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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
(Mark one)
[ X ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended March 31, 2019
 
 
[     ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the transition period from                     to                     .
 
Commission File Number:  001-35113
 GNC Holdings, Inc.
(Exact name of registrant as specified in its charter)
Delaware
20-8536244
(State or other jurisdiction of
(I.R.S. Employer
Incorporation or organization)
Identification No.)
 
 
300 Sixth Avenue
15222
Pittsburgh, Pennsylvania
(Zip Code)
(Address of principal executive offices)
 
 
Registrant’s telephone number, including area code:  (412) 288-4600
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading Symbol
 
Name of each exchange on which registered
Class A common stock, par value $0.001 per share
 
GNC
 
New York Stock Exchange
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                  [ X ] Yes [    ] No
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).                             [ X ] Yes [    ] No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer [  ]
Accelerated filer [ X ]
Non-accelerated filer [   ]
Smaller reporting company [   ]
Emerging growth company [   ]

 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.                                                       [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
[     ] Yes [ X ] No
 
As of April 25, 2019, there were 83,969,311 outstanding shares of Class A common stock, par value $0.001 per share (the “common stock”), of GNC Holdings, Inc.


Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
PAGE
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements
 
GNC HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
(in thousands)
 
March 31, 2019
 
December 31, 2018
Current assets:
 
Cash and cash equivalents
$
137,117


$
67,224

Receivables, net
119,352


127,317

Inventory (Note 4)
410,951


465,572

Forward contracts for the issuance of convertible preferred stock

 
88,942

Prepaid and other current assets
17,528


55,109

Total current assets
684,948

 
804,164

Long-term assets:
 

 
 

Goodwill
79,111


140,764

Brand name
300,720


300,720

Other intangible assets, net
75,463


92,727

Property, plant and equipment, net
95,574


155,095

Right-of-use assets (Note 8)
401,456

 

Equity method investments (Note 6)
97,803

 

Other long-term assets
35,062


34,380

Total long-term assets
1,085,189

 
723,686

Total assets
$
1,770,137

 
$
1,527,850

Current liabilities:
 

 
 

Accounts payable
$
174,682


$
148,782

Current portion of long-term debt (Note 5)


158,756

Current lease liabilities (Note 8)
117,093

 

Deferred revenue and other current liabilities
107,770


120,169

Total current liabilities
399,545

 
427,707

Long-term liabilities:
 

 
 

Long-term debt (Note 5)
888,353


993,566

Deferred income taxes
15,304


39,834

Lease liabilities (Note 8)
401,617

 

Other long-term liabilities
43,007


82,249

Total long-term liabilities
1,348,281

 
1,115,649

Total liabilities
1,747,826

 
1,543,356

Contingencies (Note 9)


 


 
 
 
 
Mezzanine equity:
 
 
 
  Convertible preferred stock (Note 10)
211,395

 
98,804

 
 
 
 
Stockholders’ deficit:
 

 
 

Common stock
130

 
130

Additional paid-in capital
1,009,041


1,007,827

Retained earnings
538,439


613,637

Treasury stock, at cost
(1,725,349
)

(1,725,349
)
Accumulated other comprehensive loss
(11,345
)

(10,555
)
Total stockholders’ deficit
(189,084
)
 
(114,310
)
Total liabilities, mezzanine equity and stockholders’ deficit
$
1,770,137

 
$
1,527,850

 
The accompanying notes are an integral part of the Consolidated Financial Statements.

1

Table of Contents

GNC HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(unaudited)
(in thousands, except per share amounts)

 
Three months ended March 31,
 
2019
 
2018
 
 
Revenue (Note 3)
$
564,764

 
$
607,533

Cost of sales, including warehousing, distribution and occupancy
361,673

 
400,659

Gross profit
203,091

 
206,874

Selling, general, and administrative
148,303

 
160,730

Loss on net asset exchange for the formation of the joint ventures (Note 6)
19,514

 

Other income, net
(208
)
 
(245
)
Operating income
35,482

 
46,389

Interest expense, net (Note 5)
32,956

 
21,773

Loss on debt refinancing

 
16,740

    Loss on forward contracts for the issuance of convertible preferred stock
16,787

 

(Loss) income before income taxes
(14,261
)
 
7,876

Income tax expense (Note 13)
1,956

 
1,686

(Loss) income before income from equity method investments
(16,217
)
 
6,190

Income from equity method investments (Note 6)
955

 

Net (loss) income
$
(15,262
)
 
$
6,190

(Loss) earnings per share (Note 11):
 

 
 

Basic
$
(0.23
)
 
$
0.07

Diluted
$
(0.23
)
 
$
0.07

Weighted average common shares outstanding (Note 11):
 

 
 

Basic
83,510

 
83,232

Diluted
83,510

 
83,368

 
The accompanying notes are an integral part of the Consolidated Financial Statements.


2

Table of Contents

GNC HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(unaudited)
(in thousands)
 
 
Three months ended March 31,
 
2019
 
2018
 
 
Net (loss) income
$
(15,262
)
 
$
6,190

Other comprehensive loss:
 

 
 

 Net change in interest rate swaps:
 
 
 
Periodic revaluation of interest rate swap, net of tax benefit of $0.7 million
(1,464
)
 

Reclassification adjustment for interest recognized in Consolidated Statement of Operations, net of tax expense of $0.1 million
236

 

 Net change in unrecognized loss on interest rate swaps, net of tax
(1,228
)
 

 Foreign currency translation gain (loss)
438

 
(846
)
Other comprehensive loss
(790
)
 
(846
)
Comprehensive (loss) income
$
(16,052
)
 
$
5,344

 
The accompanying notes are an integral part of the Consolidated Financial Statements.


3

Table of Contents

GNC HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Deficit
(unaudited)
(in thousands)

 
Common Stock
 
Treasury Stock
 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
Stockholders’
Deficit
 
Class A
 
 
 
 
 
 
Shares
 
Dollars
 
 
 
 
 
Balance at December 31, 2018
83,886

 
$
130

 
$
(1,725,349
)
 
$
1,007,827

 
$
613,637

 
$
(10,555
)
 
$
(114,310
)
Impact of the adoption of ASC 842

 

 

 

 
(59,936
)
 

 
(59,936
)
Comprehensive income

 

 

 

 
(15,262
)
 
(790
)
 
(16,052
)
Dividend forfeitures on restricted stock

 

 

 

 

 

 

Restricted stock awards
121

 

 

 

 

 

 

Minimum tax withholding requirements
(41
)
 

 

 
(120
)
 

 

 
(120
)
Stock-based compensation

 

 

 
1,334

 

 

 
1,334

Balance at March 31, 2019
83,966

 
$
130

 
$
(1,725,349
)
 
$
1,009,041

 
$
538,439

 
$
(11,345
)
 
$
(189,084
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
83,567

 
$
130

 
$
(1,725,349
)
 
$
1,001,315

 
$
543,814

 
$
(5,831
)
 
$
(185,921
)
Comprehensive income

 

 

 

 
6,190

 
(846
)
 
5,344

Dividend forfeitures on restricted stock

 

 

 

 
42

 

 
42

Restricted stock awards
149

 

 

 

 

 

 

Minimum tax withholding requirements
(54
)
 

 

 
(223
)
 

 

 
(223
)
Stock-based compensation

 

 

 
1,512

 

 

 
1,512

Balance at March 31, 2018
83,662

 
$
130

 
$
(1,725,349
)
 
$
1,002,604

 
$
550,046

 
$
(6,677
)
 
$
(179,246
)
 
The accompanying notes are an integral part of the Consolidated Financial Statements.


4

Table of Contents

GNC HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
(in thousands)

 
Three months ended March 31,
 
2019
 
2018
Cash flows from operating activities:

Net (loss) income
$
(15,262
)

$
6,190

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 


 

Depreciation and amortization expense
10,190


12,105

Income from equity investments
(955
)
 

Amortization of debt costs
7,988


3,609

Stock-based compensation
1,334


1,512

Loss on forward contracts related to the issuance of convertible preferred stock
16,787



Loss on net asset exchange for the formation of the joint ventures
19,514

 

Gains on refranchising
(21
)
 

Loss on debt refinancing

 
16,740

Third-party fees associated with refinancing

 
(15,753
)
Changes in assets and liabilities:





(Increase) decrease in receivables
(12,567
)

11,840

(Increase) in inventory
(6,886
)

(22,766
)
Increase in prepaid and other current assets
(3,658
)

(9,473
)
Increase in accounts payable
57,722


21,791

Increase in deferred revenue and accrued liabilities
(627
)

388

Other operating activities
(4,848
)

(1,111
)
Net cash provided by operating activities
68,711


25,072

 





Cash flows from investing activities:
 


 

Capital expenditures
(3,017
)

(3,732
)
Refranchising proceeds
710


465

Store acquisition costs
(43
)

(116
)
Proceeds from net asset exchange
101,000

 

Capital contribution to the newly formed joint ventures
(13,079
)
 

Net cash provided by (used in) investing activities
85,571


(3,383
)
 





Cash flows from financing activities:
 


 

Borrowings under revolving credit facility
22,000


50,000

Payments on revolving credit facility
(22,000
)

(32,500
)
Proceeds from the issuance of convertible preferred stock
199,950

 

Payments on Tranche B-1 Term Loan
(147,312
)
 
(1,138
)
Payments on Tranche B-2 Term Loan
(114,000
)
 
(10,700
)
Original issuance discount and revolving credit facility fees
(10,365
)

(35,216
)
Fees associated with the issuance of convertible preferred stock
(12,564
)
 
(2,183
)
Minimum tax withholding requirements
(120
)

(223
)
Net cash used in financing activities
(84,411
)

(31,960
)
 





Effect of exchange rate changes on cash and cash equivalents
22


141

Net increase (decrease) in cash and cash equivalents
69,893


(10,130
)
Beginning balance, cash and cash equivalents
67,224


64,001

Ending balance, cash and cash equivalents
$
137,117


$
53,871

 
The accompanying notes are an integral part of the Consolidated Financial Statements.


5

Table of Contents

GNC HOLDINGS, INC. AND SUBSIDIARIES
Supplemental Cash Flow Information
(unaudited)



 
As of March 31,
 
2019
 
2018
Non-cash investing activities:
(in thousands)
Capital expenditures in current liabilities
$
1,115

 
$
1,203

Non-cash financing activities:
 
 
 
Original issuance discount (Note 5)
$

 
$
19,587


Refer to Note 8, "Leases" for supplemental cash flow information related to the Company's leases.


The accompanying notes are an integral part of the Consolidated Financial Statements.


6

Table of Contents

GNC HOLDINGS, INC. AND SUBSIDIARIES
Condensed Notes to the Unaudited Consolidated Financial Statements

NOTE 1.  NATURE OF BUSINESS
GNC Holdings, Inc., a Delaware corporation (“Holdings,” and collectively with its subsidiaries and, unless the context requires otherwise, its and their respective predecessors, the “Company”), is a global health and wellness brand with a diversified, omni-channel business. The Company's assortment of performance and nutritional supplements, vitamins, herbs and greens, health and beauty, food and drink and other general merchandise features innovative private-label products as well as nationally recognized third-party brands, many of which are exclusive to GNC. 
The Company's operations consist of purchasing raw materials, formulating and manufacturing products and selling the finished products through its three reportable segments, U.S. and Canada, International, and Manufacturing / Wholesale (refer to Note 12, "Segments" for more information). Corporate retail store operations are located in the United States, Canada, Puerto Rico and Ireland. In addition, the Company offers products on the internet through GNC.com and third-party websites. Franchise locations exist in the United States and approximately 50 other countries. Additionally, the Company licenses the use of its trademarks and trade names
In February 2019, the Company entered into two joint ventures to operate its e-commerce business and retail business, respectively, in China, which will accelerate its presence and maximize the Company's opportunities for growth in the Chinese supplement market. Under the terms of the agreement, the Company contributed its China business and retained 35% interest in the joint ventures. In March 2019, the Company announced a strategic joint venture with International Vitamin Corporation ("IVC") regarding the Company's manufacturing business, which enables the Company to increase its focus on product innovation while IVC manages manufacturing and integrates with the Company's supply chain thereby driving more efficient usage of capital. Under the terms of the agreement, the Company received $101 million and contributed its Nutra manufacturing and Anderson facility net assets in exchange for an initial 43% interest in the new joint venture.
NOTE 2.  BASIS OF PRESENTATION  
The accompanying unaudited Consolidated Financial Statements, which have been prepared in accordance with the applicable rules of the Securities and Exchange Commission ("SEC"), include all adjustments (of a normal and recurring nature) that management considers necessary to fairly state the Company's results of operations, financial position and cash flows. The March 31, 2019 Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”). These interim Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Footnotes included in the Company’s audited financial statements in its Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC on March 13, 2019 (the "2018 10-K"). Interim results are not necessarily indicative of the results that may be expected for the remainder of the year ending December 31, 2019.
Recently Adopted Accounting Pronouncements

Adoption of the New Lease Standard

In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02, which requires lessees to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments for all leases with a term greater than 12 months. This standard is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2018 and is required to be applied using a modified retrospective approach. In July 2018, the FASB issued ASU 2018-11, which provides companies with the option to apply the new lease standard either at the beginning of the earliest comparative period presented or in the period of adoption. The Company adopted ASU 2016-02 and its related amendments (collectively known as "ASC 842") during the first quarter of fiscal 2019 electing the optional transition relief amendment that allows for a cumulative-effect adjustment in the period of adoption and did not restate prior periods.  In transitioning to ASC 842, the Company elected to use the practical expedient package available under the guidance for leases that commenced before the effective date and did not elect to use hindsight. The Company has implemented new lease management and accounting system and updated its processes and internal controls to comply with the new standard.

The Company leases substantially all of our retail stores in the U.S. and Canada segment, including most of the domestic franchise stores that are leased and sublease to franchisees, the four distribution centers in the United

7

Table of Contents

States and retail stores in Ireland. In addition, the Company has leased office locations, vehicles and equipment to support our store and supply chain operations. All of the Company's leases are classified as operating leases.

The Company determines if a contract contains a lease at inception. The lease liabilities are recognized based on the present value of the future minimum lease payments over the term at the commencement date for leases exceeding 12 months. The lease agreements generally contain lease and non-lease components. Non-lease components primarily include payments for maintenance and utilities. The minimum lease payments include only fixed lease components, as well as any variable rate payments that depend on an index, initially measured using the index at the lease commencement date. Lease terms may include options to renew when it is reasonably certain that the Company will exercise an option. The Company estimates its incremental borrowing rate, which is estimated to approximate the interest rate on a collateralized basis with similar terms and payments for each lease, using a portfolio approach. The right-of-use assets recognized are initially equal to the lease liability, adjusted for any lease payments made on or before the commencement dates and lease incentives.

The Company recognized lease liabilities of $550.2 million on January 1, 2019. A right-of-use asset of $504.2 million was recognized based on the lease liability, adjusted for the reclassification of deferred rent of $53.3 million and prepaid rent of $7.3 million. Additionally, the Company recognized $79.8 million of right-of-use asset impairment charges for certain of the Company's stores for which it was previously determined that the carrying value of the such stores' assets were not recoverable. The right-of-use asset impairment charges were recorded as a reduction to January 1, 2019 (opening day) retained earnings, net of tax of $19.8 million. The new lease standard has no impact on the timing or classification of the Company's cash flows as reported in the Consolidated Statement of Cash Flows.

The lease liabilities for the operating leases are amortized using the effective interest method. The right-of-use asset is amortized by taking the difference between total rent expense recorded on straight line basis and the lease liability amortization. When the right-of-use asset for an operating lease is impaired, lease expense is no longer recognized on a straight-line basis. For impaired leases, the Company continues to amortize the lease liability using the same effective interest method as before the impairment charge and the right-of-use asset is amortized on a straight-line basis.

Refer to Note 8 "Leases" for additional information relating to the impact of adopting ASC 842.

Recently Issued Accounting Pronouncements
In August 2018, the FASB issued ASU 2018-15, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-used software. This standard is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of the new standard to have a material impact on its Consolidated Financial Statements.

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NOTE 3.  REVENUE  
Revenue is recognized when obligations under the terms of a contract with the customer are satisfied. Generally, this occurs with the transfer of control of products or services. The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is measured as the amount of consideration expected to be received in exchange for transferring goods or providing services. Applicable sales tax collected concurrent with revenue-producing activities is excluded from revenue.
U.S. and Canada Revenue
The following is a summary of revenue disaggregated by major source in the U.S. and Canada segment:
 
Three months ended March 31,
 
2019
 
2018
U.S. company-owned product sales: (1)
(in thousands)
   Protein
$
80,257

 
$
87,670

   Performance supplements
74,778

 
75,616

   Weight management
30,779

 
39,787

   Vitamins
47,056

 
50,371

   Herbs / Greens
15,873

 
16,158

   Wellness
47,200

 
47,701

   Health / Beauty
46,388

 
48,054

   Food / Drink
28,243

 
25,360

   General merchandise
6,800

 
7,062

Total U.S. company-owned product sales
$
377,374

 
$
397,779

Wholesale sales to franchisees
58,257

 
57,160

Royalties and franchise fees
8,472

 
8,748

Sublease income
10,976

 
11,765

Cooperative advertising and other franchise support fees
5,067

 
5,533

Other (2)
29,011

 
31,429

Total U.S. and Canada revenue
$
489,157

 
$
512,414

(1)
Includes GNC.com sales.
(2)
Includes revenue primarily related to Canada operations and loyalty programs, myGNC Rewards and PRO Access.
International Revenues
The following is a summary of the revenue disaggregated by major source in the International reportable segment:
 
Three months ended March 31,
 
2019
 
2018
 
(in thousands)
Wholesale sales to franchisees
$
25,437

 
$
21,760

Royalties and franchise fees
6,202

 
6,621

Other (1)
9,284

 
11,684

Total International revenue
$
40,923

 
$
40,065

(1) Includes revenue primarily related to China operations prior to the newly formed joint ventures in China effective February 13, 2019 and company-owned stores located in Ireland.

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Manufacturing / Wholesale Revenue
The following is a summary of the revenue disaggregated by major source in the Manufacturing / Wholesale reportable segment:
 
Three months ended March 31,
 
2019
 
2018
 
(in thousands)
Third-party contract manufacturing(1)
$
15,783

 
$
32,722

Intersegment sales(1)
35,505

 
64,663

Wholesale partner sales
18,901

 
22,332

Total Manufacturing / Wholesale revenue
$
70,189

 
$
119,717


(1) The decrease in third-party contract manufacturing and intersegment sales for the three months ended March 31, 2019 compared to the prior year quarter is due to the transaction with IVC for the newly formed manufacturing joint venture effective March 1, 2019.
Revenue by Geography
The following is a summary of the revenue by geography:
 
Three months ended March 31,
 
2019
 
2018
Total revenues by geographic areas(1):
(in thousands)
United States
$
535,943

 
$
572,231

Foreign
28,821

 
35,302

Total revenues
$
564,764

 
$
607,533


(1) Geographic areas are defined based on legal entity jurisdiction.
Balances from Contracts with Customers
Contract assets represent amounts related to the Company's contractual right to consideration for completed performance obligations not yet invoiced. As of December 31, 2018, the Company had contract assets of $25.5 million for specialty manufacturing recorded within prepaid and other current assets on the Consolidated Balance Sheet (with a corresponding reduction to inventory at cost). Due to the contribution of the Nutra manufacturing net assets to the manufacturing joint venture with IVC on March 1, 2019, the Company has no contract assets on the Consolidated Balance Sheet as of March 31, 2019.

Contract liabilities include payments received in advance of performance under the contract, and are realized with the associated revenue recognized under the contract. The Company's PRO Access and loyalty program points are recorded within deferred revenue and other current liabilities on the Consolidated Balance Sheets. Deferred franchise and license fees are recorded within deferred revenue and other current liabilities and other long-term liabilities on the Consolidated Balance Sheets.

The following table presents changes in the Company’s contract liabilities during the three months ended March 31, 2019:

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Three months ended March 31, 2019
 
Balance at Beginning of Period
 
Recognition of revenue included in beginning balance
 
Contract liability, net of revenue, recognized during the period
 
Balance at the End of Period
 
(in thousands)
Deferred franchise and license fees
$
33,464

 
(2,861
)
 
668

 
$
31,271

PRO Access and loyalty program points
24,836

 
(12,423
)
 
12,863

 
25,276

Gift card liability
3,416

 
(1,523
)
 
181

 
2,074


As of March 31, 2019, the Company had deferred franchise fees with unsatisfied performance obligations extending throughout 2029 of $31.3 million, of which approximately $7.2 million is expected to be recognized over the next 12 months. The Company has elected to use the practical expedient allowed under the rules of adoption to not disclose the duration of the remaining unsatisfied performance obligations for contracts with an original expected length of one year or less.
NOTE 4.  INVENTORY
The net realizable value of inventory consisted of the following:
 
March 31, 2019
 
December 31, 2018
 
(in thousands)
Finished product ready for sale
$
410,951

 
$
416,113

Work-in-process, bulk product and raw materials(1)

 
46,520

Packaging supplies(1)

 
2,939

Inventory
$
410,951

 
$
465,572

(1) The decrease in work-process, buck and raw materials and packaging supplies as of March 31, 2019 compared with December 31, 2018 is due to the transaction with IVC for the newly formed manufacturing joint venture effective March 1, 2019.
NOTE 5.  LONG-TERM DEBT / INTEREST EXPENSE
Long-term debt consisted of the following: 
 
March 31,
2019
 
December 31,
2018
 
(in thousands)
Tranche B-1 Term Loan
$

 
$
147,289

Tranche B-2 Term Loan (net of $11.4 million and $17.5 million discount)
446,799

 
554,760

FILO Term Loan (net of $10.2 million and $10.9 million discount)
264,768

 
264,086

Unpaid original issuance discount

 
11,445

Notes
177,440

 
175,504

Debt issuance costs
(654
)
 
(762
)
Total debt
888,353

 
1,152,322

Less: current debt

 
(158,756
)
Long-term debt
$
888,353

 
$
993,566


On February 28, 2018, the Company amended and restated its Senior Credit Facility, which included an extension of the maturity date of a portion of the term loan from March 2019 to March 2021 (the "Tranche B-2 Term Loan"). The remaining term loan continued to have a maturity date of March 2019 ("the Tranche B-1 Term Loan"). Provided that all outstanding amounts under the convertible senior notes exceeding $50.0 million have not been repaid, refinanced, converted or effectively discharged prior to May 2020 ("Springing Maturity Date"), the maturity date of the Tranche B-2 Term Loan becomes the Springing Maturity Date, subject to certain adjustments. In connection with the debt refinancing, the Company recognized a loss of $16.7 million during the first quarter of 2018, which primarily includes third-party fees. As of March 31, 2019, the Company had paid down the Tranche B-1 Term Loan and had $446.8 million Tranche B-2 Term Loan outstanding. The Company also had a new asset-based credit agreement (the "ABL Credit Agreement"), consisting of:
a $264.8 million asset-based Term Loan Facility advanced on a “first-in, last-out” basis (the "FILO Term Loan") with a maturity date of December 2022 (which maturity date will become May 2020, subject to certain adjustments, should the Springing Maturity Date be triggered); and
a $100 million asset-based Revolving Credit Facility (the "Revolving Credit Facility") with a maturity date of August 2022 (which maturity date will become May 2020, subject to certain adjustments, should the Springing Maturity Date be triggered). In connection with the contribution of the Nutra manufacturing and Anderson facility net assets to the manufacturing joint venture with IVC, the Revolving Credit Facility decreased from $100 million to $81 million effective March 2019. As of March 31, 2019 there were no borrowings outstanding on the Revolving Credit Facility.
The Tranche B-2 Term Loan requires annual aggregate principal payments of at least $43 million and bears interest at a rate of, at the Company's option, LIBOR plus a margin of 8.75% per annum subject to change under certain circumstances (with a minimum and maximum margin of 8.25% and 9.25%, respectively, per annum), or prime plus a margin of 7.75% per annum subject to change under certain circumstances (with a minimum and maximum

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margin of 7.25% and 8.25%, respectively, per annum). Any mandatory repayments as defined in the credit agreement shall be applied to the remaining annual aggregate principal payments in direct order of maturity. As discussed in further detail below, in November 2018, the Company paid $100 million on the Tranche B-2 Term Loan and elected to use the payment to satisfy the scheduled amortization payments on the Term Loan Facility through December 2020. The Term Loan Agreement is secured by a (i) first lien on certain assets of the Company primarily consisting of capital stock issued by General Nutrition Centers, Inc. ("Centers") and its subsidiaries, intellectual property and equipment (“Term Priority Collateral”) and (ii) second lien on certain assets of the Company primarily consisting of inventory and accounts receivable (“ABL Priority Collateral”). The Term Loan Agreement is guaranteed by all material, wholly-owned domestic subsidiaries of the Company (the “U.S. Guarantors”) and by General Nutrition Centres Company, an unlimited liability company organized under the laws of Nova Scotia (together with the U.S. Guarantors, the “Guarantors”).    
There are no scheduled amortization payments associated with the FILO Term Loan, which bears interest at a rate of LIBOR plus a margin of 7.00% per annum subject to decrease under certain circumstances (with a minimum possible interest rate of LIBOR plus a margin of 6.50% per annum). Outstanding borrowings under the Revolving Credit Facility bear interest at a rate of LIBOR plus 1.75% (subject to an increase or decrease of 0.25% based on the amount available to be drawn under the Revolving Credit Facility). The Company is also required to pay an annual fee to revolving lenders equal to a maximum of 2.0% (subject to adjustment based on the amount available to be be drawn under the Revolving Credit Facility) on outstanding letters of credit and an annual commitment fee of 0.375% on the undrawn portion of the Revolving Credit Facility subject to an increase to 0.5% based on the amount available to drawn under the Revolving Credit Facility. The FILO Term Loan and Revolving Credit Facility are secured by a (i) first lien on ABL Priority Collateral and (ii) second lien on Term Priority Collateral. The FILO Term Loan and Revolving Credit Facility are guaranteed by the Guarantors.
Under the Company’s Term Loan Agreement and ABL Credit Agreement (collectively, the "Credit Facilities"), the Company is required to make certain mandatory prepayments, including a requirement to prepay first the Tranche B-2 Term Loan (until repaid in full) and second the FILO Term Loan (until repaid in full, but only if such prepayment is permitted under the ABL Credit Agreement) in each case annually with amounts based on excess cash flow, as defined in the Company’s Credit Facilities, based on the results of the Company for the prior fiscal year. The payment will be 75% of excess cash flow for each such fiscal year, subject to a reduction to 50% based on the attainment of a certain Consolidated Net First Lien Leverage Ratio, and will be reduced by certain scheduled debt payment amounts. The Company made the first excess cash flow payment in April 2019 of $9.8 million with respect to the year ending December 31, 2018. The Company expects this excess cash flow payment to be between $25 million and $35 million at 50% with respect to the year ending December 31, 2019, which is expected to be paid in the second quarter of 2020.
At March 31, 2019, the interest rates under the Tranche B-2 Term Loan and the FILO Term Loan were 11.3% and 9.5%, respectively. At December 31, 2018, the interest rate under the Tranche B-1 Term Loan, Tranche B-2 Term Loan, and the FILO Term Loan were 5.7%, 11.8%, and 9.5%, respectively. At March 31, 2019, the Company had $74.2 million available under the Revolving Credit Facility, after giving effect to $6.2 million utilized to secure letters of credit and $0.6 million reduction to borrowing ability as a result of decrease in net collateral.
The Company’s Credit Facilities contain customary covenants, including limitations on the ability of GNC Corporation, Centers, and Centers' subsidiaries to, among other things, incur debt, grant liens on their assets, enter into mergers or liquidations, sell assets, make investments or acquisitions, make optional payments in respect of, or modify, certain other debt instruments, pay dividends or other payments on capital stock, or enter into arrangements that restrict their ability to pay dividends or grant liens. In addition, the Term Loan Agreement requires compliance, as of the end of each fiscal quarter of the Company, with a maximum Consolidated Net First Lien Leverage Ratio initially set at 5.50 to 1.00 through December 31, 2018 and decreasing to 5.00 to 1.00 from March 31, 2019 to December 31, 2019 and 4.25 to 1.00 thereafter. Depending on the amount available to be drawn under the Revolving Credit Facility, the ABL Credit Agreement requires compliance as of the end of each fiscal quarter of the Company with a minimum Fixed Charge Coverage Ratio of 1.00 to 1.00. The Company is currently in compliance, and expects to remain in compliance over the next twelve months, with the terms of its Credit Facilities.
In connection with the strategic investment from Harbin Pharmaceutical Group Co., Ltd ("Harbin") and the manufacturing joint venture with IVC, the Company received (i) $100 million investment from Harbin in November 2018, which was utilized to pay a portion of the Tranche B-2 Term Loan and elected to use the payment to satisfy the scheduled amortization payments through December 2020, (ii) approximately $200 million from Harbin in the first quarter of 2019 and (iii) $101 million from IVC in the first quarter of 2019. The Company applied such proceeds to pay down the remaining balance of the Tranche B-1 Term Loan that matured in March 2019. The remaining proceeds together with cash generated from operating activities were utilized to pay $114.0 million of the Tranche B-2 and the original issuance discount due to the Tranche B-2 Term Loan lenders at 2% of the outstanding balance.

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Convertible Debt
The Company maintains $188.6 million in principal amount of 1.5% convertible senior notes due in 2020 (the "Notes"). The Notes consist of the following components:
 
March 31, 2019
 
December 31, 2018
 
(in thousands)
Liability component
 
 
 
Principal
$
188,565

 
$
188,565

Conversion feature
(9,788
)
 
(11,489
)
Discount related to debt issuance costs
(1,337
)
 
(1,572
)
Net carrying amount
$
177,440

 
$
175,504


Interest Rate Swaps
On June 13, 2018, the Company entered into two interest rate swaps with notional amounts of $275 million and $225 million to limit the exposure of its variable interest rate debt by effectively converting it to a fixed interest rate. The Company receives payments based on the one-month LIBOR and makes payments based on a fixed rate. The Company receives payments with a floor of 0.00% and 0.75%, respectively, on the $275 million and $225 million interest rate swaps, which aligns with the related debt instruments. The interest rate swap agreements had an effective date of June 29, 2018. The $225 million interest rate swap expires on February 28, 2021, and the $275 million interest rate swap expires on June 30, 2021. The notional amount of the $225 million interest rate swap is scheduled to decrease to $175 million on June 30, 2019, $125 million on June 30, 2020 and $75 million on December 31, 2020. The Company designated these instruments as cash flow hedges deemed effective upon initiation. The interest rate swaps are recognized on the balance sheet at fair value. Changes in fair value are recorded within other comprehensive gain (loss) on the Consolidated Balance Sheet and reclassified into the Consolidated Statement of Operations as interest expense in the period in which the underlying transaction affects earnings.

The fair values of the derivative financial instruments included in the Consolidated Balance Sheets consisted of the following:

(in thousands, except percentages)
 
 
 
 
 
 
 
 
 
 
 
Fair Value at
 
Notional Amount
 
Fixed Rate
 
Balance Sheet Classification
 
March 31, 2019
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
Accounting cash flow hedges:
 
 
 
 
 
 
 
 
Interest rate swap
$
275,000

 
2.82
%
 
Other long-term liabilities
 
$
3,641

 
$
2,371

Interest rate swap
225,000

 
2.74
%
 
Other long-term liabilities
 
1,348

 
839

Net carrying amount
$
500,000

 
 
 
Total liabilities
 
$
4,989

 
$
3,210



At March 31, 2019, there was a cumulative unrealized loss of $3.4 million, net of tax, related to these interest rate swaps included in accumulated other comprehensive income loss. This loss would be immediately recognized in the Consolidated Statement of Operations if these instruments fail to meet certain cash flow hedge requirements. As of March 31, 2019, the amount included in accumulated other comprehensive loss related to the interest rate swaps to be reclassified into earnings during the next 12 months is not material. Refer to Note 7, "Fair Value Measurements of Financial Instruments" for more information on how the interest rate swaps are valued.

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Interest Expense
Interest expense consisted of the following:
 
Three months ended March 31,
 
2019
 
2018
 
(in thousands)
 
 
 
 
Tranche B-1 Term Loan coupon
$
928

 
$
8,058

Tranche B-2 Term Loan coupon
16,468

 
6,824

FILO Term Loan coupon
6,751

 
2,122

Revolving Credit Facility
123

 
132

Terminated revolving credit facility

 
316

Amortization of discount and debt issuance costs
6,043

 
1,755

Subtotal
30,313

 
19,207

Notes:
 
 
 
Coupon
707

 
707

Amortization of conversion feature
1,701

 
1,610

Amortization of discount and debt issuance costs
244

 
244

Total Notes
2,652

 
2,561

Other
(9
)
 
5

Interest expense, net
$
32,956

 
$
21,773



NOTE 6. EQUITY METHOD INVESTMENTS

In February 2019, the Company contributed its China business in exchange for 35% ownership of each of the newly formed joint ventures (the “HK JV” and the "China JV"). The HK JV includes the operation of the cross-border China e-commerce business, and has an exclusive right to use the Company’s trademarks to manufacture and distribute the Company’s products in China (excluding Hong Kong, Taiwan and Macau) via e-commerce channels. The China JV is a retail-focused joint venture to operate GNC's brick-and-mortar retail business in China and it will have an exclusive right to use the Company's trademarks to manufacture and distribute the Company's products in China (excluding Hong Kong, Taiwan and Macau) via retail stores and pharmacies. The HK JV closed in February 2019 and the China JV agreement is expected to be completed in the second or third quarter of 2019 following the satisfaction of certain routine regulatory and legal requirements.
In March 2019, the Company received $101 million from IVC and contributed the net assets of the Nutra manufacturing and Anderson facilities in exchange for an initial 43% equity interest in a newly formed joint venture (the “Manufacturing JV”). In addition, the Company made a capital contribution of $10.7 million to the Manufacturing JV for its share of short-term working capital needs. Over the next four years, GNC expects to receive an additional $75 million, adjusted up or down based on the Manufacturing JV's future performance, from IVC as IVC’s ownership of the joint venture increases to 100%. The Manufacturing JV is responsible for the manufacturing of the products previously produced by the Company’s Nutra manufacturing facility.
Gain (loss) from the net asset exchange
In connection with the formation of the joint ventures, the Company deconsolidated its China business and the Nutra manufacturing business effective in the first quarter of 2019 and recorded a pre-tax gain of $5.8 million and loss of $25.3 million, respectively, which is recorded within loss on net asset exchange for the formation of the joint ventures on the Consolidated Statements of Operations. The $5.8 million gain from the Harbin transaction is calculated based on the difference between the fair value of the 35% equity interest in the HK JV and China JV, less the carrying value of the contributed China business, including $2.4 million of cash, and third-party closing fees. The $25.3 million loss from the Manufacturing JV transaction is calculated based on the fair value of the 43% equity interest retained in the Manufacturing JV and the $101 million in cash received, less the carrying value of the contributed Nutra and Anderson facilities and third-party closing fees.

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The Company's interest in the joint ventures are accounted for as equity method investments due to the Company’s ability to exercise significant influence over the management decisions of the joint ventures. Under the equity method, the Company's share of profits and losses from the joint ventures is recorded within equity income (loss) from equity method investments in the Consolidated Statement of Operations. The following table provides a reconciliation of equity method investments on the Company’s Consolidated Balance Sheets:
 
 
March 31, 2019
 
December 31, 2018
 
 
 
(in thousands)
 
Manufacturing JV
$
75,434

 
$

 
Manufacturing JV capital contribution
10,714

 

 
HK JV and China JV
10,700

 

 
Income from equity method investments
955

 

 
Total Equity method investments
$
97,803

 
$


In connection with the transaction with IVC, the Company entered into a lease for warehouse space within the Anderson facility. Refer to Note 8, "Leases" for more information on the lease with the Manufacturing JV. Subsequent to the formation of the Manufacturing JV, the Company purchased approximately $21 million finished goods from the Manufacturing JV during the period ended March 31, 2019 and had approximately $20 million and $4 million accounts payable and accounts receivable, respectively, outstanding as of March 31, 2019. The intra-entity transactions between the Company and the HK JV, which primarily consist of wholesale sales, were immaterial during the period ended March 31, 2019.
NOTE 7.  FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS
Accounting Standards Codification 820, Fair Value Measurements and Disclosures defines fair value as a market-based measurement that should be determined based on the assumptions that marketplace participants would use in pricing an asset or liability. As a basis for considering such assumptions, the standard establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:
Level 1 — observable inputs such as quoted prices in active markets for identical assets and liabilities;
Level 2 — observable inputs such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, other inputs that are observable, or can be corroborated by observable market data; and
Level 3 — unobservable inputs for which there are little or no market data, which require the reporting entity to develop its own assumptions.
The carrying amounts of cash and cash equivalents, receivables, accounts payable, accrued liabilities and the Revolving Credit Facility approximate their respective fair values. Based on the interest rates currently available and their underlying risk, the carrying value of franchise notes receivable recorded in other long-term assets approximates its fair value.
The carrying value and estimated fair value of the forward contracts for the issuance of convertible preferred stock, the Term Loan Facility, net of discount, Notes (net of the equity component classified in stockholders' equity and discount) and the interest rate swaps were as follows:

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March 31, 2019
 
December 31, 2018
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Forward contracts for the issuance of convertible preferred stock
$

 
$

 
$
88,942

 
$
88,942

Liabilities:
 
 
 
 
 
 
 
Tranche B-1 Term Loan
$

 
$

 
$
147,289

 
$
145,080

Tranche B-2 Term Loan
446,799

 
430,938

 
554,760

 
511,766

FILO Term Loan
264,768

 
267,204

 
264,086

 
260,125

Notes
177,440

 
134,854

 
175,504

 
131,628

Interest rate swaps
4,989

 
4,989

 
3,210

 
3,210


The forward contracts for the issuance of convertible preferred stock are measured at fair value, as of the valuation date, using a single factor binomial lattice model (the "Lattice Model") which incorporates the terms and conditions of the convertible preferred stock and is based on changes in the prices of the underlying common share price over successive periods of time. Key assumptions of the Lattice Model include the current price of the underlying stock and its historical and expected volatility, risk-neutral interest rates and the instruments remaining term.  These assumptions require significant management judgment and are considered Level 3 inputs. The forward contracts were revalued at each reporting period with changes in fair value recognized in the Consolidated Statements of Operations. The forward contracts settled upon issuance on January 2, 2019 and February 13, 2019.
    The fair values of the term loans were determined using the instrument’s trading value in markets that are not active, which are considered Level 2 inputs. The fair value of the Notes was determined based on quoted market prices and bond terms and conditions, which are considered Level 2 inputs. The Company's interest rate swaps are carried at fair value, which is based primarily on Level 2 inputs utilizing readily observable market data, such as LIBOR forward rates, for all substantial terms of the interest rate swap contracts and the assessment of nonperformance risk.
NOTE 8. LEASES
The Company has operating leases for retail stores, distribution centers, other leased office locations, vehicles and certain equipment with remaining lease terms of 1 year to 14 years, some of which include options to extend the leases for up to 10 years. On the Company’s Consolidated Balance Sheets as of March 31, 2019, the Company had lease liabilities of $518.7 million, of which $117.1 million are classified as current, and right-of-use assets of $401.5 million.
The Company has elected to apply the short-term lease exemption for all asset classes and excluded them from the balance sheet. Lease payments for short-term leases are recognized on a straight-line basis over the lease term. The short-term rent expense recognized during the three months ended March 31, 2019 is immaterial. The components of the Company's rent expense, which is recorded within cost of sales on the Consolidated Statements of Operations, was as follows:
 
Three months ended March 31, 2019
 
(in thousands)
Company-owned and franchise stores:
 
Operating leases
$
36,602

Variable lease costs (1)
21,509

Total company-owned and franchise stores
58,111

Other
2,188

Total rent expense
$
60,299

(1) Includes percent and contingent rent, landlord related taxes and common operating expenses.
The weighted average remaining lease term and weighted average discount rate were as follows:

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Three months ended March 31, 2019
 
 
Weighted average remaining lease term
4.6 years

Weighted average discount rate
10
%
Supplemental cash flow information related to leases was as follows:
 
Three months ended March 31, 2019
 
(in thousands)
Operating cash flow information:
 
Cash paid for amounts included in the measurement of operating lease liabilities
$
44,936

Right-of-use assets obtained in exchange for new operating lease liabilities
$
6,442


The Company recorded sublease revenue, within revenue on the Consolidated Statements of Operations, of $11.0 million and $11.8 million in the three months ended March 31, 2019 and 2018, respectively, relating to subleases with its franchisees, which includes rental income and other occupancy related items.
Maturities of the lease liabilities (undiscounted lease payments, as defined in Note 2 "Basis of Presentation") as of March 31, 2019 were as follows:
 
Operating Leases for Company-Owned and Franchise Stores
 
Operating Leases for Other (1)
 
Total Operating Leases
 
Sublease
Income from Franchisees
 
Rent on Operating Leases, net of Sublease Revenue
 
(in thousands)
2019 (remainder)
$
120,954

 
$
4,270

 
$
125,224

 
$
(23,783
)
 
$
101,441

2020
135,834

 
4,964

 
140,798

 
(27,829
)
 
112,969

2021
109,994

 
3,643

 
113,637

 
(22,697
)
 
90,940

2022
84,925

 
2,342

 
87,267

 
(17,882
)
 
69,385

2023
63,125

 
1,180

 
64,305

 
(13,384
)
 
50,921

Thereafter
136,071

 
6,703

 
142,774

 
(29,548
)
 
113,226

Total future obligations
$
650,903

 
$
23,102

 
$
674,005

 
$
(135,123
)
 
$
538,882

Less amounts representing interest


 
 
 
(155,295
)
 
 
 


Present value of lease obligations


 


 
$
518,710

 
 
 
 
(1) Includes various leases for warehouses, vehicles, and various equipment at our facility
As of March 31, 2019, leases that the Company has entered into but have not yet commenced are immaterial.
In connection with the transaction with IVC for the Manufacturing JV effective March 1, 2019, the Company leased warehouse space within the Anderson facility from the Manufacturing JV for a term of one year. The lease was accounted for as sale leaseback transaction and classified as an operating lease included in the current lease liabilities on the Consolidated Balance Sheet.

Disclosures related to periods prior to adoption of ASU 2016-02

The Company adopted ASU 2016-02 using a modified retrospective adoption method at January 1, 2019 as noted in Note 2. "Basis of Presentation." As required, the following disclosure is provided for periods prior to adoption. Minimum future rent obligations for non-cancelable operating leases, excluding optional renewal periods, were as follows for the period ending December 31, 2018 and exclude landlord related taxes, common operating expenses, and percent and contingent rent.

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