-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ITn+WPgqYYMKLpZrBjxUy8RdPXIJGrIRX177lqG74bZk0KkdubVxIVo+pWBKZNqo H3RHX3aSSeTmLw7itiAD7A== 0000950128-97-000728.txt : 19970507 0000950128-97-000728.hdr.sgml : 19970507 ACCESSION NUMBER: 0000950128-97-000728 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19970201 FILED AS OF DATE: 19970506 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENERAL NUTRITION COMPANIES INC CENTRAL INDEX KEY: 0000880120 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-FOOD STORES [5400] IRS NUMBER: 043056351 STATE OF INCORPORATION: DE FISCAL YEAR END: 0202 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-19592 FILM NUMBER: 97596664 BUSINESS ADDRESS: STREET 1: 921 PENN AVE CITY: PITTSBURGH STATE: PA ZIP: 15222 BUSINESS PHONE: 4122884600 MAIL ADDRESS: STREET 1: 921 PENN AVENUE CITY: PITTSBURGH STATE: PA ZIP: 15222 10-K/A 1 GENERAL NUTRITION COMPANIES, INC. 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A (MARK ONE) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED FEBRUARY 1, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM ________________ TO ________________ COMMISSION FILE NUMBER: 0-19592 GENERAL NUTRITION COMPANIES, INC. (Exact name of Registrant as specified in its charter) DELAWARE 04-3056351 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 300 SIXTH AVENUE PITTSBURGH, PENNSYLVANIA 15222 (Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (412) 288-4600 Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: COMMON STOCK-PAR VALUE $.01 (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13, or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2), has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Yes [ ] No As of April 28, 1997, 80,252,080 shares of the Registrant's Common Stock were outstanding. The aggregate market value of the voting stock held by non-affiliates as of that date was $58,975,980 based on the last reported sale price of the Common Stock on the NASDAQ Stock Market. DOCUMENTS INCORPORATED BY REFERENCE:
INCORPORATED BY DOCUMENT REFERENCE IN PART NO. - --------------------------------------------------------------------------- ---------------------- Portions of General Nutrition Companies, Inc. Proxy Statement for its 1997 Annual Meeting of Stockholders........................................... III
================================================================================ 2 TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business........................................................................ 1 Item 2. Properties...................................................................... 11 Item 3. Legal Proceedings............................................................... 11 Item 4. Submission of Matters to a Vote of Security Holders............................. 12 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters....... 12 Item 6. Selected Consolidated Financial Information and Other Data...................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................... 14 Item 8. Financial Statements and Supplementary Data..................................... 19 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................................................................... 40 PART III Item 10. Directors and Executive Officers of the Registrant............................. 41 Item 11. Executive Compensation......................................................... 43 Item 12. Security Ownership of Certain Beneficial Owners and Management................. 43 Item 13. Certain Relationships and Related Transactions................................. 43 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................ 44 Signatures................................................................................ 47
3 PART I ITEM 1. BUSINESS General Nutrition Companies, Inc. (the "Company"), collectively with its subsidiaries, is the only nationwide specialty retailer of vitamin and mineral supplements, sports nutrition products and herbs, and is also a leading provider of personal care, and other health-related products. Domestically, the Company's products are sold through 2,809 General Nutrition Centers and GNC Live Well stores ("GNC"), of which 1,760 are owned and operated by the Company and 1,049 are franchised. Additionally, the Company generates retail revenue from 73 stores operating under various names including Natures Food Centres(R), Amphora(TM) and Nature's Fresh(TM). Internationally, the Company operates 20 Health and Diet Centres and 9 General Nutrition Centres in the United Kingdom, 10 General Nutrition Centres in Canada and holds a controlling interest in 1 store in New Zealand. There are also 125 operating franchise stores in 15 different countries. The Company's marketing emphasizes high-margin, value-added vitamin and mineral supplements, sports nutrition products and herbs sold under the Company's GNC proprietary brands and other nationally recognized third-party brand names. The Company's strategy is to increase its market share in the vitamin, mineral and supplement market and to leverage this increase to maximize profitability. The Company strives to achieve these goals through: (i) unit growth, with the addition of company-owned and franchised stores both domestically and internationally; (ii) enhanced performance at existing stores, with comparable store sales gains driven by advertising, new product introductions and updated store formats; and (iii) improved profitability through increased introduction of GNC proprietary branded product mix changes, and increased economies of scale. The success of the Company's strategy can be seen in its financial information with revenue and operating earnings showing compound growth rates of 21.5% and 32.0%, respectively, since 1992. Set forth below is the Company's net revenue, operating earnings, earnings per fully diluted common share and store information for years 1992 through 1996. COMPANY GROWTH
1992 1993 1994 1995 1996 -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) NET REVENUE........................... $453,527 $546,253 $672,945 $845,952 $990,845 Operating earnings.................... 43,392 75,766 97,750 137,116 60,347 Earnings per share.................... (0.06) 0.30 0.44 0.78 0.05 OPERATING EARNINGS AS ADJUSTED*....... 50,169 75,826 98,425 138,699 152,413 EARNINGS PER SHARE AS ADJUSTED*....... 0.01 0.36 0.54 0.79 0.95 NUMBER OF STORES...................... 1,216 1,553 2,115 2,543 3,047 COMPARABLE STORE SALES GROWTH (GNC STORES)........................ 12.6% 12.5% 5.8% 10.3% 0.3%
- --------- * Operating earnings and earnings per share has been adjusted for comparative purposes for non-cash compensation expenses, extraordinary items, restructuring, and non-recurring charges in all years presented. Unit Growth. Since 1992, the Company has opened or acquired in the United States 1,684 new GNC stores, net of closings, of which 786 are company-owned and 898 are franchised locations. The Company's initial growth was through company-owned stores located primarily in regional malls. Beginning in late 1992 the Company broadened its location selections to include strip shopping centers and secondary malls as well as regional malls. The Company's franchise program has also enabled the Company's expansion into secondary locations as well as into international markets. In 1996, the Company opened 479 new domestic GNC stores, of which 229 are company-owned and 250 are franchised. In 1996, the Company opened 10 General Nutrition Centres in Canada, 9 in the United Kingdom and has a controlling interest in 1 store in New Zealand. Additionally, 22 franchise stores opened in various international markets. Additional store growth is expected in 1997 as the Company continues its store expansion program for company-owned and franchised locations. In Franchising, at February 1, 1997, there were 218 domestic and 1 international franchises awarded that had 1 4 not yet opened and development agreements to open 41 and 373 franchise stores in domestic and international markets, respectively. In addition to its aggressive store opening program, the Company increased its market share through acquisitions of existing locations. In 1996, the Company acquired Nature's Fresh Northwest, Inc., a 6 store gourmet natural food grocery store chain located in the Portland, Oregon area and a controlling interest in Amphora, an aromatherapy retail store located in Seattle, Washington. Comparable Store Sales Gains. The Company believes that it has achieved gains in comparable store sales in both company-owned and franchised GNC locations through the continued introduction, or reformulation, of value added specialty branded products as well as through refinements of its store format. In 1996, the Company introduced more than 231 new or reformulated proprietary branded products and plans to introduce more than 250 additional products in 1997. The Company continues to focus on creating updated store formats that provide consumers with informational displays and signage in an attractive shopping environment. Historically, when stores are converted to the updated format, comparable store sales gains in the first year after conversion are significantly better than in those stores not converted. Beginning in 1993, all new stores were constructed utilizing the Company's current updated store format. The Company updates stores built prior to 1993 as leases are renewed. Set forth below for the periods presented, are comparable store sales gains for company-owned and franchise stores in the United States and gains for company-owned GNC stores in the first year after conversion to the updated store format. COMPARABLE STORE SALES GAINS
STORES 1993 1994 1995 1996 ---------------------------------------------------- ---- ---- ---- ---- Company-owned (total)............................... 12.5% 5.8% 10.3% 0.3% Franchise........................................... 20.3% 19.0% 15.5% 8.5% Conversions to updated format....................... 20.3% 12.3% 16.1% 4.0%
Enhanced Profitability. The Company continues to focus on improving its profitability by shifting its mix to proprietary branded products which typically yield higher profit margins. In addition, as the Company continues to grow, it expects to further leverage its investments in manufacturing, distribution, purchasing and marketing and benefit from its vertical integration. The Company operates in three distinct business segments; Retail, Franchising and Manufacturing. For financial information concerning segments, see Note 15 of Notes to Consolidated Financial Statements. RETAIL PRODUCTS The Company's products are sold under its various proprietary brand names, including Ultra Mega(R), Solotron(R), GNC(R), Natural Brand(TM), Pro Performance, Challenge(TM), Herbal Plus(R), Nature's Fingerprint(TM), Preventive Nutrition(R), 24-Hour Diet(R), Quick Shot(TM), Optibolic(TM), Bio-Remedy(R), Harvest of Nature(TM), Vita Worth(R), Natural Solutions(R), Food for Thought(TM), and Opti-Body(R). In addition, the Company carries various third-party brand name products including Weider(TM), Cybergenics(R), Health Valley(R), Twin Lab(R), Nature's Herbs(R), Nature's Way(R), Natural Max(TM) and Met-Rx(R). The Company's product mix focuses on high-margin, GNC proprietary branded, value-added products emphasizing vitamin and mineral supplements, sports nutrition and herbal products. Vitamin and Mineral Supplements. For over 60 years, vitamin and mineral supplements have represented the core of the Company's product line. Vitamins and minerals are sold in single vitamin and multi-vitamin form, and in different potency levels. Products are produced in tablets, soft gelatin and hard-shell capsules, and powder forms. The Company has reformulated many of its existing private label products and added new "consumer focused" special nutritional formulas to its line of GNC proprietary branded products. These new GNC proprietary branded products are designed to meet the customers' lifestyle requirements, have unique formulations and packaging designed for target markets, and therefore do not require competitive pricing. The 2 5 Company places continued emphasis on these high-margin, value-added special nutritional formulas for its vitamin and mineral products sold under its GNC proprietary brand names. Sports Nutrition Products. Sports nutrition products are food supplements designed to be taken in conjunction with a fitness program. Management believes that these products, which include various protein and weight gain powders as well as high potency vitamin formulations, appeal to consumers who are engaged in regular exercise, including athletes who are in training to gain weight and develop their physique. Over 200 different sports nutrition products, including the Company's GNC proprietary brands and national brands, are stocked by the average GNC store. Herbs. The herb category has been the fastest growing category of the supplement market over the past four years. Herbal supplements are sold in various hard-shell capsule, soft gel capsule, tea and liquid forms. These products are sold in both single herb and combination formulas. The Company merchandises herbs under its GNC proprietary brands Herbal Plus(R), Nature's Fingerprint(TM), Harvest of Nature(TM) and Natural Brand(TM) along with products provided by third-parties, including Nature's Way(R), Nature's Herbs(R), Kyolic(R) and Ginsana(R). Diet Products. The diet category consists of vitamin, mineral and herbal formulas designed to supplement the diet of weight conscious consumers. These products are sold in various pills, teas and meal replacement drinks. The Company provides a GNC proprietary brand line of diet supplements, 24-Hour Diet(R), along with third-party products. Food Products. The Company sells a selection of specialty food products in its GNC stores. As commodity natural food products have become available through more distribution channels, the Company has reduced its line of food products, focusing more on proprietary branded sports drinks, sports bars, and health related snack items that carry a higher gross margin. This category is being de-emphasized as part of the Company's ongoing reallocation of shelf space to higher-margin, specialty non-food products. Through the acquisition of Nature's Fresh Northwest, Inc. the Company has entered into the gourmet natural food grocery business. These stores offer a broad assortment of natural produce as well as meat, poultry, and seafood. Personal Care and Miscellaneous Health Care Products. The Company sells personal care products including hair care products, soaps, skin creams, lotions, bath and massage products. These products are generally termed "natural" because they contain few synthetic chemicals and additives. The Company seeks to offer products within this category which include vitamins, herbs and other natural ingredients and avoids products which contain harsh chemicals. Fitness and Apparel. Certain of the Company's store offer a variety of sports accessories, including light-line fitness equipment, weight training accessories and specialty workout apparel. In 1996 the Company discontinued selling these products in most of the company-owned stores and will merchandise selected third-party products in a limited number of stores in the future. Gold Card/Other. This category primarily represents sales of the Company's Gold Card. The card, for a $15 annual fee, provides customers with a 20% discount on all products purchased, both on the date the card is purchased and the first Tuesday of each month. At February 1, 1997, there were approximately 2.4 million active Gold Card members, with more than 7,000 new card holders being added each week. 3 6 Set forth below is a comparison for the last three years, of company-owned GNC retail sales in each of its major product categories and their respective percentage of total GNC retail sales:
MAJOR PRODUCT CATEGORIES 1994 1995 1996 ------------------- ------------------- ------------------- % OF TOTAL % OF TOTAL % OF TOTAL SALES SALES SALES SALES SALES SALES ----- ---------- ----- ---------- ----- ---------- (SALES IN MILLIONS) Vitamins & Minerals.......................... $ 149 30% $ 197 32% $ 233 35% Sports Nutrition............................. 145 29 164 27 182 27 Herbs........................................ 86 18 117 19 129 20 Diet Products................................ 35 7 46 8 39 6 Food Products................................ 20 4 21 4 18 3 Personal Care................................ 26 5 28 4 26 4 Fitness and Apparel.......................... 14 3 11 2 8 1 Gold Card/Other.............................. 19 4 25 4 27 4 ----- --- ----- --- ----- --- $ 494 100% $ 609 100% $ 662 100% ===== === ===== === ===== ===
Sales of the Company's GNC proprietary brands represented approximately 51%, 52% and 54% of the total retail sales in 1994, 1995 and 1996, respectively. STORES At February 1, 1997 the Company operated a network of 1,873 retail stores, of which 1,833 were located in the United States and Puerto Rico, 39 stores in the United Kingdom and Canada, and 1 in New Zealand. The following table sets forth the number of retail stores and the respective operating names at the end of the fiscal years 1994, 1995 and 1996. NUMBER OF COMPANY-OWNED STORES OPERATING AT YEAR END
OPERATING NAME 1994 1995 1996 ---------------------------------------------------------------- ----- ----- ----- Domestic General Nutrition Centers..................................... 1,181 1,462 1,760 Nature's Food Centres......................................... 184 100 65 Nature's Fresh................................................ -- -- 6 Amphora....................................................... -- -- 2 ----- ----- ----- Subtotal domestic stores................................... 1,365 1,562 1,833 International General Nutrition Centres..................................... -- -- 20 Health & Diet Centres......................................... -- 22 20 ----- ----- ----- Subtotal international stores.............................. -- 22 40 ----- ----- ----- Total Company operated stores.............................. 1,365 1,584 1,873 ===== ===== =====
GENERAL NUTRITION CENTERS. Most GNC stores contain between 1,200 and 1,800 square feet. Historically these GNC stores were constructed primarily in regional shopping malls ("Traditional"). Beginning in late 1992, the Company, as part of its store expansion strategy, focused its growth on strip centers and secondary mall locations ("Expansion") rather than the Traditional mall sites. While similar in sizes and profit margins, the strip center stores generate less customer transactions and therefore have lower annual sales volume and sales per square foot. The following table sets forth for the periods indicated, the weighted average sales per store and sales per square foot for Traditional and Expansion GNC stores. 4 7 WEIGHTED AVERAGE SALES PER STORE AND SALES PER SQUARE FOOT (SALES IN THOUSANDS)
1993 1994 ---------------------------------- ---------------------------------- SALES PER NUMBER SALES PER NUMBER STORES SALES SQUARE FOOT OF STORES SALES SQUARE FOOT OF STORES - ------------------------------ ------ ----------- --------- ------ ----------- --------- Traditional................... $458.7 $279 887 $485.9 $296 861 Expansion..................... $203.9 $134 142 $252.2 $169 449
1995 1996 ---------------------------------- ---------------------------------- SALES PER NUMBER SALES PER NUMBER STORES SALES SQUARE FOOT OF STORES SALES SQUARE FOOT OF STORES - ------------------------------ ------ ----------- --------- ------ ----------- --------- Traditional................... $536.3 $327 851 $530.4 $324 836 Expansion..................... $316.0 $210 618 $300.0 $199 878
Updated Store Formats. The Company's current store format has been utilized since 1990 and emphasizes the products and information concerning the products as a merchandising tool. The Company began the implementation of this format by converting existing GNC stores and is in the process of converting additional stores as their leases renew. Sales generated by updated stores have shown significant increases when compared to sales prior to conversion. For the past three years, the Company has been developing a new concept store with the goal of providing a unique shopping experience for GNC customers. In 1996, the Company opened its second prototype store called "GNC Live Well". The GNC Live Well store offers a full line of supplements, sports nutrition, herbs, and expanded product lines, including aromatherapy, bath and spa, and a broad selection of self-care related products. These self-care products include both customized personal vita plans and health and body products. This new format is designed to be a total health and self-care experience and not just a supplement store. In 1997, the Company expects to open three new stores and convert 22 existing high volume stores in prime real estate to the GNC Live Well format. The Company continues to evaluate and modify its store formats to maximize productivity and profitability. Store Management. The Company's GNC stores are currently regionalized into three divisions and, beginning in the second quarter of 1997, will be realigned into four divisions. Each division is led by a Vice President who, along with managers responsible for merchandising, promotions, and inventory, a Financial Analyst and a network of Regional Sales Directors, manages company-owned store operations. This decentralized organization has been in existence for over eight years, allowing the Company's field management to customize stores to the demographics of particular markets, and to have responsibility for merchandise assortment, promotions, certain advertising and product pricing. In 1990, with the new emphasis on franchising, a franchise management and field support group was added to the divisional organization. This group is responsible for all aspects of the franchise field operations. NATURE FOOD CENTRES. At February 1, 1997 there were 65 Nature Food Centres operating. In 1994, the Company acquired 207 Natures Food Centres and has since converted 81 to GNC stores and closed 61 stores. The remaining 65 stores will close at the date the Company negotiates termination of the remaining leases. NATURE'S FRESH. In 1996, the Company acquired Nature's Fresh Northwest, Inc., a 6 store gourmet grocery store chain located in the Portland, Oregon area. These stores offer a broad assortment of natural produce, meat, poultry, and seafood as well as vitamins and health and beauty aids. The stores range in square footage from 4,500 to 31,000 square feet. AMPHORA. In 1996, the Company acquired Amphora, a 1 store retail concept offering aromatherapy based bath, body, and relaxation products. The Company has plans to develop an Amphora line of products to be distributed through GNC stores as well as to continue the testing of the Amphora retail store concept. GENERAL NUTRITION CENTRES. The Company in 1996, opened 10 GNC stores in Canada and 9 stores in the United Kingdom to test the GNC retail concept in these international markets. The Company also has a controlling interest in 1 GNC store located in New Zealand. 5 8 HEALTH AND DIET CENTRES. The Company purchased United Kingdom based Health and Diet Centres in 1995. The stores offer products similar to that of a GNC store with a greater mix of health food products and less proprietary branded products. The Company introduced certain of the Company's proprietary branded products in Health and Diet Centres in 1996. MARKETING Trends. The Company's current marketing and store expansion efforts have resulted in approximately 13.0% share of the total retail supplement market, including the vitamins, minerals, herbs, and sports nutrition categories, compared with 9.7% in 1993. According to various sources including Packaged Facts and Beyond Data, the retail supplement market in which the Company competes, is forecasted to grow at an accelerating rate through the rest of this decade (11.8%, 12.7%, 13.6%, and 14.5% in 1997, 1998, 1999, and 2000, respectively), reaching $10.7 billion by 2000. This growth is driven by a combination of an aging population and increased consumer acceptance of supplements. For example, people over age 35, which account for 73% of vitamin users, will grow from 127 million in 1995 to 150 million people in the U.S. alone by the year 2005. Meanwhile, between 1993 and 1996, usage of vitamins grew from 36% of the population to 40%; usage of herbs grew from 14% of the population to 19%, and usage of sports nutrition products grew from 4.3% of the population to 6.4%. The overall alternative medicine category grew at an average 30% versus 8% for conventional medicine from 1989 to 1993, the last year for which statistics are available. The Company markets its proprietary brands of specialty nutrition products through an integrated marketing program whose executional elements include television, print and radio media, storefront graphics, Gold Card member communications, and point of purchase materials. The Company further benefits from product advertising paid for entirely by third-party vendors, promoting their products and identifying GNC stores as the place to purchase these products. In 1996, the Company spent $37.7 million net on retail advertising and other marketing efforts, or approximately 5.2% of retail net revenue, compared with $30.9 million, or approximately 4.7% of retail net revenue in 1995. Additionally, the Company's franchisees currently are required to spend up to 3% of sales on local advertising and may be required to contribute up to 3% of their retail sales to a fund utilized for national advertising. In 1995, the Company began setting up co-op advertising funds with participating franchisees in major markets. These co-ops require franchisees to contribute 2.5% of sales to the fund while the Company contributes the same percentage of sales for company-owned stores in the market. This permits the Company to pool its own funds with those of its franchisees to advertise in a more effective and cohesive way. Total dollars spent in 1996 by the co-ops was $6.1 million, up from $690,000 in 1995. There were 33 co-ops in place at February 1, 1997. An additional 15 co-ops formations are anticipated in 1997. Advertising. The Company completed a comprehensive in-market test of a new advertising approach in 1996, which indicated that improved consumer credibility and expanded mainstream consumer appeal could be achieved contemporaneously with improved short term sales performance. Management believes this new marketing approach positions GNC as the customer's inspirational partner in living their best life. "Live Well" has been added to advertising, point of purchase materials, new store signage and even the Company logo to reflect the new, value-based positioning. To execute the new marketing approach, which management believes will serve as the basis for future marketing efforts, the Company contracted Deutsch, Inc., an independent New York advertising agency with strong retail and strategic experience. Training. The Company's marketing efforts include a comprehensive training and educational effort for all store personnel, including a standard training curriculum on basic nutrition, GNC brands, manufacturing, customer service, and basic selling strategies. Additionally, a toll-free consumer information line has been established to answer customer questions regarding GNC brand products. Gold Card Program. The Company's Gold Card Program has developed into a key component of the Company's marketing strategy, with membership as of February 1, 1997 of approximately 2.4 million customers. The Company believes that its Gold Card Program builds customer loyalty and makes GNC a destination-oriented retailer for customers that hold a Gold Card. Average sales per Gold Card customer increases to nearly $50 per transaction on "Super Tuesday," the first Tuesday of every month and the day on 6 9 which Gold Card holders receive a 20% discount on all purchases. The average sale per customer on Super Tuesday is nearly three times the Company's daily average. Gold Card holders also receive a complimentary issue of Let's Live Magazine on a monthly basis which provides information that educates members to make larger investments in their health. The Company completed the design and installation of a state-of-the-art database marketing system for the Gold Card program. The system allows matching and analysis of consumer information; including who they are and what and when they buy. During 1997, the database system will be used to increase card usage and member participation rate on Super Tuesdays, to sell more product to the most likely prospects based on proven buying patterns, and to reduce communications costs to non-participating members. Scientific Studies. Scientific studies are bringing new credibility to the supplement category. Consumers now list scientific research as the single most compelling factor in their category participation and purchase decisions, and well publicized new research drives massive swings in consumer demand for clinically proven nutritionals. The Company's scientific affairs group is staffed with highly qualified personnel, including a Ph.D. The group combines high quality science with GNC product development, research support, information dissemination and regulatory affairs to enhance scientific credibility for the Company and its product lines. COMPETITION In the vitamin, mineral, and supplement line, the Company has no national specialty retail competitor. However, the Company competes on a regional basis directly with other specialty health retailers and also competes directly with many drug stores, supermarkets, and mass merchandisers. Prior to 1986, the Company's principal basis of competition was price. However, as the Company has emphasized higher-margin specialty products, the Company has enhanced its competitive position by offering proprietary branded formulations, a broad product assortment and service provided by its retail sales force. The Company believes that none of its competitors offers the same level of product selection and customer service as the Company or benefits to the same extent from national advertising. In the sports nutrition line, the Company competes principally with health clubs, gyms and mail order companies. The Company believes that, as a specialty retailer, the quality and selection of its products, marketing dollars spent, store appearance, informative sales force, convenience, and consumer confidence in the GNC name provides a distinct competitive advantage. FRANCHISING Beginning in 1987, the Company developed a franchising strategy to enhance the Company's operating performance through the conversion of certain marginally performing stores and to increase its store base through the addition of new stores. Franchise stores have demonstrated that GNC stores can operate successfully in locations such as strip centers and secondary malls that were previously considered secondary locations. The Company's selection criteria for its franchisees is directed towards the owner/operator versus a passive investor. The Company believes that the consistency and customer service an owner/operator provides is important given the specialized nature of the Company's product line. The success of the franchise program was recognized as GNC was named the number one franchise opportunity in a survey published by Success magazine in its 1994 rating of over 2,000 franchise operations. In 1995, Franchise Buyer magazine ranked GNC the number one non-food retail franchise. In 1996, Franchise Times magazine ranked GNC the sixth Retail and Specialty Franchise in the United States. The Company offers franchisees a three-part training program consisting of in-store, classroom and field training concentrating on product education and franchise operations. This training program is augmented by the franchise management group. Currently all franchise agreements are effective for a ten-year period. At the end of the franchise agreement, the Company has the option to permit renewal for another 10 year period for 1/2 of the franchise fee that is then in effect. Although franchise contracts contain strict requirements for store operations, the Company cannot exercise the same degree of control over franchisees as it does over its store managers; however, the Company does retain the right to approve vendors, specific products and requires franchisees to obtain legal approval of any franchise advertising. The Company recognizes a lower margin on the sale of its products to franchisees because of the wholesale prices charged. However, such lower margins on product sales to franchisees are partially offset by franchise royalties and incremental business at the 7 10 Company's manufacturing facility as well as the absence of direct store operating expenses incurred by the Company. The following table sets forth, for the years presented, the number of operating franchise locations and the number of franchise stores that were awarded, but were not yet open at the end of each year: NUMBER OF OPERATING FRANCHISE LOCATIONS
1994 1995 1996 ------------------------- ------------------------- ------------------------- FRANCHISE LOCATIONS DOMESTIC INTERNATIONAL DOMESTIC INTERNATIONAL DOMESTIC INTERNATIONAL - ------------------------------- -------- ------------- -------- ------------- -------- ------------- At beginning of year........... 480 29 676 74 848 111 Added during year.............. 224 45 257 37 272 22 Closed or converted............ 28 -- 85 -- 71 8 --- --- --- --- ----- --- At end of year................. 676 74 848 111 1,049 125 === === === === ===== === Stores awarded but not yet open......................... 185 8 267 4 218 1 Development agreements......... 11 131 6 161 41 373
Domestic. The Company's current franchising program is directed primarily toward existing franchisees and third-parties. New franchisees to the system are currently required to pay an initial fee of $27,500 for a franchise license, $22,500 if the applicant has an existing franchise agreement. The initial fee has increased to $27,500 in 1996 and from $17,500 to $25,000 in years 1993 through 1995. The Company offers limited financing to qualified franchisees at current fixed interest rates of 13.75% per annum ordinarily for a term up to five years. Once established, franchisees are required to pay the Company a continuing royalty of 6% of sales, to spend up to 3% of sales on local advertising, and may be required to contribute up to 3% of sales toward a national advertising fund. Reduced license fees of $10,000 and a lower initial royalty fee of 4%, 5% and 6% for years 1, 2 and 3 with 6% for years thereafter, respectively, is offered to independently owned health food/ nutrition store owners to encourage them to convert to GNC franchises. Franchises receive limited geographical exclusivity and are required to carry all of the Company's own GNC proprietary brand name vitamins and mineral supplements. GNC requires owners to operate the stores, and currently limits the number of stores a franchisee can own to five. If a franchisee does not meet specified performance and appearance criteria, the Company is permitted to terminate the franchisee agreement. In these situations, the Company may take possession of the location, inventory, and equipment, and continue to operate it as a company-owned or franchise location. International. A new participant in the Company's international franchise program is required to pay an initial fee of $20,000 per store. Upon the store opening, the franchise is required to pay a continuing royalty up to 5% of sales. The Company's strategy for international franchising is to grant a franchise for an entire country to an entity with extensive knowledge of that country's business environment and adequate capital for market penetration. International franchised stores generate sales per square foot comparable with domestic store locations. However, the Company generates less revenue from these franchises due to lower international royalty rates and a smaller percentage of products purchased from the Company. In 1996, the Company opened 22 international franchised locations, bringing the total to 125 franchised stores operating in 15 countries outside of the United States, including Mexico, Philippines, Taiwan, Guatemala, Bahamas, Guam, Peru, Spain, Brazil, Singapore, El Salvador, the Dominican Republic, Columbia, Indonesia and Saudi Arabia. The Company has entered into development agreements for an additional 373 international franchise stores in 15 countries, including stores in countries already mentioned as well as Chile, Israel, Costa Rica, South Korea, Thailand, and Turkey. MANUFACTURING The Company's main manufacturing plant, located in Greenville, South Carolina, is one of the largest vitamin and mineral supplement manufacturing facilities in the United States. The plant, which is owned by the Company, is solely dedicated to the manufacture of vitamin, mineral, herbal and sports nutrition supplements. The Company manufactures the majority of its products in three forms: tablet, soft gel capsule and hard shell capsules. The plant also manufactures certain powder products. Revenue at the facility is 8 11 generated through sales to other segments of the Company and sales to various third-parties. Revenue generated through sales to other segments of the Company represented approximately 68% of total manufacturing revenue in 1996 and approximately 74% in 1995. The Company will continue to invest in the expansion of the manufacturing facility to ensure sufficient capacity to meet the demands of the Retail and Franchise business, through 1999. In early 1998, the Company, to allow for increased manufacturing capacity requirements, is planning to move its packaging lines and finished goods inventory to a new 100,000 square foot facility to be constructed adjacent to the existing facility. The Company places added emphasis on quality control, and conducts testing on all raw materials and finished products, weight testing and purity testing in the Company's state of the art micro bacterial lab. The Company's product development and quality control team currently consists of 56 individuals, who work closely with the retail sales group and scientific affairs group to respond to new science and consumer demands to reformulate existing and develop new products. In 1996 the plant developed a total of 92 new or reformulated products with over 130 scheduled for 1997. The principal raw materials used in the manufacturing process are natural and synthetic vitamins and gelatin. The Company maintains multiple sources for all raw materials. Currently, one vendor supplies approximately 28% of the manufacturing facility's raw materials. No other single vendor accounts for more than 8% of its raw material purchases. The Company believes multiple sources exist to meet its raw material requirements. In 1995, the Company acquired Health and Diet Food Company Limited, a United Kingdom manufacturing facility specializing in the packaging of vitamin supplements and manufacture of certain food and cosmetic products, sold primarily to third-parties in the U.K. and Europe as well as to the Health and Diet Centre stores. During 1996, the Company acquired the manufacturing operation of DFC Thompson Australia Pty Limited ("DFC"), an Australian manufacturer. On a short-term basis, the acquisition is designed to educate the Company in conducting business in that geographical area. The Company's long-term objective is to convert DFC into a manufacturing facility for GNC products, supplying needed inventory to GNC stores that the Company intends to open in Australia, New Zealand and the Pacific Rim. WAREHOUSING AND DISTRIBUTION The Company currently distributes its products through three leased distribution centers with its own drivers and leased trucks as well as through contract and common carriers. Substantially all the products sold at company-owned stores, and approximately 85% of products sold by franchisees, flow through one of the Company's distribution centers. It is the Company's policy that all products be received in the Company's distribution centers to assure that such products and their labels are reviewed for compliance with the Company's Federal Trade Commission consent decrees prior to sale. Scheduled deliveries are made directly to GNC stores on a one or two-week basis. The Company's three distribution centers are located in Pittsburgh, Pennsylvania; Atlanta, Georgia; and Phoenix, Arizona. The Company closed its distribution center in Dallas, Texas as a result of the addition of the larger square foot facility in Phoenix. In 1996 the Company increased its square footage of warehousing by approximately 129,000 square feet or 41% to meet the continuing demands of the retail store expansion program. In addition to adding new automated conveyor systems, the Company is engaged in an ongoing process of upgrading its distribution computer systems to increase mechanization and to provide maximum productivity. This automation and computer system upgrades resulted in a 47% increase in warehouse through-put in 1996. GOVERNMENT REGULATIONS The processing, formulation, packaging, labeling and advertising of the Company's products are subject to regulation by one or more federal agencies, including the Food and Drug Administration ("FDA"), Federal Trade Commission ("FTC"), the Consumer Product Safety Commission, the United States Department of Agriculture and the Environmental Protection Agency. These activities are also regulated by various agencies of the states and localities in which the Company's products are sold. The FDA, in particular, regulates the formulation, manufacture, and labeling of vitamin and mineral supplements. 9 12 Partially in response to the enactment of the Nutrition Labeling and Education Act of 1990, the FDA, in November, 1991, issued proposed regulations designed to, among other things, establish specific regulations for the nutrition labeling of vitamin and mineral supplements and establish procedures for FDA approval of health claim messages. Final regulations were issued on January 4, 1994 with respect to the procedures established for FDA approval of health claim messages. The regulations prohibit the use of any health claim for a dietary supplement unless the health claim is supported by significant scientific agreement and is pre-approved by the FDA. To date, the FDA has approved the use of health claims for dietary supplements only in connection with calcium and osteoporosis, and folic acid and neural tube defects. Principally through the efforts of the dietary supplement industry, on October 25, 1994, the Dietary Supplement Health and Education Act of 1994 was signed into law. The new law amends the Federal Food, Drug, and Cosmetic Act and, in the judgment of the Company, is favorable to the dietary supplement industry. First and foremost, the legislation creates a new statutory class of "dietary supplements." This new class includes vitamins, minerals, herbs, amino acids and other dietary substances for human use to supplement the diet and the legislation grandfathers all dietary ingredients on the market as of October 15, 1994. A dietary supplement which contains a new dietary ingredient, one not on the market as of October 15, 1994, will require evidence of a history of use or other evidence of safety establishing that it will reasonably be expected to be safe, such evidence to be provided by the manufacturer or distributor to the appropriate authority before it may be marketed. The legislation also recognizes a need for the dissemination of information linking nutrition and long-term good health and provides that publications, which are not false and misleading and present a balanced view of available scientific information on a dietary supplement, may be used in connection with the sale of dietary supplements to consumers. Among other changes, the new law prevents the further regulation of dietary ingredients as "food additives" and allows the use of statements of nutritional support on product labels and in product labeling. It also establishes a Commission to study and provide recommendations for "the regulation of label claims and statements for dietary supplements, including the use of literature in connection with the sale of dietary supplements and procedures for the evaluation of such claims. In making such recommendations, the Commission shall evaluate how best to provide truthful, scientifically valid, and non misleading information to consumers so that consumers may make informed and appropriate health care choices for themselves and their families". It also revokes a negative Advance Notice of Proposed Rule making that the FDA had published in June of 1993. On December 28, 1995, the FDA published a notice in the Federal Register setting forth proposed new nutrition labeling regulations for dietary supplements. Comments were submitted by the industry in June 1996, and it is anticipated that the FDA will publish final rules in 1997. It is anticipated the industry will have one year from the publication of the final rules to bring their products in compliance with the new rules. In 1984, the FTC instituted an investigation of GNI, a subsidiary of the Company, alleging deceptive acts and practices in connection with the advertising and marketing of certain of GNI's products. GNI accepted a proposed consent order which was finalized in 1989, under which GNI agreed to refrain from, among other things, making certain claims with respect to certain of its products unless the claims are based on and substantiated by reliable and competent scientific evidence. The Company had also entered into a consent order in 1970 with the FTC which generally addressed "iron deficiency anemia" type products. As a result of routine monitoring by the FTC as to compliance with these orders, disputes arose concerning GNI's compliance with these orders, and with regard to advertising for certain hair care products. While GNI believes that, at all times, it operated in material compliance with the orders, GNI entered into a settlement in 1994 with the FTC to avoid protracted litigation. As a part of this settlement, GNI entered into a consent decree and paid, without admitting liability, a civil penalty in the amount of $2.4 million. GNI agreed to adhere to the terms of the 1970 and 1989 consent orders and to abide by the provisions of the settlement document concerning hair care products. The Company does not believe that future compliance with the outstanding consent decrees will materially affect its business operations. GNI intends to petition the FTC for clarification of what it believes is ambiguous and outmoded language contained in the 1970 order and also to modify the 1989 order, to minimize future conflicts over the meaning of the orders. The FTC continues to monitor the Company's advertising and, from time to time, requests substantiation with respect to such advertising to assess compliance with the various outstanding consent decrees and with the Federal Trade Commission Act. The Company's policy is to use advertising that complies with the consent 10 13 decrees and applicable regulations. To better ensure compliance, in 1993 the Company discontinued purchasing products at the store and division levels and began to purchase centrally all third-party products for company-owned stores and third-party products distributed by the Company to franchise stores. It is also the Company's policy that all products be received in the Company's distribution centers to assure that such products and their labels are reviewed for compliance with the consent decrees prior to sale. The Company also reviews the use of third-party point of purchase materials such as store signs and promotional brochures. Nevertheless, there can be no assurance that inadvertent failures to comply with the consent decrees and applicable regulations will not occur. Approximately 85% of the products sold by franchise stores flow through one of the Company's distribution centers. Although franchise contracts contain strict requirements for store operations, including compliance with federal, state, and local laws and regulations, the Company cannot exercise the same degree of control over franchisees as it does over its company-owned stores. As a result of the Company's efforts to comply with applicable statutes and regulations, the Company has from time to time reformulated, eliminated or relabeled certain of its products and revised certain provisions of its sales and marketing program. The Company believes it is in material compliance with the various consent decrees and with applicable federal and state rules and regulations regulating its products and marketing program. Compliance with the provisions of national, state and local environmental laws and regulations has not had a material effect upon the capital expenditures, earnings, financial position, liquidity or competitive position of the Company. The Company cannot determine what effect additional governmental regulations or administrative orders, when and if promulgated, would have on its business in the future. They could, however, require the reformulation of certain products to meet new standards, require the recall or discontinuance of certain products not capable of reformulation, or impose additional record keeping, expanded documentation of the properties of certain products, expanded or different labeling, and scientific substantiation. Any or all of such requirements could adversely affect the Company's operations and its financial condition. EMPLOYEES At February 1, 1997, the Company employed 10,906 people, of whom approximately 9,398 were employed in Retail; 816 were employed in Manufacturing; 63 were employed in Franchising and 629 were employed in corporate support functions. None of the Company's employees were covered by a collective bargaining agreement. 11 -----END PRIVACY-ENHANCED MESSAGE-----