GENERAL NUTRITION COMPANIES INC - Registration Statement for securities to be issued in business combination transactions (S-4/A) BUSINESS

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The following is an excerpt from a S-4/A SEC Filing, filed by GENERAL NUTRITION COMPANIES INC on 8/9/2004.

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GENERAL NUTRITION COMPANIES INC - S-4/A - 20040809 - BUSINESS

BUSINESS

General Nutrition Centers, Inc.

We are the largest global specialty retailer of nutritional supplements, which include sports nutrition products, diet products, vitamins, minerals and herbal supplements (VMHS) and specialty supplements. We derive our revenues principally from product sales through our company-owned stores, franchise activities and sales of products manufactured in our facilities to third parties. On December 5, 2003, we acquired from Numico USA, Inc., 100% of the outstanding equity interests of General Nutrition Companies, Inc., a company that opened its first health food store in 1935 and today sells products through a worldwide network of more than 5,600 locations operating under the GNC brand name. According to the 2003 Gallup Survey of Vitamin Users, the GNC brand name is one of the most widely recognized brands in the nutritional supplements industry. An estimated 84% of the U.S. population recognizes GNC as a source of health and wellness products based on the Parker 2003 Awareness Study. Our product mix, which is focused on high-margin, value-added nutritional products, is sold under our GNC proprietary brands, including Mega Men, Pro Performance, Total Lean and Preventive Nutrition, and under nationally recognized third-party brands, including Muscletech, EAS and Atkins.

The following charts illustrate, for the twelve months ended June 30, 2004, the percentage of our net revenues generated by our three business segments and the percentage of our net U.S. retail supplement revenues generated by our four product categories:


Net Revenues By Segment		Net U.S. Retail Revenues By Product Category

Business Overview

Retail Locations

Our retail network represents the largest specialty retail store network in the nutritional supplements industry according to the NBJ 2003 Supplement Report. As of June 30, 2004, there were 4,974 GNC locations in the United States and Canada and 692 franchised stores operating in other international locations under the GNC name. Of our U.S. and Canadian locations, 2,649 were company-owned stores, 1,331 were franchised stores and 994 were GNC store-within-a-store locations under our strategic alliance with Rite Aid. Our retail network in the United States was approximately eight times larger than that of our nearest specialty retail competitor as of June 30, 2004. Most of our U.S. stores are between 1,000 and 2,000 square feet and are located in shopping malls and strip shopping centers. In the fourth quarter of 2002, we completed a store reset and upgrade program. As a result, many of our stores have a modern and customer-friendly layout and promote our GNC Live Well theme.

Franchise Activities

As of June 30, 2004, we had 1,331 franchised stores in the United States and Canada and 692 other international franchised stores. We generate income from franchise activities primarily through product sales to franchisees, royalties on franchise retail sales and franchise fees. To assist our franchisees in the successful

operation of their stores and to protect our brand image, we offer a number of services to franchisees including training, site selection, construction assistance and accounting services. We believe that our franchise program enhances our brand awareness and market presence and will enable us to expand our store base internationally with minimal capital expenditures by us. We enjoy strong relationships with our franchisees, as evidenced by our franchisee renewal rate of over 98% between 2000 and 2003. Our franchise program has been recognized numerous times by several publications as one of the top franchise programs in the country.

Store-Within-a-Store Locations

To increase brand awareness and promote access to customers who may not frequent specialty nutrition stores, we entered into a strategic alliance with Rite Aid to open our GNC store-within-a-store locations. As of June 30, 2004, we had 994 store-within-a-store locations. Through this strategic alliance, we generate revenues from sales to Rite Aid of our products at wholesale prices, the manufacture of Rite Aid private label products and retail sales of consignment inventory. We are Rite Aid’s sole supplier for the PharmAssure® vitamin brand and a number of Rite Aid private label supplements. We recently extended our alliance with Rite Aid through April 30, 2009, with its commitment to open 300 new store-within-a-store locations by December 31, 2006.

Products

We offer a wide range of nutritional supplements sold under our GNC proprietary brand names, including Mega Men, Pro Performance, Total Lean and Preventive Nutrition, and under nationally recognized third-party brand names, including Muscletech, EAS and Atkins. Sales of our proprietary brands at our company-owned stores represented approximately 42% of our net retail product revenues for the twelve months ended June 30, 2004. We generally have higher gross margins on sales of our proprietary brands than on sales of third-party brands. We develop our proprietary products independently at our own facilities and through collaborative efforts with our suppliers. In addition, we have arrangements with several of our suppliers that enable us to be the preferred distributor of a number of third-party products. We believe that new products are a key driver of customer traffic and purchases, and we are committed to developing new and innovative products for the nutritional supplements industry. We launched 37 new products during the year ended December 31, 2003. During the six months ended June 30, 2004, we launched 33 new products, and we expect to launch 60 additional new products during the remainder of 2004.

Marketing

We market our proprietary brands of nutritional products through an integrated marketing program that includes television, print and radio media, storefront graphics, direct mailings to members of our Gold Card program and point of purchase materials. Our Gold Card program is a key component of our marketing strategy and entitles members to discount offers and other benefits. With 4.5 million Gold Card members as of June 30, 2004, we believe that our Gold Card program builds customer loyalty and serves to make us a destination retailer. We also benefit from product advertising paid for entirely by third-party vendors, which promotes their products and identifies our locations as a place to purchase their products.

Manufacturing and Distribution

With our technologically sophisticated manufacturing and distribution facilities supporting our retail stores, we are a low-cost, vertically integrated producer and supplier of nutritional supplements. We operate two manufacturing facilities in South Carolina and three distribution centers located in Pennsylvania, South Carolina and Arizona. Although we utilize our facilities primarily for the production of our proprietary products that are sold at GNC locations, we have available capacity to produce products for sale to third-party customers. By controlling the production and distribution of our proprietary products, we believe we can better control costs, protect product quality, monitor delivery times and maintain appropriate inventory levels.

Industry Overview

The U.S. nutritional supplements retail industry, which includes nutritional supplements sold through all channels, is large and highly fragmented, with no single industry participant accounting for more than 10% of total industry retail sales in 2002, the most recent period for which information is available. Participants include specialty retailers, supermarkets, drugstores, mass merchants, multi-level marketing organizations, mail order companies and a variety of other smaller participants. The nutritional supplements sold through these channels are divided into four major product categories: sports nutrition products, diet products, VMHS and specialty supplements. Most supermarkets, drugstores and mass merchants have narrow nutritional supplement product offerings limited primarily to simple vitamins and herbs, with less knowledgeable sales associates than specialty retailers. We believe that these merchants’ share of the nutritional supplements market over the last five years has remained relatively constant.

During the 1990s, our industry underwent a period of rapid expansion. From 1990 to 2002, industry retail sales grew at a compound annual growth rate of 10.0%, with the most rapid growth in the early 1990s. According to the NBJ 2003 Supplement Report, total industry sales in the United States were approximately $18.8 billion in 2002 and were estimated to grow at a compound annual growth rate of 3.7% from 2002 through 2008. Several demographic, healthcare and lifestyle trends are expected to drive the continued growth of the nutritional supplements industry. These trends include:


	•	Aging Population: The average age of the U.S. population is increasing. U.S. Census Bureau data indicates that the number of Americans age 55 or older is expected to increase by 19% from 2003 to 2010. We believe that consumers over the age of 55 are significantly more likely to use VMHS products than younger persons.

	•	Rising Healthcare Costs and Use of Preventive Measures: Healthcare related costs have increased substantially in the United States. According to a leading healthcare provider, private health insurance premiums increased an average of 13.9% from 2002 to 2003. To reduce medical costs and avoid the complexities of dealing with the healthcare system, many consumers take preventive measures, including alternative medicines and nutritional supplements.

	•	Increasing Focus on Fitness: The number of Americans belonging to health clubs has grown 23% from 29.5 million in 1998 to 36.3 million in 2002, according to the most recent trend report published by the International Health, Racquet & Sportsclub Association. We believe that fitness-oriented consumers are interested in taking sports nutrition products to increase energy, endurance and strength during exercise.

	•	Increasing Incidence of Obesity: According to a 2002 study by the National Heart, Lung and Blood Institute, 61% of adults ages 20-74 in the United States are either overweight or obese. Obesity may lead to more serious health conditions, such as diabetes, heart disease and high blood pressure. An estimated 46% of adults in the United States are dieting, according to a 2003 Gallup Study of Dieting and the Market for Diet Products and Services.

According to the NBJ 2003 Supplement Report, total global industry sales were approximately $50.0 billion in 2001, the most recent period for which international information is available. The largest markets were the United States at $18.1 billion, followed by Europe at $14.5 billion and Asia with $13.4 billion.

Competitive Strengths

We believe we are well positioned to capitalize on the emerging demographic, healthcare and lifestyle trends affecting our industry and to grow our revenues due to the following competitive strengths:

Unmatched Specialty Retail Footprint. Our retail network in the United States was approximately eight times larger than that of our nearest specialty retail competitor as of June 30, 2004. The size of our retail network provides us with advantages within the fragmented nutritional supplements industry. For instance, our scale helps us to attract industry-leading vendors to sell their products in our locations, often on a preferred

basis. Our extensive retail footprint in established territories also provides us with broad distribution capabilities that we believe are difficult for our competitors to replicate without significant time and cost. Through our multiple store formats located across the United States, large franchise operations and extensive international store base, we are not dependent on any single store format or geographic location.

Strong Brand Recognition and Customer Loyalty. We have strong brand recognition within the nutritional supplements industry. According to the Parker 2003 Parker Awareness Study, an estimated 84% of the U.S. population recognizes the GNC brand name as a source of health and wellness products. We utilize extensive marketing and advertising campaigns through television, print and radio media, storefront graphics, Gold Card membership communications and point of purchase materials to strengthen and reinforce our brand recognition. Our Gold Card program cultivates customer loyalty through a combination of discount offers and targeted marketing efforts. We believe that our Gold Card program helps to make us a destination retailer.

Ability to Leverage Existing Retail Infrastructure. Our incremental retail sales result in disproportionate increases in operating income as we leverage the largely fixed cost nature of our retail operations and our high retail gross product margins. Our existing store base, stable size of our workforce and established distribution network can support higher sales volume without adding significant incremental costs and enable us to convert a high percentage of our net revenues into cash flow from operations.

Extensive Product Selection. We offer an extensive mix of brands and products, including approximately 2,200 stock keeping units (“SKUs”) across multiple categories. This variety provides our customers with a wide selection of products to fit their specific needs and provides us with an advantage over drugstores, supermarkets and mass merchants who offer a more limited product selection. Our products include powders, bars, tablets, meal replacements, shakes and teas. With a broad range of products, our success does not depend on any one specific product or vendor. During the twelve months ended June 30, 2004, no single product accounted for more than 4.6% of our company-owned store sales.

New Product Development. We believe that new products are a key driver of customer traffic and purchases. Interactions with our customers and raw materials vendors help us identify changes in consumer trends that, in turn, influence our development, manufacturing and marketing of new products. In March 2003, we integrated and upgraded our previously decentralized product development function, creating dedicated development teams that conduct extensive market research and use scientific methods and third-party product testing to formulate new value-added products geared to specific nutritional concerns, such as heart health, digestive function and women’s health issues. This initiative has led to a meaningful increase in new product development activity. We launched 37 new products during the year ended December 31, 2003. During the six months ended June 30, 2004, we launched 33 new products, and we expect to launch 60 additional new products during the remainder of 2004.

Value-Added Customer Service. Our sales associates are trained to provide guidance to customers with respect to the broad selection of products sold in our stores. We believe this level of customer service provides us with an advantage over supermarkets, drugstores and mass merchants. We provide ongoing training to our sales associates to ensure that they are prepared to educate customers about product features and direct them to products that will address their specific requests. In 2002, we instituted the “GNC University,” an online training program for our sales associates at our company-owned stores and for sales associates at participating franchised locations. We provide additional education and training materials through a monthly newsletter detailing new products and through interactive training modules. We also provide a wide range of nutritional information in numerous forms, including signage, brochures, and touch screen computers enabling customers to make informed purchases.

Vertically Integrated Operational Capabilities. Our vertically integrated manufacturing, distribution and retail capabilities differentiate us from many of our competitors. We believe our technologically sophisticated manufacturing facilities and distribution centers, combined with our retail footprint, enable us to better control costs and protect product quality. We are also better able to monitor delivery times and to maintain appropriate inventory levels for our proprietary products by controlling production scheduling and distribution.

Experienced Management Team. Our senior management team is comprised of experienced retail executives who have on average been employed with us for over 14 years. As of June 30, 2004, our senior management and our directors owned approximately 2.3%, in the aggregate, and had options to purchase an additional 5.6%, in the aggregate, of the fully diluted common equity of our parent company. In addition, our board of directors is comprised of executives with significant experience in the retail industry.

Business Strategy

As the largest global specialty retailer of nutritional supplements, our goal is to further capitalize on the trends affecting our industry by pursuing the following initiatives:


	•	continue to obtain additional third-party preferred distributor arrangements and position ourselves to be first-to-market with new and innovative products by partnering with our suppliers and leveraging our extensive specialty retail footprint. We intend to offer distributors additional opportunities to place preferred products in highly visible merchandising locations within the store, as well as including these products in our monthly direct marketing communications to our Gold Card customers as a means of expanding our preferred distributor arrangements.

	•	continue to formulate new value-added products and shift our product mix to emphasize our proprietary products, which typically have higher gross product margins, by utilizing our integrated product development capabilities and featuring our proprietary products through our in-store merchandising.

	•	encourage customer loyalty, facilitate direct marketing, and increase cross-selling and up-selling opportunities by using our extensive Gold Card customer database. Our database of Gold Card members allows us to execute extensive direct marketing activities. We are focused on increasing cross-selling and up-selling opportunities by analyzing customer buying patterns in greater detail and using this data to distribute targeted direct marketing materials to specific customer groups. We intend to develop additional loyalty programs focused on building strong, long-term, value added relationships with our best customers to further strengthen their loyalty to the GNC brand.

	•	expand our international store network by growing our international franchise presence, which requires minimal capital expenditures by us. We intend to continue our policy of awarding franchising rights within a country to well-capitalized franchisees that will, together with us, determine future year commitments for stores and product distribution in that country and annually review the potential for new locations. We currently have 488 international stores scheduled to be opened in the next three years under existing development agreements.

	•	produce products for sale to third-party retail and wholesale customers to better utilize our available manufacturing capacity. We intend to continue to actively pursue these customers with competitive pricing that will enhance our sales and better utilize our current excess manufacturing capacity.

	•	reduce our debt by using excess cash flow not otherwise needed in our business or for the execution of our business strategies, as appropriate.

Company History

We are a wholly owned subsidiary and an operating company of GNC Corporation, our parent. We were formed as a Delaware corporation in October 2003 by Apollo Management V, L.P., an affiliate of Apollo and certain members of our management, to acquire General Nutrition Companies, Inc. (“GNCI”) from Numico USA, Inc. (“Numico USA”). GNCI was acquired in August 1999 by Numico Investment Corp. (“NIC”) which, subsequent to the acquisition, was merged into GNCI. NIC was a wholly owned subsidiary of an entity ultimately merged into Numico USA. Numico USA is a wholly owned subsidiary of Koninklijke (Royal) Numico N.V. (together with Numico USA, “Numico”), a Dutch public company. Prior to the acquisition by NIC in 1999, GNCI was a publicly traded company, listed on the Nasdaq National Market.

On December 5, 2003, we purchased 100% of the outstanding equity interests of GNCI. Simultaneously with the closing of the Acquisition, we entered into a new senior credit facility with a syndicate of lenders, consisting of a term loan facility and a revolving credit facility. We borrowed the full amount of the term loan facility to fund a portion of the Acquisition purchase price, but made no borrowings under the revolving credit facility. Our obligations under the senior credit facility are guaranteed by our parent company and our domestic subsidiaries. See “Description of Senior Credit Facility” for a more detailed description of our senior credit facility. We also used the net proceeds from the offering of the old notes to fund a portion of the Acquisition purchase price. In addition, our parent received an equity contribution in exchange for its common and preferred stock from GNC Investors, LLC, its principal stockholder, which we refer to in this prospectus as our equity sponsor. Our parent contributed the full amount of the equity contribution to us to fund a portion of the Acquisition purchase price. Our equity sponsor subsequently resold all of our preferred stock to other institutional investors.

Our equity sponsor held approximately 96% of our parent’s outstanding common stock as of June 30, 2004. Affiliates of Apollo Advisors V, L.P. (“Apollo Advisors V”) and other institutional investors own all of the equity interests of our equity sponsor, with affiliates of Apollo Advisors V owing approximately 76% of such equity interests.

Business Segments

We generate revenues primarily from our three business segments, Retail, Franchise and Manufacturing/ Wholesale. The following chart outlines our business segments and the historical contribution to our consolidated revenues by those segments, after intercompany eliminations. For a description of operating income (loss) by business segment, our total assets by business segment, total revenues by geographic area, and total assets by geographic area, see note 23 to our consolidated financial statements included elsewhere in this prospectus.



		Predecessor												Successor				Predecessor				Successor


										Period from								Six				Six
										January 1, 2003				27 Days				Months				Months
										to				Ended				Ended				Ended
		Year Ended December 31,

										December 4,				December 31,				June 30,				June 30,
(dollars in millions)		2001				2002				2003				2003				2003				2004


Retail		$	1,123.1	74.4	%	$	1,068.6	75.0	%	$	993.3	74.1	%	$	66.2	74.1	%	$	543.2	75.1	%	$	541.0	75.1	%
Franchise			273.1	18.1			256.1	18.0			241.3	18.0			14.2	15.9			128.1	17.7			123.0	17.1
Manufacturing/ Wholesale			112.9	7.5			100.3	7.0			105.6	7.9			8.9	10.0			51.9	7.2			56.3	7.8

	Total	$	1,509.1	100.0	%	$	1,425.0	100.0	%	$	1,340.2	100.0	%	$	89.3	100.0	%	$	723.2	100.0%		$	720.3	100.0%

Retail

Our Retail segment generates revenues from sales of products to customers at our company-owned stores in the United States and Canada.

Locations

As of June 30, 2004, we operated 2,649 company-owned stores across 50 states and in Canada, Puerto Rico and Washington DC. Most of our U.S. company-owned stores are between 1,000 and 2,000 square feet and are located primarily in shopping malls and strip shopping centers. Traditional mall and strip mall locations typically generate a large percentage of our total retail sales. All of our company-owned stores follow one of two consistent formats, one for mall locations and one for strip shopping center locations. Our store graphics are periodically redesigned to better identify with our GNC customers and provide product information to allow the consumer to make educated decisions regarding product purchases and usage. Our product labeling is consistent within our product lines and the stores are designed to present a unified approach to packaging with emphasis on added information for the consumer. In addition, in the fourth quarter of 2002 we completed a store reset and upgrade program for all of our company-owned stores to create a more modern and customer-friendly layout, while promoting our GNC Live Well theme. As part of the store reset and upgrade program, we redesigned our floor layouts to create one-stop stations where our customers can locate a variety of products to address their specific needs.

Products

We offer a wide range of nutritional supplements sold under our GNC proprietary brand names, including, Mega Men, Pro Performance, Total Lean and Preventive Nutrition, and under nationally recognized third-party brand names, including Muscletech, EAS and Atkins. We operate in four major nutritional supplement categories: sports nutrition products, diet products, VMHS and specialty supplements. We offer an extensive mix of brands and products, including approximately 2,200 SKUs across multiple categories. This variety is designed to provide our customers with a vast selection of products to fit their specific needs. Sales of our proprietary brands at our company-owned stores represented approximately 42% of our net retail product revenues for the twelve months ended June 30, 2004.

Products are delivered to our retail stores through our distribution operations located in Leetsdale, Pennsylvania; Anderson, South Carolina; and Phoenix, Arizona. Our distribution centers support our company-owned stores as well as franchised stores and Rite Aid locations. Our distribution fleet delivers raw materials and components to our manufacturing facilities and delivers our finished goods and third-party products through our distribution centers to our company-owned and domestic franchised stores on a weekly and biweekly basis, depending on sales volume of the store. Each of our distribution centers has a quality control department that monitors products received from our vendors to determine if they meet our requirements.

Based on data collected from our point of sale systems (POS), below is a comparison of our domestic retail product sales by major product category and the respective percentage of our retail supplement sales for the period shown:



	Year Ended December 31,												Six Months				Six Months
													Ended				Ended
													June 30,				June 30,
	2001				2002				2003(1)				2003				2004

(dollars in millions)
Sports Nutrition Products		287.5	26.5	%		288.7	28.1	%		300.9	29.8	%		158.7	32.0	%		160.3	33.0	%
Diet Products		289.2	26.7	%		267.1	26.0	%		265.6	26.3	%		141.5	28.6	%		115.9	23.8	%
VMHS		273.1	25.2	%		252.8	24.6	%		238.4	23.6	%		122.4	24.7	%		124.0	25.5	%
Specialty Supplements		148.9	13.7	%		139.8	13.6	%		126.6	12.5	%		63.4	12.8	%		63.5	13.1	%
Other		85.0	7.8	%		77.8	7.6	%		78.4	7.8	%		9.5	1.9	%		22.5	4.6	%

Total		1,083.7	100.0	%		1,026.2	100.0	%		1,009.9	100.0	%		495.5	100.0	%		486.2	100.0	%


(1)	2003 data calculated on a combined basis, by adding data for the period from January 1, 2003 through December 4, 2003 to data for the 27 days ended December 31, 2003.

Sports Nutrition Products

Sports nutrition products are designed to be taken in conjunction with an exercise and fitness regimen. Our target consumer for sports nutrition products is the 18-49 year old male. We typically offer a broad selection of sports nutrition products, such as protein and weight gain powders, sports drinks, sports bars, and high potency vitamin formulations, including GNC brands such as Pro Performance and popular third-party products such as NO2®.

Diet Products

Diet products consist of various formulas designed to supplement the diet and exercise plans of weight conscious consumers. Our target consumer for diet products is the 18-49 year old female. We typically offer a variety of diet products, including pills, meal replacements, shakes, diet bars and teas. Our retail stores offer our proprietary and third-party products suitable for different diet and weight management approaches, including low-carbohydrate products and products designed to increase thermogenesis (a change in the body’s metabolic rate measured in terms of calories) and metabolism. We also offer several ephedra-free diet products, including our Total Lean and our Body Answers™ product lines.

VMHS

We sell vitamins and minerals in single nutrient and multi-nutrient form and in different potency levels. Our vitamin and mineral products are available in tablets, soft gelatin and hard-shell capsules and powder forms. Many of our special vitamin and mineral formulations, such as Mega Men® and Ultra Mega®, are only available at GNC locations. In addition to our selection of VMHS products with unique formulations, we also offer the full range of standard “alphabet” vitamins. We sell herbal supplements in various solid dosage and soft gelatin capsules, tea and liquid forms. We have consolidated our traditional herbal offerings under a single umbrella brand, Herbal Plus®. In addition to the Herbal Plus line, we offer a full line of whole food-based supplements and top selling herb and natural remedy products. Our target consumers for VMHS are women over the age of 35.

Specialty Supplements

Specialty supplements is a catch-all category for nutritional supplements that do not fit within the bounds of the other nutritional supplement categories. Specialty supplements products containing glucosamine (a sugar produced in the body that is involved in the formation of cartilage, ligaments, tendons, bones, eyes, nails and heart valves) and melatonin (a hormone linked to regulation of the body’s sleep-wake cycle), as well as products that are designed to provide nutritional support to specific areas of the body. Our target consumers for specialty supplements are women over the age of 35. Many of our specialty supplements have ingredients unique to our formulations that are not available at other outlets. Our specialty supplements particularly emphasize recent third party research and available literature regarding the positive benefits from certain ingredients. Our comprehensive Preventive Nutrition product line includes Heart Advance™, a product designed to support healthy heart and blood vessel function, Triple Cleanse™, a product designed to support healthy digestive function, and Fast Flex, a product designed to provide comprehensive joint support. Our specialty supplements are located in designated wall areas that include information and other products that offer a comprehensive solution to meet a customer’s particular nutritional concerns.

Product Development

We believe a key driver of customer traffic and purchases is the introduction of new products. According to the Parker 2003 Awareness Study, 49% of consumers surveyed rated the availability of “new, innovative products” as extremely or very important when making purchase decisions and rated this as one of our competitive strengths. We identify changing customer trends through interactions with our customers and leading industry vendors to assist in the development, manufacturing and marketing of our new products. We develop proprietary products independently and through the collaborative effort of our dedicated development team. During 2003, we targeted our product development efforts on sports nutrition products, diverse diet products and specialty supplements, including ephedra-free and low-carbohydrate weight management products and new sports formulas and delivery systems. We launched 37 new products during the year ended December 31, 2003. During the six months ended June 30, 2004, we launched 33 new products, and we expect to launch 60 additional new products during the remainder of 2004.

Franchise

Our Franchise segment is comprised of our domestic and international franchise operations. Our Franchise segment generates revenues from franchise activities primarily through product sales to franchisees, royalties on franchise retail sales and franchise fees.

As a means of enhancing our operating performance and building our store base, we began opening franchised locations in 1988. As of June 30, 2004, there were 2,023 franchised stores operating, including 1,331 stores in the United States and Canada and 692 stores operating in other international locations. Approximately 88% of our franchises in the United States as of June 30, 2004 were in strip mall shopping centers and are typically between 1,200 and 1,800 square feet. The international franchised stores are smaller, typically an average of 750 square feet and, depending upon the country and cultural preferences, are located in mall, strip mall shopping center, street or store-within-a-store locations. All of our franchised stores in the

United States were recently reset in the same manner as our company-owned stores. Typically, our international stores have a store format and signage similar to our U.S. franchised stores. To assist our franchisees in the successful operation of their stores and to protect our brand image, we offer site selection, construction assistance, accounting services and a three-part training program, which consists of classroom instruction, training in a company-owned location and actual on-site training after the franchised store opens. We enjoy strong relationships with our franchisees, as evidenced by our franchisee renewal rate of over 98% between 2000 and 2003. In addition, we do not have heavy reliance on any single franchise operator in the United States, as the largest franchisee owns and/or operates 11 store locations.

All of our franchised stores in the United States offer both our proprietary products and third-party products, with a product selection similar to that of our company-owned stores. Our international franchised stores offer a more limited product selection than our franchised stores in the United States. Products are distributed to our franchised stores in the United States through our distribution centers and transportation fleet in the same manner as our company-owned stores.

Franchises in the United States

Franchise revenues from our franchisees in the United States accounted for approximately 84% of our franchise revenues for the twelve months ended June 30, 2004. In 2004, new franchisees in the United States are required to pay an initial fee of $40,000 for a franchise license. Existing GNC franchise operators may purchase an additional franchise license for a fee of $30,000. We typically offer limited financing to qualified franchisees in the United States for terms up to five years. Once a store is established, franchisees are required to pay us a continuing royalty of 6% of sales and contribute 3% of sales to a national advertising fund. Our standard franchise agreements for the United States are effective for a ten-year period with two five-year renewal options. At the end of the initial term and each of the renewal periods, the renewal fee is 33% of the franchisee fee that is then in effect. The franchise renewal option is at our election for all franchise agreements executed after December 1995. Our franchisees in the United States receive limited geographical exclusivity and are required to follow the GNC store format.

Franchisees must meet certain minimum standards and duties prescribed by our franchise operations manual and we conduct periodic field visit reports to ensure our minimum standards are maintained. Generally, we enter into a five-year lease with two five-year renewal options with landlords for our franchised locations in the United States. This allows us to secure space at cost-effective rates, which we sublease to our franchisees at cost. By subleasing to our franchisees, we have greater control over the location and have greater bargaining power for lease negotiations than an individual franchisee typically would have, and we can elect not to renew subleases for underperforming locations. If a franchisee does not meet specified performance and appearance criteria, the franchise agreement specifies the procedures under which we are permitted to terminate the franchise agreement. In these situations, we may take possession of the location, inventory, and equipment, and operate the store as a company-owned store or re-franchise the location. Our U.S. franchise agreements and operations in the United States are regulated by the FTC. See “— Government Regulation — Franchise Regulation.”

International Franchises

Franchise revenues from our international franchisees accounted for approximately 16% of our franchise revenues for the twelve months ended June 30, 2004. In 2004, new international franchisees were required to pay an initial fee of $20,000 for a franchise license for each store and continuing royalty fees of 5% of sales. Our franchise program has enabled us to expand into international markets with limited capital expenditures. We expanded our international presence from 457 international franchised locations at the end of 2001 to 692 international locations as of June 30, 2004, without incurring any capital expenditures related to such expansion. Our international franchised stores generate sales per square foot of store space comparable to domestic store locations. However, we typically generate less revenues from franchises outside the United States due to lower international royalty rates and a smaller percentage of products that are purchased by the franchisees from us.

Franchisees in international locations enter into development agreements with us for either full size stores or a store-within-a-store at a host location. The development agreement grants the franchisee the right to develop a specific number of stores in a territory, often an entire country. The international franchisee then enters into a franchise agreement for each location. The full-size store franchise agreement has an initial ten-year term with two five-year renewal options. At the end of the initial term and each of the renewal periods, the international franchisee has the option to renew the agreement at 33% of the franchise fee that is then in effect. Franchise agreements for international store-within-a-store locations have an initial term of five years, with two five-year renewal options. At the end of the initial term and each of the renewal periods, the international franchisee of a store-within-a-store location has the option to renew the agreement for 50% of the franchise fee that is then in effect. Our international franchisees often receive exclusive franchising rights to the entire country franchised, excluding military bases. Our international franchisee must meet minimum standards and duties similar to our U.S. franchisees and our international franchise agreements and international operations may be regulated by various state, local and international laws. See “— Government Regulation — Franchise Regulation.”

Manufacturing/ Wholesale

Our Manufacturing/ Wholesale segment is comprised of our manufacturing operations in South Carolina and our wholesale sales business. This segment supplies our Retail and Franchise segments as well as various third parties with finished products. Our Manufacturing/ Wholesale segment generates revenues through sales of manufactured products to third parties, generally for third-party private label brands, and the sale of our proprietary and third-party brand products to Rite Aid and drugstore.com.

Manufacturing

Our technologically sophisticated manufacturing and distribution facilities support our Retail and Franchise segments and enable us to control the production and distribution of our proprietary products, better control costs, protect product quality, monitor delivery times and maintain appropriate inventory levels. We operate two main manufacturing facilities, one in Greenville, South Carolina and one in Anderson, South Carolina. We utilize our plants primarily for the production of proprietary products. Our manufacturing operations are designed to allow low- cost production of a variety of products of different quantities, sizes and packaging configurations while maintaining strict levels of quality control. Our manufacturing procedures are designed to promote consistency and quality in our finished goods. We conduct sample testing on raw materials and finished products, including weight, purity and microbiological testing. Our manufacturing facilities also service our wholesale operations, including the manufacture and supply of Rite Aid private label products for distribution to Rite Aid locations. We also use our available capacity at these facilities to produce products for sale to third-party customers. Our distribution fleet delivers raw materials and components to our manufacturing facilities and delivers our finished goods and third-party products to our distribution centers.

The principal raw materials used in the manufacturing process are natural and synthetic vitamins, herbs, minerals, and gelatin. We maintain multiple sources for the majority of our raw materials, with the remaining being single sourced due to the uniqueness of the material. As of December 31, 2003, no one vendor supplied more than 7% of our raw materials. In the event any of our third-party suppliers or vendors were to become unable or unwilling to continue to provide raw materials and third-party products in the required volumes and quality levels or in a timely manner, we would be required to identify and obtain acceptable replacement supply sources. If we are unable to obtain alternative suppliers, our business could be adversely affected.

Wholesale

Store-Within-a-Store Locations

To increase brand awareness and promote access to customers who may not frequent specialty nutrition stores, we entered into a strategic alliance with Rite Aid to open GNC store-within-a-store locations. As of

June 30, 2004, we had 994 store-within-a-store locations. Through this strategic alliance, we generate revenues from sales to Rite Aid of our products at wholesale prices, the manufacture of Rite Aid private label products and retail sales of consignment inventory. We are Rite Aid’s sole supplier for the PharmAssure vitamin brand and a number of Rite Aid private label supplements. We recently extended our alliance with Rite Aid through April 30, 2009, with its commitment to open 300 new store-within-a-store locations by December 31, 2006.

Distribution Agreement with drugstore.com

We have an Internet distribution agreement with drugstore.com, inc. Through this strategic alliance, drugstore.com became the exclusive Internet retailer of our proprietary products, the PharmAssure vitamin brand and certain other nutritional supplements. The initial term of the agreement expires in July 2009, subject to early termination provisions, and the exclusivity period expires in June 2005. This alliance allows us to access a larger customer base, who may not otherwise live close to, or have the time to visit, a GNC store. We generate revenues from the distribution agreement with drugstore.com through sales of our proprietary and third-party products on a wholesale basis and through retail sales of certain other products on a consignment basis.

Our wholesale operations, including our Rite Aid and drugstore.com wholesale operations, are supported by our Anderson distribution center. Products are delivered to our store-within-a-store locations in a manner similar to our company-owned stores.

Research and Development

We have an internal research and development group that performs scientific research on potential new and existing products, in part to assist our product development team in creating new products, and in part to support claims that may be made as to the purpose and function of the product. We incurred $0.8 million, $0.1 million, $0.8 million, $1.4 million and $0.4 million in our internal research and development for the six months ended June 30, 2004, the 27 days ended December 31, 2003, the period ended December 4, 2003, and the years ended December 31, 2002 and 2001, respectively. Additionally, prior to the Acquisition, Numico provided research and development services and allocated costs to us of $5.0 million, $4.6 million, and $4.9 million for the period ended December 4, 2003, and the years ended December 31, 2002 and 2001, respectively.

Revenue and Long Lived Assets by Location

Revenue and long lived assets segregated by location are as follows:



	Predecessor						Successor		Predecessor		Successor

	Twelve		Twelve						Six		Six
	Months		Months		Period		27 Days		Months		Months
	Ended		Ended		Ended		Ended		Ended		Ended
	December 31,		December 31,		December 4,		December 31,		June 30,		June 30,
	2001		2002		2003		2003		2003		2004

(In millions)
*Revenue:*
United States	$	1,465.2	$	1,379.2	$	1,290.7	$	84.6	$	698.2	$	688.5
Canada		41.7		42.9		45.0		4.2		23.7		28.2
Other Foreign Countries		2.3		2.9		4.5		0.5		1.9		3.6

Total International		44.0		45.8		49.5		4.7		25.0		31.8

Total Revenue	$	1,509.2	$	1,425.0	$	1,340.2	$	89.3	$	723.2	$	720.3

*Long Lived Assets:*
United States	$	2,591.9	$	1,287.5	$	498.9	$	555.6	$	1,282.1	$	583.2
Canada		6.5		6.7		6.4		6.5		7.3		5.0
Other Foreign Countries		5.3		4.5		1.0		4.7		0.9		0.9

Total International		11.8		11.2		7.4		11.2		8.2		5.9

Total Long Lived Assets	$	2,603.7	$	1,298.7	$	506.3	$	566.8	$	1,290.3	$	589.1

Competition

The U.S. nutritional supplements retail industry is a large, highly fragmented and growing industry, with no single industry participant accounting for more than 10% of total industry retail sales. Competition is based primarily on price, quality and assortment of products, customer service, marketing support and availability of new products.

We compete with publicly owned and privately owned companies, which are highly fragmented in terms of geographical market coverage and product categories. We compete with other specialty retailers, including Vitamin World and Vitamin Shoppe®, supermarkets, drugstores, mass merchants, multi-level marketing organizations, mail order companies and a variety of other smaller participants. In addition, the market is highly sensitive to the introduction of new products, including various prescription drugs, which may rapidly capture a significant share of the market. In the United States, we also compete with supermarkets, drugstores and mass merchants with heavily advertised national brands manufactured by large pharmaceutical and food companies, as well as with the Nature’s Bounty and Nature’s Wealth brands, sold by Vitamin World and other retailers. Our international competitors also include large international pharmacy chains and major international supermarket chains as well as other large U.S.-based companies with international operations. Our wholesale and manufacturing operations also compete with other wholesalers and manufacturers of third-party nutritional supplements such as Tree of Life and Leiner Health Products.

Trademarks and Other Intellectual Property

We believe trademark protection is particularly important to the maintenance of the recognized brand names under which we market our products. We own or have rights to material trademarks or trade names that we use in conjunction with the sale of our products, including the GNC brand name. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. We protect our intellectual property rights through a variety of methods, including trademark, patent and trade secret laws, as well as confidentiality agreements and proprietary information agreements with vendors, employees, consultants and others who have access to our proprietary information. Protection of our intellectual property often affords us the opportunity to enhance our position in

the marketplace by precluding our competitors from using or otherwise exploiting our technology and brands. We are also a party to several intellectual property license agreements relating to certain of our products. For example, several of our products are covered by patents which we license from Numico. The scope and duration of our intellectual property protection varies throughout the world by jurisdiction and by individual product.

Insurance and Risk Management

We purchase insurance to cover standard risks in the nutritional supplements industry, including policies to cover general and products liability, workers compensation, auto liability and other casualty and property risks. Our insurance rates are based on our safety record as well as trends in the insurance industry. We also maintain workers compensation insurance and auto insurance policies that are retrospective in that the cost per year will vary depending on the frequency and severity of claims in the policy year. Prior to the Acquisition, we were covered by certain of Numico’s insurance policies. Following the consummation of the Acquisition, we obtained our own insurance policies to replace those policies that were covered by Numico policies, including policies for general and products liability. We currently maintain products liability insurance with a deductible/retention of $1.0 million per claim with an aggregate cap on retained losses of $10.0 million, and general liability insurance with a deductible/retention of $100,000 per occurrence with an aggregate cap on retained losses of $600,000.

We face an inherent risk of exposure to product liability claims in the event that, among other things, the use of our products results in injury. With respect to product liability coverage, we expect to carry insurance coverage typical of our industry and product lines. Our coverage involves self-insured retentions with primary and excess liability coverage above the retention amount. We have the ability to refer claims to our vendors and their insurers to pay the costs associated with any claims arising from such vendors’ products. Our insurance covers such claims that are not adequately covered by a vendor’s insurance and provides for excess secondary coverage above the limits provided by our product vendors.

We self-insure certain property and casualty risks due to our analysis of the risk, the frequency and severity of a loss, and the cost of insurance for the risk. We believe that the amount of self-insurance is not significant and will not have an adverse impact on our performance.

Employees

As of June 30, 2004, we had a total of 5,249 full-time and 8,846 part-time employees, of whom approximately 12,249 were employed in our Retail segment; 39 were employed in our Franchise segment; 1,266 were employed in our Manufacturing/ Wholesale segment; and 541 were employed in corporate support functions. None of our employees belongs to a union or is a party to any collective bargaining or similar agreement. We consider our relationships with our employees to be good.

Properties

In our Retail segment, there were 2,649 company-owned stores operating in the United States and Canada as of June 30, 2004. All but one of our stores are located on leased premises that typically range in size from 1,000 to 2,000 square feet. In our Franchise segment, substantially all of our 1,331 franchised stores in the United States and Canada are located on premises we lease, and then sublease to our respective franchisees. All of our 692 franchised stores in other international locations are owned or leased directly by our franchisees. No single store is material to our operations.

As of June 30, 2004, our company-owned and franchised stores in the United States and Canada (excluding store-within-a-store locations) and our other international franchised stores consisted of:


	Company-
	Owned
United States and Canada	Retail		Franchise		Other International		Franchise

Alabama		32		14		Aruba		2
Alaska		6		5		Australia		35
Arizona		45		15		Bahamas		3


		Company-
		Owned
United States and Canada		Retail		Franchise		Other International		Franchise

Arkansas			18		6		Brazil		15
California			202		182		Brunei		1
Colorado			47		29	Cayman Islands			1
Connecticut			38		8		Chile		47
Delaware			8		10		China		1
District of Columbia			6		2		Columbia		1
Florida			220		120	Costa Rica			5
Georgia			88		63	Dominican Republic			12
Hawaii			20		1		Ecuador		14
Idaho			9		5	El Salvador			8
Illinois			85		76		Guam		3
Indiana			48		35		Guatemala		12
Iowa			23		11		Honduras		1
Kansas			19		14	Hong Kong			10
Kentucky			36		11		Indonesia		24
Louisiana			39		7		Israel		16
Maine			9		0		Japan		8
Maryland			55		29		Kuwait		4
Massachusetts			54		12		Lebanon		5
Michigan			78		49		Malaysia		18
Minnesota			60		16		Mexico		167
Mississippi			20		8		Pakistan		1
Missouri			44		21		Panama		5
Montana			4		3		Peru		13
Nebraska			6		18		Philippines		42
Nevada			12		10	Saudi Arabia			35
New Hampshire			17		5		Singapore		62
New Jersey			72		59	South Africa			8
New Mexico			21		2	South Korea			18
New York			148		60		Taiwan		14
North Carolina			83		48		Thailand		29
North Dakota			6		0		Turkey		20
Ohio			103		66	U.S. Virgin Islands			2
Oklahoma			31		7		Venezuela		30
Oregon			22		11
Pennsylvania			134		54
Puerto Rico			25		0
Rhode Island			12		1
South Carolina			28		27
South Dakota			5		0
Tennessee			42		36
Texas			203		91
Utah			23		8
Vermont			5		0
Virginia			81		31
Washington			48		23
West Virginia			25		3
Wisconsin			47		11
Wyoming			4		1
Canada			134		7

	Total		2,649		1,331		Total		692

In our Manufacturing/ Wholesale segment, we lease facilities for manufacturing, packaging, warehousing, and distribution operations. We manufacture a majority of our proprietary products at a 230,000 square foot facility in Greenville, South Carolina. We also lease a 630,000 square foot complex located in Anderson, South Carolina, for packaging, materials receipt, lab testing, warehousing, and distribution. Both the Greenville and Anderson facilities are leased on a long-term basis pursuant to “fee-in-lieu-of-taxes” arrangements with the counties in which the facilities are located, but we retain the right to purchase each of the facilities at any time during the lease for $1.00, subject to a loss of tax benefits. We also lease a 210,000

square foot distribution center in Leetsdale, Pennsylvania and a 112,000 square foot distribution center in Phoenix, Arizona. We conduct additional manufacturing for wholesalers and retailers of third-party products as well as warehouse certain third-party products at a leased facility located in New South Wales, Australia.

We also lease four small regional sales offices in Clearwater, Florida; Fort Lauderdale, Florida; Laguna Hills, California; and Mississauga, Ontario. None of the regional sales offices is larger than 5,000 square feet. Our 253,000 square foot corporate headquarters in Pittsburgh, Pennsylvania is owned by Gustine Sixth Avenue Associates, Ltd., a Pennsylvania limited partnership, of which General Nutrition, Incorporated, one of our subsidiaries, is a 50% limited partner. The partnership’s ownership of the land and buildings, and the partnership’s interest in the ground lease to General Nutrition, Incorporated, are all encumbered by a mortgage in the original principal amount of $17.9 million, with an outstanding balance of $13.7 million as of June 30, 2004.

Environmental

We are subject to numerous federal, state, local and foreign environmental laws and regulations governing our operations, including the handling, transportation and disposal of our products, and our non-hazardous and hazardous substances and wastes, as well as emissions and discharges into the environment, including discharges to air, surface water and groundwater. Failure to comply with such laws and regulations could result in costs for corrective action, penalties or the imposition of other liabilities. Changes in laws or the interpretation thereof or the development of new facts could also cause us to incur additional capital and operation expenditures to maintain compliance with environmental laws and regulations. We also are subject to laws and regulations that impose liability and cleanup responsibility for releases of hazardous substances into the environment without regard to fault or knowledge about the condition or action causing the liability. Under certain of these laws and regulations, such liabilities can be imposed for cleanup of previously owned or operated properties, or properties to which substances or wastes were sent by current or former operations at our facilities. The presence of contamination from such substances or wastes could also adversely affect our ability to sell or lease our properties, or to use them as collateral for financing. From time to time, we have incurred and are incurring costs and obligations for correcting environmental noncompliance matters and for remediation at or relating to certain of our properties. We believe we have complied with, or are currently complying with, our environmental obligations to date and that such liabilities will not have a material adverse effect on our business or financial performance. However, it is difficult to predict future liabilities and obligations which could be material.

Legal Proceedings

We are from time to time engaged in litigation. We regularly review all pending litigation matters in which we are involved and establish reserves deemed appropriate by management for these litigation matters. However, some of these matters are material and an adverse outcome in these matters could have a material impact on our financial condition and operating results.

As a manufacturer and retailer of nutritional supplements and other consumer products that are ingested by consumers or applied to their bodies, we have been and are currently subjected to various product liability claims. Although the effects of these claims to date have not been material to us, it is possible that current and future product liability claims could have a material adverse impact on our financial condition and operating results. We currently maintain product liability insurance with a deductible/retention of $1.0 million per claim with an aggregate cap on retained loss of $10 million per claim. We typically seek and have obtained contractual indemnification from substantially all parties that supply raw materials for our products or that manufacture or market products we sell. We also typically seek to be added, and have been added, as additional insured under most of such parties’ insurance policies. We are also entitled to indemnification by Numico for certain losses arising from claims related to products containing ephedra or Kava Kava sold prior to December 5, 2003. However, any such indemnification or insurance is limited by its terms and any such indemnification, as a practical matter, is limited to the creditworthiness of the indemnifying party and its insurer, and the absence of significant defenses by the insurers. See “Risk Factor — Risks Relating to Our

Business and Industry — We may incur material products liability claims, which could increase our costs and adversely affect our reputation, revenues and operating income.”

Ephedra (Ephedrine Alkaloids). As of August 4, 2004, we have been named as a defendant in 137 pending cases involving the sale of third-party products that contain ephedra. Ephedra products have been the subject of adverse publicity and regulatory scrutiny in the United States and other countries relating to alleged harmful effects, including the deaths of several individuals. In early 2003, we instructed all of our locations to stop selling products containing ephedra that were manufactured by GNC or one of our affiliates. Subsequently, we instructed all of our locations to stop selling any products containing ephedra by June 30, 2003. In April 2004, the FDA banned the sale of products containing ephedra. All claims to date have been tendered to the third-party manufacturer or to our insurer and we have incurred no expense to date with respect to litigation involving ephedra products. Furthermore, we are entitled to indemnification by Numico for certain losses arising from claims related to products containing ephedra sold prior to December 5, 2003. All of the pending cases relate to products sold prior to such time and, accordingly, we are entitled to indemnification from Numico for all of the pending cases.

Pro-Hormone/ Androstenedione. On July 29, 2001, five substantially identical class action lawsuits were filed in the state courts of the States of Florida, New York, New Jersey, Pennsylvania and Illinois against us and various manufacturers of products containing pro-hormones, including androstenedione:


	•	Brown v. General Nutrition Companies, Inc., Case No. 02-14221-AB, Florida Circuit Court for the 15th Judicial Circuit Court, Palm Beach County;

	•	Rodriguez v. General Nutrition Companies, Inc., Index No. 02/126277, New York Supreme Court, County of New York, Commercial Division;

	•	Abrams v. General Nutrition Companies, Inc., Docket No. L-3789-02, New Jersey Superior Court, Mercer County;

	•	Toth v. Bodyonics, Ltd., Case No. 003886, Pennsylvania Court of Common Pleas, Philadelphia County; and

	•	Pio v. General Nutrition Companies, Inc., Case No. 2-CH-14122, Illinois Circuit Court, Cook County.

On March 20, 2004, a similar lawsuit was filed in California (Guzman v. General Nutrition Companies, Inc., Case No. 04-00283). Plaintiffs allege that we have distributed or published periodicals that contain advertisements claiming that the various pro-hormone products promote muscle growth. The complaint alleges that we knew the advertisements and label claims promoting muscle growth were false, but nonetheless continued to sell the products to consumers. Plaintiffs seek injunctive relief, disgorgement of profits, attorney’s fees and the costs of suit. We have tendered these cases to the various manufacturers for defense and indemnification. Based upon the information available to us at the present time, we believe that these matters will not have a material adverse effect upon our liquidity, financial condition or results of operations.

California Wage Claim. On November 2, 2001, Matthew Capelouto, a former store manager in California, filed a putative class action lawsuit in the Superior Court of California, Orange County (Capelouto v. General Nutrition Corporation, Case No. 01-CC-00138). The lawsuit alleges that we misclassified store managers at our company-owned stores in California as exempt from overtime requirements and/or required them to work off the clock, and failed to pay them overtime, in violation of California’s wage and hour laws. On October 23, 2003, an amended complaint was filed, adding another named plaintiff, Lamar Wright, as well as claims for failure to provide required meal periods and rest periods for GNC managers at company-owned stores in California. The plaintiff seeks compensatory damages with interest, disgorgement of profits, punitive damages, meal period and rest period compensation, attorney’s fees and the costs of suit. On May 13, 2004, we entered into an agreement in principle to settle the claims of the putative class members, without admitting any liability, for a total payment of approximately $4.6 million, inclusive of class counsel’s attorneys’ fees, costs and expenses, plus up to $20,000 of the costs of settlement administration. The settlement is subject to approval by the court and the plaintiff’s class. Moreover, we have the right to rescind the settlement if more than 10% of the putative class members opt out of the settlement.

Wage and Hour Claim. On or about May 10, 2004, seven former employees brought an action in the United States District Court for the Southern District of New York on behalf of themselves and a purported class of other similarly situated former employees employed by GNC within the last six years and who allegedly worked but were not paid overtime for hours worked in excess of 40 hours per week (Shockley v. General Nutrition Corporation, Case No. 04-CIV-2336). The complaint is brought under the federal Fair Labor Standards Act and New York State Labor Law. The plaintiffs seek actual damages, liquidated damages on claims asserted under the FLSA, an order enjoining GNC from engaging in the practices alleged in their complaint, and attorney’s fees and the costs of suit. Based on the information available to us at the present time, we believe that this matter will not have a material adverse effect upon our liquidity, financial condition or results of operations.

Government Regulation

Product Regulation

Domestic

The processing, formulation, manufacturing, packaging, labeling, advertising and distribution of our products are subject to regulation by several federal agencies, including the Food and Drug Administration (“FDA”), the 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 our products are sold. Pursuant to the Federal Food, Drug, and Cosmetic Act (“FDCA”), the FDA regulates the processing, formulation, safety, manufacture, packaging, labeling and distribution of dietary supplements, (including vitamins, minerals, herbs) and over-the-counter drugs. The FTC has jurisdiction to regulate the advertising of these products.

The FDCA has been amended several times with respect to dietary supplements, in particular by the Dietary Supplement Health and Education Act of 1994 (“DSHEA”). DSHEA established a new framework governing the composition, safety, labeling and marketing of dietary supplements. “Dietary supplements” are defined as vitamins, minerals, herbs, other botanicals, amino acids and other dietary substances for human use to supplement the diet, as well as concentrates, metabolites, constituents, extracts or combinations of such dietary ingredients. Generally, under DSHEA, dietary ingredients that were on the market prior to October 15, 1994 may be used in dietary supplements without notifying the FDA. “New” dietary ingredients (i.e., dietary ingredients that were “not marketed in the United States before October 15, 1994”) must be the subject of a new dietary ingredient notification submitted to the FDA unless the ingredient has been “present in the food supply as an article used for food” without being “chemically altered.” A new dietary ingredient notification must provide the FDA evidence of a “history of use or other evidence of safety” establishing that use of the dietary ingredient “will reasonably be expected to be safe.” A new dietary ingredient notification must be submitted to the FDA at least 75 days before the initial marketing of the new dietary ingredient. There is no certainty that the FDA will accept any particular evidence of safety for any new dietary ingredient. The FDA’s refusal to accept such evidence could prevent the marketing of such dietary ingredients.

The FDA issued a consumer warning in 1996, followed by proposed regulations in 1997, covering dietary supplements that contain ephedra or its active substance, ephedrine alkaloids. In February 2003, the Department of Health and Human Services, announced a series of actions that the Department of Health and Human Services and the FDA plan to execute with respect to products containing ephedra, including the solicitation of evidence regarding the significant or unreasonable risk of illness or injury from dietary supplements containing ephedra and the immediate execution of a series of actions against ephedra making unsubstantiated claims about sports performance enhancement. In addition, many states proposed regulations and three states enacted laws restricting the promotion and distribution of ephedra- containing dietary supplements. The botanical ingredient ephedra was formerly used in several third party and private label dietary supplement products. In January 2003, we began focusing our diet category on products that would replace ephedra products. In early 2003, we instructed all of our locations to stop selling products containing ephedra that were manufactured by GNC or one of our affiliates. Subsequently, we instructed all of our

locations to stop selling any products containing ephedra by June 30, 2003. Sales of products containing ephedra amounted to approximately $35.2 million, or 3.3% of our retail sales, in 2003 and approximately $182.9 million, or 17.1% of our retail sales, in 2002. In February 2004, the FDA issued a final regulation declaring dietary supplements containing ephedra illegal under the FDCA because they present an unreasonable risk of illness or injury under the conditions of use recommended or suggested in labeling, or if no conditions of use are suggested or recommended in labeling, under ordinary conditions of use. The rule took effect on April 12, 2004 and bans the sale of dietary supplement products containing ephedra. Similarly, the FDA issued a consumer advisory in 2002 with respect to dietary supplements that contain the ingredient Kava, and the FDA is currently investigating adverse effects associated with ingestion of this ingredient. One of our subsidiaries, Nutra Manufacturing, Inc. (f/k/a Nutricia Manufacturing USA, Inc.), manufactured products containing Kava Kava from December 1995 until August 2002. All stores were instructed to stop selling products containing Kava Kava in December 2002. The FDA could take similar actions against other products or product ingredients which it determines present an unreasonable health risk to consumers.

DSHEA permits “statements of nutritional support” to be included in labeling for dietary supplements without FDA premarket approval. Such statements must be submitted to FDA within 30 days of marketing and must bear a label disclosure that “This statement has not been evaluated by the Food and Drug Administration. This product is not intended to diagnose, treat, cure, or prevent any disease.” Such statements may describe how a particular dietary ingredient affects the structure, function or general well-being of the body, or the mechanism of action by which a dietary ingredient may affect body structure, function or well-being, but may not expressly or implicitly represent that a dietary supplement will diagnose, cure, mitigate, treat, or prevent a disease. A company that uses a statement of nutritional support in labeling must possess scientific evidence substantiating that the statement is truthful and not misleading. If the FDA determines that a particular statement of nutritional support is an unacceptable drug claim or an unauthorized version of a disease claim for a food product, or if the FDA determines that a particular claim is not adequately supported by existing scientific data or is false or misleading, we would be prevented from using the claim.

In addition, DSHEA provides that so-called “third-party literature,” e.g., a reprint of a peer-reviewed scientific publication linking a particular dietary ingredient with health benefits, may be used “in connection with the sale of a dietary supplement to consumers” without the literature being subject to regulation as labeling. Such literature must not be false or misleading; the literature may not “promote” a particular manufacturer or brand of dietary supplement; and a balanced view of the available scientific information on the subject matter must be presented. If the literature fails to satisfy each of these requirements, we may be prevented from disseminating such literature with our products, and any dissemination could subject our product to regulatory action as an illegal drug.

We expect that the FDA will adopt in the near future the final regulations, proposed on March 13, 2003, regarding Good Manufacturing Practice in manufacturing, packing, or holding dietary ingredients and dietary supplements, authorized by DSHEA. Good Manufacturing Practice regulations will require dietary supplements to be prepared, packaged and held in compliance with strict rules, and will require quality control provisions similar to those in the Good Manufacturing Practice regulations for drugs. We or our third-party supplier or vendors may not be able to comply with the new rules without incurring substantial additional expenses. In addition, if our third-party suppliers or vendors are not able to timely comply with the new rules, we may experience increased costs or delays in obtaining certain raw materials and third-party products.

The FDA has broad authority to enforce the provisions of the FDCA applicable to dietary supplements, including powers to issue a public warning letter to a company, to publicize information about illegal products, to request a recall of illegal products from the market, and to request the Department of Justice to initiate a seizure action, an injunction action, or a criminal prosecution in the United States courts. The regulation of dietary supplements may increase or become more restrictive in the future.

Legislation has been introduced in Congress to impose substantial new regulatory requirements for dietary supplements, e.g., S.722, S.1538, S.1780, H.R. 3377 and H.R. 3866. S.722 would impose adverse event reporting, postmarket surveillance requirements, FDA reviews of dietary supplement ingredients, and

other requirements. H.R. 3377 would impose similar requirements as well as safety testing and records inspection. S.1538 would increase FDA appropriations to allow full implementation and enforcement of DSHEA. S.1780 and H.R. 3866 would subject specified anabolic steroid substances currently used in some dietary supplements, such as “andro,” to the requirements of the Controlled Substances Act. The dietary supplement industry supports S.1538, S.1780, and H.R. 3866. Key members of Congress and the dietary supplement industry have indicated that they have reached agreement to support legislation requiring adverse event reporting. If enacted, S.722 and H.R. 3377 could raise our costs and hinder our business.

The FTC exercises jurisdiction over the advertising of dietary supplements. In recent years, the FTC has instituted numerous enforcement actions against dietary supplement companies for failure to have adequate substantiation for claims made in advertising or for the use of false or misleading advertising claims. We continue to be subject to three consent orders issued by the FTC. In 1984, the FTC instituted an investigation of General Nutrition, Incorporated, one of our subsidiaries, alleging deceptive acts and practices in connection with the advertising and marketing of certain of its products. General Nutrition, Incorporated accepted a proposed consent order which was finalized in 1989, under which it 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. We 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, disputes arose concerning its compliance with these orders, and with regard to advertising for certain hair care products. While General Nutrition, Incorporated believes that, at all times, it operated in material compliance with the orders, it entered into a settlement in 1994 with the FTC to avoid protracted litigation. As a part of this settlement, General Nutrition, Incorporated entered into a consent decree and paid, without admitting liability, a civil penalty in the amount of $2.4 million and 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. We do not believe that future compliance with the outstanding consent decrees will materially affect our business operations. In 2000, the FTC amended the 1970 order to clarify language in the 1970 order that was believed to be ambiguous and outmoded.

The FTC continues to monitor our 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. Our policy is to use advertising that complies with the consent decrees and applicable regulations. We review all products brought into our distribution centers to assure that such products and their labels comply with the consent decrees. We also review 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 20% of the products sold by franchised stores are purchased by franchisees directly from other vendors and these products do not flow through our distribution centers. Although franchise contracts contain strict requirements for store operations, including compliance with federal, state, and local laws and regulations, we cannot exercise the same degree of control over franchisees as we do over our company-owned stores. As a result of our efforts to comply with applicable statutes and regulations, we have from time to time reformulated, eliminated or relabeled certain of our products and revised certain provisions of our sales and marketing program. We believe we are in material compliance with the various consent decrees and with applicable federal, state and local rules and regulations concerning our products and marketing program. Compliance with the provisions of national, state and local environmental laws and regulations has not had a material effect upon our capital expenditures, earnings, financial position, liquidity or competitive position.

Foreign

Our products sold in foreign countries are also subject to regulation under various national, local, and international laws that include provisions governing, among other things, the processing, formulation, manufacturing, packaging, labeling, advertising and distribution of dietary supplements and over-the-counter drugs. Government regulations in foreign countries may prevent or delay the introduction, or require the reformulation, of certain of our products.

We cannot determine what effect additional domestic or international governmental legislation, regulations or administrative orders, when and if promulgated, would have on our business in the future. New legislation or regulations may require the reformulation of certain products to meet new standards, require the recall or discontinuance of certain products not capable of reformulation, impose additional record keeping or require expanded documentation of the properties of certain products, expanded or different labeling, or scientific substantiation.

Franchise Regulation

We must comply with regulations adopted by the FTC and with several state laws that regulate the offer and sale of franchises. The FTC’s Trade Regulation Rule on Franchising and certain state laws require that we furnish prospective franchisees with a franchise offering circular containing information prescribed by the Trade Regulation Rule on Franchising and applicable state laws and regulations.

We also must comply with a number of state laws that regulate some substantive aspects of the franchisor-franchisee relationship. These laws may limit a franchisor’s business practices in a number of ways, including limiting the ability to:


	•	terminate or not renew a franchise without good cause;

	•	interfere with the right of free association among franchisees;

	•	disapprove the transfer of a franchise;

	•	discriminate among franchisees with regard to charges, royalties and other fees; and

	•	place new stores near existing franchises.

To date, these laws have not precluded us from seeking franchisees in any given area and have not had a material adverse effect on our operations. Bills intended to regulate certain aspects of franchise relationships have been introduced into Congress on several occasions during the last decade, but none have been enacted.

Our international franchise agreements and franchise operations are regulated by various foreign laws, rules and regulations. To date, these laws have not precluded us from seeking franchisees in any given area and have not had a material adverse effect on our operations.

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