Looking backwards, Vitacost.com looks unattractive, which is reflected in its valuation (.65x ev/sls) and a heavy short interest (days to cover of 45). However, we think looking forward that the business is reaching an important inflection point with an impressive new management/board, and strategy, whereby we think the business can grow substantially while generating positive cash flow. Our bet is that the company should be able to mirror at least what offline competitors earn over time with scale, while growing at a rate of 2-3x offline competitors. We think VITC can grow revenue substantially with attractive customer acquisition points and sticky customers and and at scale the business should be able to generate 8-12% OCF margins. Despite significant growth, 2011 was filled with tons of short term noise, which has caused the valuation to fall to about 40% of what the offline peers are valued at on an ev/sales basis. With more of a peer multiple, we think the business could be valued in the $10-12 range (offline peer group ev/sls multiple and recent prices paid by strategic buyers 1.2x ev/sls). Despite a number of transitions, revenue grew 26% yr/yr in the most recent qtr. The business has predictable unit economics based on average order volume, active customers, and customer acquisition costs. With the old team since 3Q08, active customers have grown by 100% while the business had about year of serious distractions.

New team: Over the last 12 months  a mix of industry veterans have joined VITC including:  a board member who was the former CFO of GNC (GNC $3.6bn EV), the CEO was formerly the founder of Vitamin Shoppe (VSI $1.2bn EV) 1977-2000, the COO was formerly the Head of North American Operations from Amazon (was with AMZN for 14 years), the new CMO was former CMO of Gilt Groupe (NYT estimates value $1bn+), a new CIO from 1-800-Flowers.com, and most recently the former CFO of Rosetta Stone 2007-2010 joined VITC as well.

VITC sells 30,000+ items that are typically organic and specialty brands focused on healthy lifestyle at 30-60% discounts to offline competitors. They offer products similar to what you would find at Whole Foods (WFM averages 21K SKU’s per store or 2/3 of VITC’s). Here is a brief price comparison check we did: 

Whole Foods estimates that 33% of their sales come from non-perishable products or about $3.3bn in annual sales which is growing at about $330 million a year. This is what VITC is after, and as shown above VITC is selling the identical products for about 30% off.

The company recently sponsored the Ironman and hired former Saturday Night Live star Maya Rudolph for national ad campaign. Vitacost is also relaunching their site and logo in March 2012. The company is very active on internet, with customer acquisition through email, Twitter, Facebook and social media as well as through Groupon and refer-a-friend to grow the business with a focus on heavy discounts, 160,000+ customer reviews of products, and advice.  

Why now?

• New customers adds growing 157K 2Q11 to 180K 3Q11 and appears on the right track to continue to grow with recently added intiatives (Groupon/refer a friend) plus pretty easy comps coming. 
• Adding new products: already largest in terms of SKU’s and adding about 1,300 new products last quarter. Additionally, adding to Vitacost branded SKU’s as well.
• Dramatic improvement in customer satisfaction over the last couple of months according to resellerratings.com since new team is in place:http://www.resellerratings.com/store/Vitacost# 92% of customers said they would reorder with VITC and overall score 89.6%. This far exceeds any of VITC competitors. http://www.resellerratings.com/seller_rating_history.pl?seller_seo_name=Vitacost

2011 in a near worst case scenario net of true one time charges the business generated +$500K in cash flow

Last CC:

Q Fred Moran: “Final question. You've gone through a transition with significant severance, recruiting and legal expenses which have whittled

your cash down to about $13 million. Are the bulk of those expenses now behind you, and do you anticipate being able to sustain a debt-free position with some cash on the books, maybe north of $10 million cash potentially?

Answer from CFO :” Yes. To be specific, there is still a little over $1 million remaining to be paid that's sitting in (technical difficulty) payables or

contractually. The biggest piece of that relates to the former CFO. So although it's accrued, the cash actually flowed out in the

early part of October. As we pointed out in both the Q and the press release, as much money as we've paid out in cash over the past nine months,

we've done quite a bit of let's say managing our working capital and controlling our other costs so that actual cash flow actually

turned slightly positive for that nine months. So to answer your last question more directly, we believe we have enough cash

on the books to do business going forward.”

We think this business makes sense on a number of levels and has a sustainable runway:

• Large fragmented market with 50-70% of American taking vitamin/supplements.
• Industry Channel Conflict: GNC.com is GNC fastest growing channel +38% with 20% OM, yet only 3% of GNC’s revenue is from online and there are potential problems from pricing offline vs. online. Vitamin Shoppe offline is not surprisingly more expensive than Vitaminshoppe.com.  In speaking with a store, they said if I come into a store and request they will do a pricing check to their website and give me the discount at the register. This is not something they want to push. Other comps like Iherb.com, Purtian.com, Swansonvitamins.com are smaller competitors that do not appear to be as well run strategically as VITC. See reviews and websites. 
• Vitamin manufacturers spend significantly on distribution/marketing
• Product is shelf stable(long expiration) and easy to ship due to light weight, combined with high user satisfaction not a lot of hand holding or salesmanship (how many people want to return Vitamin C)
• Opportunity to vertically integrate and manufacture sell own line of supplements which is currently about 25% of total revenue. GNC.com does this and claims 38% revenue growth with 20% OM.
• Growing sticky customer base (+100% since 3Q08) with predictable order volumes (+/-10%): http://files.shareholder.com/downloads/VITC/1494603714x0x515801/54b8e38b-ad09-46f0-9199-db077782aafe/VITA_EComm_11.7.11.pdf
• New high growth verticals: Food +63% growth, Sports Nutrition/Bodybuilding +41%, Personal Care +27%, and (Core: Vitamins/Supplements +20%)

Attractive Business Model

• VITC has a cash conversion cycle of 16 vs. offline peer group 90 (mainly inventories and payables)
• Inventory turns 7
• Business has grown 10x in years and generated approximately $20 million in OCF

New social networking intiatives:

• New Refer-a-friend program
• Groupon: 3 Groupons in 4Q11 http://www.groupon.com/deals/vitacost-kalamazoo

Heavy focus on leveraging cost advantage selling online in scale vs. high cost offline competitors (Whole Foods etc): http://www.vitacost.com/Coupons-Deals-And-Discounts

While it is Luckyvitamin.com was acquired by GNC for .5x sales. Was a very small (1/6^th the size of VITC) which did not sell their own brands which is 25% of VITC revenue. There have been 2 transactions of scale comps $300mn + in revenue more similar to VITC scale and strategy done; DSCM .9x ev/sls (very little organic growth) and Quidsi bought by AMZN  $345mn in sales sold for $545 million.

Risks:
Hard to value as the business with a strategy based on scale...currently not generating much cash (net of one time charges +CF of $500K or so YTD).

Disclosure: This does not constitute a recommendation to buy or sell shares of VITC. We own shares in VITC and we may buy or sell shares with out updating this board. 

A management team of industry veterans, pure play industry leader, total focus on the online channel without offline vs. online conflicts, heavy use of accelerating this edge with social media and stressing "channel conflict" pricing. Even better opportunity to go after Whole Foods customer base see price point differentials above.

Dramatic increase in customer satisfaction over the last 6 months (resellerratings.com)

Ramp in new sub adds and very easy comps

Should have more than enough cash on hand...net of one time charges $500K in positive CF and $12 million in cash in worst case scenario  

3Q11 CEO said will announce long term guidance/targets in the near future.

We think the stock is cheap @ .65x trailing sales last quarter yr/yr revenue was +26%. Plus 2 million plus shares short with avg daily volume of 60K. 

Insider buying: CEO bought 300,000 shares in the open market in Fall of 2011 between $4.25-$6.40 per share.

Company should show attractive revenue growth given strategy with significant opportunities to expand margins: increase sales of Vitacost/prorietary brands, ramp customers and further leverage distribution, add new products, and continue to explore new low cost customer acquisiton channels. 

Great Hill Partner have done a lot of heavy lifting and have significant industry rolodex as can be seen from new hires. Their cost basis for nearly 20% of VITC is north of $11. 

Comparable transactions: CVS bought drugstore.com (DSCM) without much organic growth at .9x sales May 2011. Amazon.com bought Quidsi (diapers.com, soap.com, and beautybar.com) for 1.81x sales  http://techcrunch.com/2010/11/08/confirmed-amazon-spends-545-million-on-diapers-com-parent-quidsi/