2.3 million in local currency from ournon-same store sales.  Our Canadiancompany-owned same store sales declined by 5.0%, in local currency, for thenine months ended September 30, 2010 compared to the same period in 2009.This decline was more than offset by the weakening of the U.S. dollar from 2009to 2010.  Our company-owned store baseincreased by 62 domestic stores to 2,702 at September 30, 2010 compared to2,640 at September 30, 2009, primarily due to new store openings andfranchise store acquisitions, and by three Canadian stores to 169 at September 30,2010 compared to 166 at September 30, 2009.

 

*Franchise.*Revenues in our Franchise segmentincreased $21.6 million, or 10.7%, to $222.6 million for the nine months ended September 30,2010 compared to $201.0 million for the same period in 2009. Domestic franchiserevenue increased by $5.1 million for the nine months ended September 30,2010 compared to the same period in 2009 due to increased product sales andfranchise fee revenues.  There were 897stores at September 30, 2010 compared to 919 stores at September 30,2009.  International franchise revenueincreased by $16.5 million for the first nine months of 2010 compared to thesame period in 2009 primarily as a result of increases in product sales.  Our international franchise store baseincreased by 144 stores to 1,401 at September 30, 2010 compared to 1,257at September 30, 2009.

 

*Manufacturing/Wholesale.*  Revenues in our Manufacturing/Wholesalesegment, which includes third-party sales from our manufacturing facility inSouth Carolina, as well as wholesale sales to Rite Aid and www.drugstore.com,decreased $7.3 million, or 5.2%, to $132.2 million for the nine months ended September 30,2010 compared to $139.5 million for the same period in 2009.  Third party sales decreased in the SouthCarolina manufacturing plant by $16.8 million. This was partially offset by anincrease in wholesale revenue of $9.5 million.

 

***Cost of Sales***

 

Consolidated cost of sales, whichincludes product costs, costs of warehousing and distribution and occupancycosts, increased $44.8 million, or 5.3%, to $894.0 million for the nine monthsended September 30, 2010 compared to $849.2 million for the same period in2009.  Consolidated cost of sales, as apercentage of net revenue, was 64.5% and 65.2% for the nine months ended September 30,2010 and 2009, respectively. Increase in cost of sales was primarily due tohigher sales volumes and store counts.

 

***Selling,General and Administrative******(“SG&A”)******Expenses***

 

Our consolidated SG&A expenses,including compensation and related benefits, advertising and promotion expense,other selling, general and administrative expenses, and amortization expense,increased

 

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$8.7 million, or 2.8%, to $319.2 million, for the ninemonths ended September 30, 2010 compared to $310.5 million for the sameperiod in 2009.  These expenses, as apercentage of net revenue, were 23.0% for the nine months ended September 30,2010 compared to 23.8% for the nine months ended September 30, 2009.

 

*Compensation and related benefits.*  Compensation and related benefits increased$8.3 million, or 4.2%, to $204.6 million for the nine months ended September 30,2010 compared to $196.3 million for the same period in 2009. Increases occurredin (1) base wages of $6.2 million to support our increased store base andsales volume; (2) health insurance expenses of $1.0 million; and (3) incentives,non cash compensation, and severance of $0.9 million; and (4) othercompensation expenses of $0.2 million.

 

*Advertising and promotion.* Advertising and promotion expenses remained unchanged at $40.2 millionfor the nine months ended September 30, 2010 compared to the same periodin 2009.

 

*Other SG&A.* Other SG&A expenses, including amortization expense increased $0.4million, or 0.5%, to $74.4 million for the nine months ended September 30,2010 compared to $74.0 million for the same period in 2009.  Increases in other SG&A included thirdparty sales commissions of $2.0 million and banking fees of $1.1 million. Thesewere partially offset by decreases in amortization and depreciation expense of$2.0 million, bad debt of $0.6 million, and other selling expenses of $0.1million.

 

***Foreign Currency (Gain) Loss***

 

Foreigncurrency (gain) loss for the nine months ended September 30, 2010 and 2009resulted primarily from accounts payable activity with our Canadian subsidiary.

 

***Operating Income***

 

As a result of the foregoing,consolidated operating income increased $30.2 million or 21.1% to $173.6million for the nine months ended September 30, 2010 compared to $143.4million for the same period in 2009. Operating income, as a percentage of net revenue, was 12.6% for the ninemonths ended September 30, 2010 and 11.0% for the nine months ended September 30,2009.

 

*Retail.*Operating income increased $24.0million, or 19.4%, to $147.3 million for the nine months ended September 30,2010 compared to $123.3 million for the same period in 2009. The increase wasprimarily the result of higher dollar margins on increased sales volumes offsetby increases in occupancy costs, compensation costs and other SG&Aexpenses.

 

*Franchise.*Operating income increased $10.5 million, or 17.0%, to $71.7million for the nine months ended September 30, 2010 compared to $61.2million for the same period in 2009. This increase was due to increases in royalty income, higher dollarmargins on increased product sales to franchisees and reductions in bad debtexpenses and amortization expense.

 

*Manufacturing/Wholesale.*Operating income decreased $3.0 million, or 5.4%, to $51.1million for the nine months ended September 30, 2010 compared to $54.1million for the same period in 2009. This decrease was primarily the result of lower margins on decreasedsales volumes from our South Carolina manufacturing facility.

 

*Warehousingand Distribution Costs.*Unallocated warehousing anddistribution costs increased $1.0 million, or 2.4%, to $41.5 million for the ninemonths ended September 30, 2010 compared to $40.5 million for the sameperiod in 2009.  The increase in costswas primarily due to increases in fuel costs.

 

*Corporate Costs.*Corporate overheadcosts increased $0.3 million, or 0.4%, to $55.0 million for the nine monthsended September 30, 2010 compared to $54.7 million for the same period in2009. This increase was due to increases in compensation expenses, offset bydecreases in other selling, general, and administrative expenses.

 

***InterestExpense***

 

Interestexpense decreased $3.7 million, or 7.0%, to $49.3 million for the nine monthsended September 30, 2010 compared to $53.0 million for the same period in2009. This decrease was primarily attributable to decreases in interest rateson our variable rate debt in 2010 as compared to 2009.

 

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***IncomeTax Expense***

 

We recognized $46.0 million (or37.0% of pre-tax income) of consolidated income tax expense during the ninemonths ended September 30, 2010 compared to $33.5 million (or 37.0% ofpre-tax income) for the same period of 2009.

 

***Net Income***

 

As a result of the foregoing,consolidated net income increased $21.4 million to $78.3 million for the ninemonths ended September 30, 2010 compared to $56.9 million for the sameperiod in 2009.

 

**Liquidity and Capital Resources**

 

AtSeptember 30, 2010, we had $121.7 million in cash and cash equivalents and$446.6 million in working capital, compared with $75.1 million in cash and cashequivalents and $382.6 million in working capital at December 31, 2009.The $64.0 million increase in our working capital was driven by increases inour accounts receivable, inventory and cash and a decrease in our accruedinterest. This was offset by increases in our accounts payable and accruedpayroll and a reduction in our prepaid income taxes.

 

Weexpect to fund our operations through internally generated cash and, ifnecessary, from borrowings under our $60.0 million revolving credit facility(the “Revolving Credit Facility”).  At September 30,2010, we had $44.7 million available under the Revolving Credit Facility, aftergiving effect to $9.0 million utilized to secure letters of credit and a $6.3million commitment from subsidiaries of Lehman Brothers Holdings Inc.(collectively, “Lehman”) that we do not expect Lehman will fund.

 

Weexpect our primary uses of cash in the near future will be debt servicerequirements, capital expenditures and working capital requirements.  In March 2010, our board of directorsdeclared and paid a $28.4 million dividend to our direct parent company, GNCCorporation. Those funds were then dividended to, and are currently held by,GNC Acquisition Holdings Inc., our ultimate parent company. The dividend waspaid with cash generated from operations.

 

We currently anticipate that cashgenerated from operations, together with amounts available under the RevolvingCredit Facility, will be sufficient for the term of the facility, which matureson March 15, 2012, to meet our operating expenses, capital expenditures anddebt service obligations as they become due. However, our ability to make scheduled payments of principal on, to payinterest on, or to refinance our debt and to satisfy our other debt obligationswill depend on our future operating performance, which will be affected bygeneral economic, financial and other factors beyond our control.  We are currently in compliance with our debtcovenant reporting and compliance obligations under the Revolving CreditFacility.

 

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The following table summarizes ourcash flows for the nine months ended September 30, 2010 and 2009:

 

 
|                                   |   |                          |   |   |                          |          |
|----------------------------------------|--------|-------------------------------|--------|--------|-------------------------------|---------------|
|                                   |   | Nine months              |   |   | Nine months              |          |
|                                   |   | ended September 30, |   |   | ended September 30, |          |
| (Dollars in millions)        |   | 2010                          |   |   | 2009                          |          |
|                                   |   |                          |   |   |                          |          |
| Cash  provided by operating activities |   |   $                 | 97.6   |   |                          |   $ | 77.8 |   |
| Cash  used in investing activities     |   | (21.2                         | )      |   | (22.0                         | )             |
| Cash  used in financing activities     |   | (29.7                         | )      |   | (33.9                         | )             |
|                                   |   |                          |   |   |                          |          |
|                                        |        |                               |        |        |                               |               |  |  |

 

***Cash Provided byOperating Activities***

 

Cashprovided by operating activities was $97.6 million for the nine months ended September 30,2010 and $77.8 million for the nine months ended September 30, 2009. Aprimary reason for the increase in cash provided by operating activities wasthe increase in net income of $21.4 million for the nine months ended September 30,2010 compared to the nine months ended September 30, 2009. Our inventoryincreased by $25.9 million in support of the higher sales volumes and purchasesfor new product introductions. Accounts payable increased by $3.4 million dueto the timing of disbursements and related inventory growth. The above weresupplemented by an increase in our accrued liabilities and a reduction in ourprepaid income taxes.

 

Forthe nine months ended September 30, 2009, the primary reason for the increasein cash provided by operating activities was the increase in net income of$10.3 million as compared to the nine months ended September 30, 2008. Ourinventory increased by $11.0 million in support of the higher sales volumes atthe stores. Accounts payable decreased by $21.0 million due to the timing ofdisbursements; in addition, accrued interest decreased by $9.5 million, as aresult of the semi-annual interest payments on our Senior Toggle Notes and10.75% Senior Subordinated Notes (each as defined below). These were offset byan increase in our accrued liabilities and a reduction in our prepaid incometaxes.

 

***Cash Used inInvesting Activities***

 

Weused cash for investing activities of $21.2 million and $22.0 million for thenine months ended September 30, 2010 and 2009, respectively. Capitalexpenditures, which were primarily for new stores, and improvements to ourretail stores and our South Carolina manufacturing facility, were $21.0 millionand $20.4 million for the nine months ended September 30, 2010 and 2009,respectively.

 

We currently have no materialcapital commitments for the remainder of 2010. Our capital expenditurestypically consist of certain periodic updates in our company-owned stores andongoing upgrades and improvements to our manufacturing facilities.

 

***Cash Used in Financing Activities***

 

Forthe nine months ended September 30, 2010 we used cash of $29.7 million,primarily for a $28.4 million dividend that was declared and paid in March 2010to GNC Corporation, our direct parent. In addition, we made payments of $1.3million on long-term debt, including $0.2 million for an excess cash payment inMarch 2010 under the requirements of the Senior Credit Facility. Thispayment was calculated based on 2009 financial results as defined by the SeniorCredit Facility.

 

Weused cash from financing activities of $33.9 million for the nine months ended September 30,2009 primarily for the following long-term debt payments: (1) $3.8 millionfor an excess cash payment in March 2009 under the requirements of the2007 Senior Credit Facility; (2) $5.4 million for the outstanding balanceon the Revolving Credit Facility in May 2009; and (3) a $9.0 millionoptional prepayment on the 2007 Senior Credit Facility in September 2009.  Also, we paid a $13.6 million dividend in August 2009to GNC Corporation, our direct parent. The following is a summary of our debt:

 

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*$735.0 Million Senior CreditFacility*. The 2007 Senior Credit Facility consists of a $675.0million term loan facility and a $60.0 million Revolving Credit Facility. Theterm loan facility will mature in September 2013. The Revolving CreditFacility will mature in March 2012. Interest on the 2007 Senior Credit Facility accrues at a variable rateand was 2.5% at September 30, 2010. As of September 30, 2010 and December 31, 2009, $9.0 millionand $7.9 million, respectively, of the Revolving Credit Facility were pledgedto secure letters of credit.

 

*Senior Toggle Notes*.  We have outstanding $300.0 million of SeniorFloating Rate Toggle Notes due 2014 at 99% of par value (the “Senior ToggleNotes”).  Interest on the Senior ToggleNotes is payable semi-annually in arrears on March 15 and September 15of each year. Interest on the Senior Toggle Notes accrues at a variable rateand was 5.8% at September 30, 2010. To date, we have elected to make interest payments in cash.

 

*10.75% Senior Subordinated Notes*.  We have outstanding $110.0 million of 10.75%Senior Subordinated Notes due 2015 (“10.75% Senior Subordinated Notes”).  Interest on the 10.75% Senior SubordinatedNotes accrues at the rate of 10.75% per year and is payable semi-annually inarrears on March 15 and September 15 of each year.

 

 

**Contractual Obligations**

 

There are no material changes in our contractualobligations as disclosed in our Annual Report on Form 10-K for the yearended December 31, 2009.

 

**Off Balance Sheet Arrangements**

 

As of September 30, 2010, wehad no relationships with unconsolidated entities or financial partnerships,such as entities often referred to as structured finance or special purposeentities, which would have been established for the purpose of facilitating offbalance sheet arrangements or other contractually narrow or limited purposes.We are, therefore, not materially exposed to any financing, liquidity, marketor credit risk that could arise if we had engaged in such relationships.

 

**Effect of Inflation**

 

Inflation generally affects us byincreasing costs of raw materials, labor and equipment. We do not believe thatinflation had any material effect on our results of operations in the periodspresented in our consolidated financial statements.

 

**Critical Accounting Estimates**

 

Our significant accounting policiesare described in the notes to our consolidated financial statements under theheading “Basis of Presentation and Summary of Significant Accounting Policies”included elsewhere in this report.

 

There have been no material changesto our application of critical accounting policies and significant judgmentsand estimates since those disclosed in the Company’s Annual Report onForm 10-K for the year ended December 31, 2009.

 

**Recently Issued AccountingPronouncements**

 

As of September 30, 2010, therewere no developments related to recently issued accounting standards, includingthe expected dates of adoption and estimated effects on the Company’sconsolidated financial statements, in addition to those disclosed in theCompany’s Annual Report on Form 10-K for the year ended December 31,2009.

 

**Item 3.   Quantitativeand Qualitative Disclosures about Market Risk.**

 

Market risk represents the risk of changes in thevalue of market risk sensitive instruments caused by fluctuations in interestrates, foreign exchange rates and commodity prices. Changes in these factorscould cause fluctuations in the results of our operations and cash flows. Inthe ordinary course of business, we are primarily exposed to foreign currencyand interest rate risks. We do not use derivative financial instruments inconnection with commodity or foreign exchange risks.

 

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Weare exposed to market risks from interest rate changes on our variable ratedebt.  Although changes in interest ratesdo not impact our operating income the changes could affect the fair value ofour interest rate swaps and interest payments. As of September 30, 2010, we had fixed rate debt of $116.1 millionand variable rate debt of $942.6 million.

 

Tomanage this risk, we have entered into interest rate swap agreements. Theseagreements are summarized in the following table:

 
| Derivative         |   | Total Notional Amount |   | Term                           |   | Counterparty Pays |   | Company Pays |
|--------------------|--------|---------------------------------|--------|--------------------------------|--------|------------------------|--------|-------------------|
| Interest Rate Swap |   | $150.0 million                  |   | April 2009-April 2011          |   | 3 month LIBOR          |   | 3.07%             |
| Interest Rate Swap |   | $150.0 million                  |   | April 2010-April 2011          |   | 3 month LIBOR          |   | 3.41%             |
| Interest Rate Swap |   | $100.0 million                  |   | September  2008-September 2011 |   | 3 month LIBOR          |   | 3.31%             |
| Interest Rate Swap |   | $150.0 million                  |   | September  2009-September 2012 |   | 6 month LIBOR          |   | 2.68%             |

 

 

Basedon our variable rate debt balance as of September 30, 2010 a 1% change ininterest rates would increase or decrease our annual interest cost by $3.9million.  At September 30, 2010there were no other material changes in our market risks relating to interestand foreign exchange rates as of December 31, 2009.

 

Wedo not enter into derivative transactions for speculative purposes and hold noderivative instruments for trading purposes.

 

**Item 4.  Controls and Procedures.**

 

**Evaluation of Disclosure Controls and Procedures**

 

Ourmanagement, with the participation of our Chief Executive Officer (“CEO”) andChief Financial Officer (“CFO”), has evaluated the effectiveness of our disclosurecontrols and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) as of the end of the period covered bythis report.  Disclosure controls andprocedures are designed to provide reasonable assurance that the informationrequired to be disclosed in the reports that we file or submit under theExchange Act has been appropriately recorded, processed, summarized andreported on a timely basis and are effective in ensuring that such informationis accumulated and communicated to the Company’s management, including our CEOand CFO, as appropriate to allow timely decisions regarding requireddisclosure.  Based on such evaluation,our CEO and CFO have concluded that, as of September 30, 2010, ourdisclosure controls and procedures are effective at the reasonable assurancelevel.

 

**Changes in Internal Control Over Financial Reporting**

 

Therehave not been any changes in our internal controls over financial reportingthat occurred during the last fiscal quarter, which have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

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**Part II - OTHER INFORMATION**

 

**Item 1.   Legal Proceedings.**

 

Please see Note 7, “Commitments and Contingencies,” to theconsolidated financial statements included in Part I, Item 1 of thisReport, which is incorporated into Item 1 of Part II by this reference.

 

**Item 1A.  Risk Factors.**

 

Risk factors that affect our business and financial resultsare discussed within Part I, Item 1A of our Annual Report on Form 10-Kfor the year ended December 31, 2009. There have been no material changesto the disclosures relating to this item from those set forth in our AnnualReport on Form 10-K for the year ended December 31, 2009.

 

**Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.**

 

There were no sales of the Company’s equity securities.

 

**Item 3.  Defaults Upon Senior Securities.**

 

None.

 

**Item 4.  Removed and Reserved.**

 

 

**Item 5. Other Information.**

 

In the firstquarter of 2010, GNC Acquisition Holdings Inc., our ultimate parent (“Parent”),entered into a memorandum of understanding to form a strategic partnership withBright Food (Group) Co., LTD to participate in China’s nutritional productsmarket (“GNC China”).  GNC China isexpected to be an indirect subsidiary of Parent but not be a direct or indirectparent or subsidiary of the Company. Consequently, its results of operations are not expected to beconsolidated with those of the Company. We expect that GNC China will begin operations in China by the end of2010; however, one of our subsidiaries has commenced wholesale sales in China.

 

 

**Item 6.  Exhibits.**

 

 
| Exhibit |   |                                                                                                                                               |
|---------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
| No.     |   | Description                                                                                                                                        |
| 31.1    |   | Certification of Principal  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                     |
| 31.2    |   | Certification of Principal  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                     |
| 32.1    |   | Certification of CEO and CFO  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the persons undersigned thereunto duly authorized.

 

 
|                  | GENERAL NUTRITION  CENTERS, INC. |
|-----------------------|---------------------------------------|
|                  | (Registrant)                          |
|                  |                                  |
|                  |                                  |
| November 4, 2010 | /s/ Joseph M. Fortunato          |   |
|                  | Joseph M. Fortunato                   |
|                  | Chief Executive Officer               |
|                  | (Principal Executive Officer)         |
|                  |                                  |
|                  |                                  |
| November 4, 2010 | /s/ Michael M. Nuzzo             |   |
|                  | Michael M. Nuzzo                      |
|                  | Chief Financial Officer               |
|                  | (Principal Financial Officer)         |

 

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