Item 1. Business.
Vitacost.com, Inc.
We are a leading online retailer of health and wellness products, including dietary supplements such as vitamins, minerals, herbs and other botanicals (which we refer to as “vitamins and dietary supplements”), as well as cosmetics, natural personal care products, pet products, sports nutrition and health foods. We sell these products directly to consumers primarily through our website,
www.vitacost.com
. We strive to offer our customers the broadest selection of healthy living products at extremely competitive prices, while providing superior customer service and timely delivery.
We offer our customers a broad selection of approximately 46,000 Stock Keeping Units (“SKUs”), from over 2,500 third-party brands, such as Garden of Life, New Chapter, Nature’s Way, Nature’s Plus, Source Naturals, Jarrow Formulas, Bob’s Red Mill, Kind, Eden Foods, Avalon Organics, Jason, Desert Essence, BSN, Optimum Nutrition, USP Labs and MuscleTech in addition to our own proprietary brands: Vitacost, ARO, Glonaturals, Cosmeceutical Sciences Institute (“CSI”), Best of All and Smart Basics. We support our operations through our customer service center and our two distribution centers, delivering what we believe are industry-leading customer satisfaction results. Our website allows customers to easily browse and purchase products at prices typically significantly lower than manufacturers’ suggested retail prices. Our website also serves as an educational resource for consumers seeking information on healthy living and the attributes of health and wellness supplements.
Our growth is driven primarily by our ability to expand our customer base and grow our product offerings. Our customers are typically individuals seeking value in their purchases of health and wellness products. Our active customer base, which we define as customers who have purchased from us within the last twelve months, has steadily increased from approximately 270,000 at the end of 2005 to approximately 2.2 million as of December 31, 2013. On average, our customers make purchases from us two to three times a year and during 2013, approximately 76% of our orders were placed by repeat customers.
Corporate Information
We were incorporated in Delaware in May 1994 and began operations as a catalog retailer of third-party vitamins and supplements under the name Nature’s Wealth Company. In 1999, we launched Vitacost.com and introduced our proprietary vitamins and supplements. In 2000, we began operating under the name Vitacost.com, Inc. (the “Company”, “Vitacost”, or “Vitacost.com”). In September 2009, the Company completed its Initial Public Offering. On September 28, 2011, Vitacost.com, Inc. completed a restructuring whereby it merged with and into Vitacost Merger Corporation, a wholly owned subsidiary of Vitacost.com, Inc., with Vitacost Merger Corporation surviving the merger. The surviving company continues to operate the business under the name Vitacost.com, Inc.
Industry Overview
The expansion of the Internet has benefited online retailers by improving methods of communication, delivery of content and ease of commerce. At the same time, consumers are leveraging online resources to make informed healthcare, dietary and nutritional choices and related purchasing decisions.
U.S. Nutrition Industry
. According to the Nutrition Business Journal (“NBJ”), total U.S. sales for the nutrition industry (including natural & organic food, functional foods, supplements and natural/organic personal care & household products) were estimated at $149.9 billion in 2013. The NBJ is forecasting U.S. sales for the total nutrition industry to grow at an 8.6% compound annual growth rate (“CAGR”) over the next seven years, reaching $266.6 billion in 2020. Steady growth reflects an overall health and wellness trend in the U.S. with an increased focus by consumers on their diet, exercise and overall health. Products targeting weight management, sports nutrition, chemical-free cleaners, and specialty diets, such as gluten-free, are becoming mainstay purchases made by today’s consumers. U.S. sales for the total nutrition industry through the Internet were estimated at $4.4 billion in 2013 and are forecast by the NBJ to grow significantly faster than the overall category, increasing at a 12.6% CAGR over the next seven years, reaching $10.1 billion by 2020.
U.S. Dietary Supplement Market
. According to the NBJ, U.S. sales of dietary supplements (including vitamins, herbs, meal supplements and sports nutrition and specialty supplements) were estimated at $34.9 billion in 2013. The NBJ is forecasting U.S. sales of dietary supplements to grow at a 7.1% CAGR over the next seven years reaching $56.4 billion in 2020. The projected steady growth reflects customers’ purchases of these natural products to protect their health and ward off more expensive medical visits and prescription drugs. The dietary supplement industry is highly fragmented with products sold through multiple channels including retailers such as mass merchants, grocery stores, drug stores and specialty retailers, as well as through direct mail, catalogs, multi-level marketers and the Internet. U.S. sales of dietary supplements through the Internet were estimated at $2.0 billion in 2013 and are forecast by the NBJ to grow significantly faster than the overall category increasing at an 11.4% CAGR over the next seven years, reaching $4.3 billion by 2020.
Our Value Proposition
We strive to offer our customers the broadest product selection of healthy living products at the best value, while providing superior customer service.
Broad Third-Party and Proprietary Product Selection
. We offer approximately 46,000 SKUs representing over 2,500 brands, including nationally-recognized third-party brands and our proprietary brands. Our product selection is designed to appeal to a variety of demographic groups, including those seeking health maintenance and general well-being, individuals making household purchasing decisions for the family, baby boomers, the elderly and those with specific health concerns or goals. Our product selection regularly evolves as consumer preferences change.
Consistently Superior Value
. We offer products at savings to our customers with prices typically significantly lower than manufacturers’ suggested retail prices. We provide even greater savings to our customers through our proprietary product lines.
Superior Customer Services.
Our website is designed to attract natural search traffic while providing a convenient, educational, secure and efficient shopping experience. Products are cross-indexed to allow consumers to easily locate and compare products when searching by brand, ingredient or keyword. In addition, we maintain a customer service center which provides customers with answers to product and technical questions as well as processes customer orders. Finally, customer orders are quickly and accurately processed in our fulfillment centers.
Growth Initiatives
Our growth strategy is based on the following key initiatives:
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Expand Customer Base:
We are focused on acquiring new customers in an effort to expand our customer base. Historically, our customers have had high repeat order rates and lifetime values, as we primarily sell consumable products. We believe future top-line growth will stem from an expanded customer base and increasing our touch points on the internet to target customers directly where and how they shop. Our marketing activities are primarily focused on online initiatives such as search engine marketing, search engine optimization and developing a network of affiliates. In addition, we are leveraging our existing customer base to attract new customers through our “Refer a Friend” program, which rewards existing customers for signing up new customers.
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Increase Brand and Company Awareness:
Our marketing strategy is designed to increase brand awareness and company awareness and drive highly targeted new and repeat customers to our website. To date, the majority of our advertising spending has been online through the use of keyword buys and developing a network of affiliates. As only a small percentage of US nutrition and supplement purchases are made through the online channel, we seek to target a wider audience of consumers through the use of offline advertising and introducing them to our value proposition and the Vitacost brand.
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Expand Product Offerings:
We continue to increase our product offerings of both third party and proprietary products to drive traffic to our site and increase basket size as we strive to become the leading online destination for health and wellness products. We continue to add brands and line extensions in our core Vitamins, Minerals, Herbs and Supplements (“VMHS”) category as well as in faster growing healthy living categories such as food, beauty, and sports nutrition. During 2013, we added nearly 6,000 net new SKUs, ending the year with approximately 46,000 SKUs live on our website.
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Increase Lifetime Value by Increasing Frequency of Purchases and Improving Customer Retention:
As we continue to diversify our product offerings in the healthy living space, there is a renewed effort to educate customers on the breadth of our product offerings to increase total basket size and the frequency of purchases in order to drive greater lifetime value. We are also focused on increasing lifetime value per customer by improving customer retention through the use of automatic reordering programs along with targeted, personalized emails and promotional offers as well as continuing to improve the customer experience.
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Expand our Mobile Business:
Our mobile sales continue to grow nicely and account for a larger percentage of our total business. Mobile sales increased nearly 100% year-over-year to 10% of total company sales in 2013. During 2013, we were named to Internet Retailer’s 2014 Mobile 500, which profiles the leading mobile commerce retail leaders worldwide ranked according to estimated 2013 mobile web sales. Vitacost.com ranked #93 in the current report, moving up substantially from its #203 ranking in the prior year. Separately, we ranked #45 in the 2013 Mobile Commerce Conversion Index (MCCI), a report published by LightningBuy, a technology company specializing in creating mobile monetization platforms for its customers.
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Expand our International Business
: Our international business also experienced high growth during 2013 with sales increasing over 50% year-over-year to 8% of total company sales, despite limited marketing efforts outside the United States. We currently ship products internationally to over 160 countries with our largest foreign markets being China, Australia, Brazil and Canada. We are now beginning to focus on improving the overall web and shipping experience for international customers. We believe continuing to grow our mobile and international businesses represents a significant long-term opportunity.
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Expand and Optimize Distribution:
We believe that processing customer orders on a timely basis is a key component of customer satisfaction. Our long-term initiatives are to reduce processing time, while increasing our fulfillment capacity and driving efficiency in the cost of processing orders. In addition, we are also focused on reducing the time in transit for customers to receive their orders. During 2013, we implemented new regional carriers for deliveries on the east and west coasts and as of December 31, 2013 nearly 50% of all orders shipped were delivered in 2 business days or less. We believe fast transit times further add to our strong value proposition and overall customer satisfaction levels.
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Improve Operating Efficiencies:
We are focused on improving operating efficiencies across our organization by reducing costs at our existing fulfillment centers primarily through improved labor productivity as well as gaining efficiency in our sales and marketing spend. We also seek to gain sales leverage on our fixed cost structure as we expand our overall sales.
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Products
We provide online shoppers with one of the broadest selections of high-quality health and wellness products, including dietary supplements such as vitamins, minerals, herbs and other botanicals, as well as cosmetics, natural personal care products, pet products, sports nutrition and health foods. We offer products in a wide range of potency levels and dosage forms for our dietary supplements such as tablets, capsules, vegi-capsules, softgels, gelcaps, liquids, gummies, pill packets and powders. Our focus on providing a broad selection enables our customers to purchase products from preferred, trusted brands through a single, comprehensive source.
We offer products that encompass four main categories: Vitamins, Minerals, Herbs and Supplements (VMHS); Natural and Organic Food; Beauty and Sports Nutrition. As we have continued to diversify our product mix into non-VMHS categories, the percentage of revenue from the sale of VMHS products has declined. In 2013, sales of VMHS products accounted for 60.0% of total company sales compared to 65.0% of total company sales in 2012.
Vitamins, Minerals, Herbs and Supplements
. VMHS products are generally taken to maintain or improve health and address specific health conditions. The Food and Drug Administration (“FDA”) classifies these products under the term “dietary supplements.” In this category, we offer our Vitacost branded products as well as third-party brands such as Garden of Life, New Chapter, Nature’s Way, Nature’s Plus, Source Naturals and Jarrow Formulas. Vitamin and mineral products include multi-vitamins, lettered vitamins, such as Vitamin A, C, D, E and B-complex, along with minerals such as calcium, magnesium, chromium and zinc. These products help prevent deficiencies that can occur when diet alone does not provide all of the necessary vitamins and minerals. Herbal products include whole herbs, standardized extracts, herb combination formulas and teas. Herbs offer a natural solution to address specific health concerns. Supplements include essential fatty acids, probiotics, anti-oxidants, phytonutrients and condition-specific formulas.
Sports Nutrition
. Sports nutrition products are used in conjunction with cardiovascular conditioning, weight training and sports activities. Major categories in sports nutrition include protein and weight gain powders, meal replacements, nutrition bars, sports drinks and pre- and post-workout supplements to either increase energy or enhance recovery after exercise. We offer bodybuilding and sports products from third parties such as BSN, Optimum Nutrition, and MuscleTech as well as our ARO line of proprietary products.
Beauty
. Our beauty category consists of a variety of natural products for skin, body, hair and oral health. We offer hundreds of natural personal care products from category leaders such as Avalon Organics, Jason and Desert Essence, as well as our Glonaturals and CSI proprietary products. These products appeal to allergen conscious, environmentally conscious, or socially conscious consumers seeking products that are made without harsh chemicals and additives or are not tested on animals.
Natural and Organic Food
. Natural and organic food consists of organic and specialty products such as organic peanut butter, gluten free foods and low mercury tuna and salmon. We offer third-party brands such as Bob’s Red Mill, Kind and Eden, as well as our Best of All proprietary products.
In 2013 and 2012, our proprietary brands accounted for approximately 20% and 22% of our net sales, respectively. Our proprietary brands include:
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Vitacost:
Our Vitacost brand is our largest proprietary brand. Under the Vitacost brand, we offer nearly 900 products including multivitamins, minerals, herbs, amino acids, anti-oxidants and others, including a separate Whole Food line of non-GMO supplements and a Targeted Wellness line which provides specific ingredients to support healthy cholesterol levels, improve cognitive function, and reduce stress levels.
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ARO
: We launched a new proprietary line of sports nutrition products in April of this year under the ARO label which stands for Attack, Recover and Optimize. The new ARO line includes pre- and post - workout formulas, protein powder, creatine, BCAAs, glutamine and other supplements designed to support and enhance athletic performance. We also launched a new line of diet shakes – called ARO Lean.
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Glonaturals:
During 2013, we launched a new beauty line called Glonaturals which includes BB crèmes, argan oil and skincare; these botanically based products are infused with natural anti-aging ingredients including hyaluronic acid and coconut.
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Cosmeceutical Sciences Institute:
Under our CSI brand, we market and sell health and beauty products such as facial cleanser, facial and body moisturizing creams and lotions, and other skincare products.
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Best of All:
Under our Best of All brand, we market and sell organic food products such as banana chips, trail mix, almonds, cashews and more. We are in the process of rebranding and expanding our healthy snacks line with innovative, environmentally friendly packaging featuring water-based ink and BPA-free materials.
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Smart Basics:
Under our Smart Basics brand, we market and sell organic fruit juices and extracts and related dietary supplements.
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Walker Diet:
Under our Walker Diet brand, we market and sell low carb powders used to assist in weight loss and management.
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Merchandising & New Product Development
We believe we carry most major domestic brands of VMHS products as well as many smaller specialty brands. We sell most of our suppliers’ most popular product lines. We also offer our proprietary brands based on our own formulations. We currently stock approximately 46,000 SKUs at both of our fulfillment centers. Currently, no single SKU represents more than 2% of our net sales. In developing new proprietary products, we review our sales and cost data and customer feedback along with evaluating new industry trends.
Marketing
Our marketing strategy is designed to increase brand awareness and drive highly targeted new and repeat customers to our website. While we primarily use online advertising as our primary vehicle to reach consumers, we also employ email campaigns, customer referral and affiliate programs to acquire and retain our customer base. We are also actively embracing mobile technology and upgrading our mobile platform as we believe mobile will be a key source of new customers going forward given the rapid growth and increased acceptance of mobile shopping.
Online Marketing.
We make our website available via keywords and shopping feeds on internet search engines including but not limited to: Google, Bing, Nextag and Shopzilla. Banner advertisements on display networks are also used to drive traffic to our website. In addition, we sell our products through Amazon.com while operating an affiliate program aimed at creating brand awareness through websites that participate in the LinkShare network.
Email Campaigns
. Our email marketing campaigns distribute information on new arrivals, promotional discounts and product information to customers.
Direct Mail and Promotional Inserts
. Direct mail is used on a limited basis to increase awareness of our proprietary brands and to target market to certain customer segments. We more commonly use promotional inserts included with customer orders.
Customer referrals.
We operate a “Refer-A-Friend’ program to further drive customers to our site. Any existing customer can “refer’ a new customer to Vitacost and both are rewarded with a $10 credit to apply to an order of $30 or more on our Vitacost.com website.
Manufacturing
All of our manufacturing is provided by third party manufacturers. Each of our contract manufacturers is required to maintain high standards of quality control consistent with federal regulatory guidelines and manufacture our products according to our strict specifications. We have implemented vendor qualification programs for all of our suppliers and manufacturers, including full analytical testing of the products we purchase.
Customer Service
We strive to offer outstanding customer service with each customer’s complete satisfaction as our goal. To achieve this goal, we maintain a fully staffed customer service center to respond to customers via incoming calls, e-mails and live-chat while providing accurate and timely shipping, all driven by our 5-Star Guarantee. We believe our customer service initiatives allow us to establish and maintain long-term customer relationships and facilitate repeat visits and purchases.
Customer Service Center.
Our service center serves as the primary contact between our customers and the Company. Customer service agents are available to answer questions and to accept customer orders. Our customer service specialists receive regular training so that they can effectively and efficiently field questions from current and prospective consumers. Our specialists are also trained not to answer questions that should be directed to a customer’s physician, such as questions relating to drug interactions.
Customer Service Portal
. We recently launched an online self-service portal for customers to assist them with quickly and easily providing customer service. Our portal includes such areas as account affirmation, order history, order tracking and a comprehensive knowledge base. We will continue to enhance our service portal in the future. This is available at service.vitacost.com.
Our 5-Star Guarantee
. Our 5-Star Guarantee makes it easy, convenient and safe for customers to purchase our products. Under the Guarantee we:
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Offer vitamins, supplements, organic products, body care and natural health products at everyday low prices, providing savings off retail 365 days a year, with no minimums, no memberships and no hidden charges.
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Provide a 30-day unconditional money-back guarantee for all our products.
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Provide the highest quality supplements and other natural health products.
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Maintain one of the largest selections of healthy living products available anywhere, with approximately 46,000 items and more than 2,500 brands from which to choose.
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Guarantee a safe, secure online shopping experience through the use of state-of-the-art Secure Socket Layer 128-bit encryption on our website.
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During 2013, we were named in the Online Trust Alliance (OTA) Honor Roll for the second year in a row. The OTA, a non-profit organization with a mission to enhance online trust, analyzed hundreds of websites across multiple industries including e-commerce, banking, social, and government, conducting an audit of the site’s data protection, security and privacy practices. Of the sites evaluated, only one-third qualified for the 2013 Honor Roll. In addition, we ranked #2 in customer satisfaction in the ForeSee Experience Index (FXI) 2013 U.S. Retail Edition which measured customer satisfaction with the top 100 e-retailers during the 2013 holiday shopping season.
Technology and Operations
Our website is supported by a technology infrastructure that is designed to provide a superior customer experience, including speed, ease of use and security. Our systems and tools allow us to monitor our website and services in real time, scale to size as required and balance traffic geographically across multiple sites. We also track and manage our inventory, order fulfillment, customer service and marketing through technologies that allow us to condense and distribute customer and sales data as part of our business intelligence management. From this data, our finance, marketing, operations and product development teams are able to optimize decision-making processes to analyze and project growth drivers and forecast demand.
We maintain strategic partnerships with vendors in the U.S. and abroad, a combination of in-house and external development, to ensure that we can rapidly deploy information technology solutions that we believe are key to our success—covering fulfillment, merchandising, supply chain management and back-office compliance. Our efforts are prioritized by the management team to map available capacity to have a positive strategic and tactical impact on the business.
Our technology infrastructure uses highly scalable, fault tolerant enterprise-standard technologies. We use a combination of internal and Tier 1 third party data centers that support product development, quality control, Ecommerce, CRM and the customer experience. Coupled with the use of leading network technologies, virtualization and cloud-based solutions, we manage redundant coverage that significantly mitigates the risk of downtime.
We follow rigorous industry standards to protect our internal operations and the personal information we collect from our customers. We do not sell or disclose the personal information of our customers. We continue to maintain and upgrade our technology framework to support high levels of security while meeting the compliance requirements of Payment Card Industry (“PCI”) security standards. We are considered a “sender” under the CAN-SPAM Act and comply with the applicable aspects thereof.
We have installed technologically advanced finished goods inventory control systems to track our finished goods from receipt through shipment. All items are barcoded to facilitate electronic tracking allowing us to tie each SKU number back to our inventory control, shipping and sales departments. Our inventory control system analyzes and automatically recommends reorders for a majority of the products we sell, managing and mitigating out-of-stock situations. We consistently evaluate low volume items in order to minimize losses due to product expiration or obsolescence and to efficiently manage our warehouse space.
Competition
The nutrition and dietary supplement market is large, growing, competitive and highly fragmented. Our competition includes multi-level marketers, online VMHS specialty and mass retailers, and extends offline to brick and mortar stores including but not limited to grocery, membership clubs, specialty and mass retailers. We believe the following are the principal competitive factors in our market:
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Selection and availability of product
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Reliability and speed of delivery
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Customer service and support
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While we believe we compete favorably with respect to the above factors, the nature and extent to which our competitors implement various pricing and promotional activities in response to increasing competition and our response to these competitive actions, could adversely affect our profitability.
Trademark and Other Intellectual Property
We rely on a combination of patent, copyright and trademark and trade secret laws, confidentiality procedures and contractual provisions to protect our proprietary rights with respect to our technology and proprietary information. We have applied for or registered all relevant trademarks with the U.S. Patent and Trademark Office (USPTO), including our Vitacost, Nutraceutical Sciences Institute, Cosmeceutical Sciences Institute, Best of All, Walker Diet, Smart Basics, Take the Cost out of Healthy Living, Momonomics and Wellness Times trademarks, among others. We believe our trademarks to be valuable and are identified strongly with our brands. The issuance of a federally registered trademark creates a rebuttable presumption of ownership of the mark; however, it is subject to challenge by others claiming first use in the mark in some or all of the areas in which it is used. We have also applied for foreign protection of certain of our trademarks in the European and Asian markets in which we operate and have registered Vitacost, NSI and Nutraceutical Sciences Institute in certain countries in these regions.
Federally registered trademarks have a perpetual life, as long as they are maintained and renewed on a timely basis and used properly as trademarks, subject to the rights of third parties to seek cancellation of the trademarks if they claim priority or confusion of usage.
We have obtained a number of U.S. patents on some product formulations and have applications pending for others. In designing our product formulations, we have attempted to blend an optimal combination of nutrients which appear to have beneficial impact based upon scientific literature. However, because formal clinical studies have in most instances not been conducted by us to validate the intended health benefits of the nutrients, we are generally prohibited by the FDA from making disease treatment and prevention claims in the promotion of products using these formulations. While we seek broad coverage for our patents, there is always a risk that an alteration to the formulation may provide sufficient basis for a competitor to avoid infringement claims by us. In addition, our issued patents expire over the next several years and we cannot provide any assurance that any patents will be issued from pending applications or that any issued patents will adequately protect our intellectual property. We intend to reevaluate each of our registered U.S. patents for strength and value as renewal dates approach. We believe our patents and trademarks are valuable and provide us certain benefits in marketing our products. We intend to actively protect our patents, trademarks, trade secrets and other intellectual property.
Government Regulation
We are subject to federal and state consumer protection laws, including laws protecting the privacy of consumer non-public information and regulations prohibiting unfair and deceptive acts and trade practices. In particular, under federal and state financial privacy laws and regulations, we must provide:
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notice to consumers of our policies on sharing non-public information with third parties;
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advance notice of any changes to our policies; and
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with limited exceptions, provide consumers the right to prevent sharing of their non-public personal information with unaffiliated third parties.
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Furthermore, the growth and demand for online commerce could result in more stringent consumer protection laws that impose additional compliance burdens on online retailers. These consumer protection laws could result in substantial compliance costs and could interfere with the conduct of our business.
There is currently great uncertainty in many states whether or how existing laws governing issues such as property ownership, sales and other taxes, and libel and personal privacy applies to the Internet and commercial online retailers. These issues may take years to resolve. For example, tax authorities in a number of states, as well as a Congressional advisory commission, are currently reviewing the appropriate tax treatment of companies engaged in online commerce, and new state tax regulations may subject us to additional state sales and income taxes. New legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or a change in application of existing laws and regulations to the Internet and commercial online services could result in significant additional taxes on our business. These taxes could have a material adverse effect on our results of operations.
Our products are subject to extensive regulation in the U.S. and abroad. As applied to products Vitacost sells, FDA enforces the Federal Food, Drug and Cosmetic Act (“FDCA”), and related regulations, which govern the identity, purity, quality, strength, and composition of dietary supplements and regulate the formulation, manufacture, packaging, labeling, holding, sale, and distribution of dietary supplements, foods, cosmetics, medical devices, animal foods and drugs, and over-the-counter (“OTC”) allopathic and homeopathic human drugs (collectively “FDA regulated products”). FDA prohibits the distribution and/or sale of misbranded and/or adulterated FDA regulated products. In particular, FDA uses the objective intent of a product’s manufacturer or distributor, as evidenced by the manufacturer or distributor’s labeling claims, advertising matter, or oral or written statements, to determine whether the product is an unapproved new drug. Changes to the manufacturing, labeling, or packaging requirements for our products could result in increased costs or manufacturing disruptions, both of which could negatively affect our financial condition and operations. Additionally, new or amended laws and regulations, such as the U.S. Food Safety Modernization Act (“FSMA”) passed in 2011 that gave FDA broader authority over the safety of the national food supply, may lead to increased compliance costs and civil remedies, including fines, injunctions, withdrawals, recalls, seizures, confiscations, or criminal sanctions, all of which could adversely impact our business, our finances, or our operations.
The Federal Trade Commission, or FTC, enforces the Federal Trade Commission Act, or FTCA, and related regulations, which govern the advertising associated with the promotion and sale of our products to prevent misleading or deceptive claims.
The U.S. Postal Inspection Service enforces federal laws governing fraudulent use of the mail. Regulation of certain aspects of the dietary supplement business at the federal level is also governed by the Consumer Product Safety Commission (“CPSC”) (e.g., concerning the presence of adulterated substances, such as toxic levels of lead or iron, that render products unsafe for consumption and require a CPSC ordered recall), the Department of Agriculture (e.g., for products that are intended for ingestion as dietary supplements for animals) and the Environmental Protection Agency (e.g., in the methods of disposal used for certain dietary ingredients, such as colloidal silver).
The manufacture, packaging, labeling, holding, sale, and distribution of dietary supplements are also subject to extensive local, state, and foreign government regulation. For example, under the European Union Directive, only dietary supplements listed in Annex II to that directive or otherwise ruled saleable in Europe by the European Union may be sold in Europe subject to EU restrictions on dosage amounts, forms, label claims and advertising. The Bureau of Customs and Border Patrol (“CBP”), a division of the Department of Homeland Security, also regulates shipments containing dietary ingredients, dietary supplements, cosmetics, drugs, biologics, and medical devices and engages in enforcement activity in concert with the FDA to block the import or export of articles deemed adulterated or otherwise unlawful for sale in the United States (imports) or in the non-U.S. country to which articles are addressed. CBP holds on articles or demands for recall can interfere with the timely delivery of products to market and can result in regulatory fines and penalties.
The FDCA has been amended several times affecting provisions that concern dietary ingredients and dietary supplements, including by the Dietary Supplement Health and Education Act of 1994 (“DSHEA”). DSHEA formally defined what may be sold as a dietary supplement, defined statements of nutritional support and the conditions under which they may lawfully be used, and included provisions that permit the FDA to regulate manufacturing practices and labeling claims peculiar to dietary supplements. “Dietary supplements” are defined as vitamins, minerals, herbs, other botanicals, amino acids and other dietary substances that are used to supplement the diet, as well as concentrates, constituents, extracts, metabolites, or combinations of such dietary ingredients. Generally, under DSHEA, dietary ingredients that were on the market before October 15, 1994 may be used in dietary supplements without notifying the FDA. However, a “new” dietary ingredient (i.e., a dietary ingredient that was not marketed in the U.S. 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 having been “chemically altered.” A new dietary ingredient notification must provide the FDA with evidence of a “history of use or other evidence of safety” which establishes 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 new dietary ingredient can be marketed. There can be no assurance that the FDA will accept evidence purporting to establish the safety of any new dietary ingredients that we may want to market, and the FDA’s refusal to accept such evidence could prevent the marketing of such dietary ingredients.
Increased FDA enforcement could lead the FDA to challenge dietary ingredients already on the market as “illegal” under the FDCA because of the failure to file a new dietary ingredient notification or because the substance may be one found to be the subject of an investigational new drug application for which clinical trials have commenced and been publicized.
The FDA generally prohibits labeling a dietary supplement with any “health claim” (i.e., any statement associating a nutrient with risk-reduction, but not treatment, of a disease or health-related condition), unless the claim is pre-approved by the FDA. The FDA prohibits entirely disease diagnosis, prevention and treatment claims when made for a dietary supplement. However, “statements of nutritional support,” including so-called “structure/function claims,” are permitted to be included in labeling for dietary supplements without FDA pre-approval. 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 the structure, function or well-being of the body, but such statements may not state that a dietary supplement will reduce the risk or incidence of a disease unless such claim has been reviewed and approved by the FDA. A company that uses a statement of nutritional support in labeling must possess evidence substantiating that the statement is truthful and not misleading. Such statements must be submitted to the FDA no later than thirty days after first marketing the product with the certification that they possess the necessary evidence and must be accompanied by an FDA mandated label disclaimer that “This statement has not been evaluated by the FDA. This product is not intended to diagnose, treat, cure or prevent any disease.” There can be no assurance; however, that the FDA will not determine that a particular statement of nutritional support that we want to use is an unacceptable disease claim or an unauthorized nutrient-disease relationship claim otherwise permitted with FDA approval as a “health claim.” Such a determination might prevent the use of such a claim.
In addition, DSHEA provides that certain “third-party literature,” such as a reprint of a peer-reviewed scientific publication linking a particular dietary ingredient with health benefits, may “in connection with the sale of a dietary supplement to consumers” be exempt from labeling regulation. However, the FDA has adopted an “intent to use” doctrine whereby such literature even if exempt from labeling may nonetheless form the basis for an agency determination that the literature in context reveals a company intent to sell a dietary ingredient or dietary supplement as a drug, thereby rendering the supplement an unlawful, unapproved new drug. Because the “intent to use” doctrine is predicated on a subjective assessment of all facts and circumstances associated with the promotion and sale of a dietary supplement, we cannot know whether any particular piece of literature otherwise exempt from labeling will be deemed by the FDA unlawful for use in association with the sale of the dietary ingredient or dietary supplement.
As authorized by the FDCA, the FDA has adopted and implemented Good Manufacturing Practices (“GMPs”), specifically for dietary supplements. These GMPs impose extensive process controls on the manufacture, holding, labeling, packaging, and distribution of dietary supplements and the components of dietary supplements. They require that every dietary supplement be made in accordance with a master manufacturing record with all dietary ingredients verified by identity testing before use, that each step in manufacture, holding, labeling, packaging, and distribution be defined with written standard operating procedures, monitored, and documented, and that any deviation in manufacture, holding, labeling, packaging, or distribution be contemporaneously documented, assessed by a quality control expert, and corrected through documented corrective action steps (whether through an intervention that restores the product to the specifications in the master manufacturing record or to document destruction of the non-conforming product). The GMPs are designed to ensure documentation, including testing results that confirm the identity, purity, quality, strength, and composition of finished dietary supplements. In addition, GMPs require a company to make and keep written records of every product complaint that is related to GMPs. The written record of the product complaint must include the following: the name and description of the dietary supplement; the batch, lot, or control number of the dietary supplement, if available; the date the complaint was received and the name, address, or telephone number of the person making the complaint, if available; the nature of the complaint, including, if known, how the product was used; the reply to the complainant, if any; and findings of the company’s quality control investigation and follow-up action taken when an investigation is performed. The regulations directly affect all who manufacture the dietary supplements we sell and our distribution of dietary supplements. The FDA may deem any dietary supplement adulterated, whether presenting a risk of illness or injury or not, based on a failure to comply with any one or more process controls in the GMP regulations. If deemed adulterated, a dietary supplement may not be lawfully sold and may have to be recalled from the market. In recent years, the FDA’s main focus has evolved from basic violations, such as failure to set specifications, to more technical violations, such as finished product testing violations. It is possible that the FDA will find one or more of the process controls implemented by our contract manufacturers, or by those whose dietary supplements we sell to be inadequate and, thus, requiring corrective action, requiring any one or more of the dietary supplements we sell to be unlawful for sale, or resulting in a judicial order that may impair our ability to market, and sell dietary supplements.
The FDA also requires adverse event notices on labels and serious adverse event reporting for all supplements and OTC drugs. An “adverse event” is defined by statute to include “any health-related event associated with the use of a dietary supplement that is adverse.” While all adverse event complaints received must be recorded in accordance with the GMPs discussed above, only serious adverse events must be reported to FDA. A “serious adverse event” is an adverse event that: results in death, a life-threatening experience, inpatient hospitalization, a persistent or significant disability or incapacity, or a congenital anomaly or birth defect; or requires, based on reasonable medical judgment, a medical or surgical intervention to prevent an outcome described above. When a manufacturer, packer, or distributor whose name appears on the product label of a dietary supplement receives any report of a serious adverse event associated with the use of the dietary supplement in the United States, the company must submit a “serious adverse event report” on MedWatch Form 3500A. The report must be filed within 15 business days of receipt of information regarding the adverse event. All adverse event reports, whether serious or not, must be recorded and kept in company records under the GMP rules. A company must maintain records of each report of any adverse event (both serious and non-serious) for a minimum of 6 years. These records should include any documents related to the report, including: the company’s serious adverse event report to the FDA with attachments; any new medical information about the serious adverse event received; all reports to the FDA of new medical information related to the serious adverse event; and any communications between the company and any other person(s) who provided information related to the adverse event.
The regulation of dietary supplements may increase or become more restrictive in the future. There can be no assurance that, if more stringent statutes are enacted for dietary supplements, or if more stringent regulations are promulgated, we will be able to comply with such statutes or regulations without incurring substantial expense.
The FDA regulates the formulation, manufacturing, packaging, labeling and distribution of all OTC drugs. It allows OTC allopathic drug products to be sold without premarket approval so long as the products comply with FDA’s “monograph” system that specifies active drug ingredients that are generally recognized as safe and effective for particular uses. If an OTC drug is not in compliance with the applicable FDA monograph, the product generally cannot be sold without first obtaining FDA approval of a new drug application, which can be a long and expensive procedure.
The homeopathic OTC drugs that we sell are regulated by FDA as non-prescription, over-the-counter drugs. These products must generally meet the manufacturing standards set forth in the Homeopathic Pharmacopeia of the United States (HPUS) and the limitations for OTC ingredients. Claims made for them must not deviate from those contained in specific homeopathic treatises recognized by the FDA as appropriate for use. The products must be labeled in compliance with FDA regulations for all OTC drugs. If these requirements are not met, the FDA can consider the products unapproved new drugs and prohibit their sale.
Cosmetics are not subject to pre-market approval by the FDA, but the products, their ingredients and their label and labeling content, are regulated by the FDA, and it is the burden of those who sell cosmetics to ensure that they are safe for use as directed. The FDA prohibits certain ingredients from being contained in cosmetic products that are authorized only for drug use or are deemed adulterated. In addition, the labeling of cosmetic products is subject to the requirements of the FDCA, the Fair Packaging Labeling Act and other FDA regulations. The FDA limits cosmetic product claims to those of beautification and enhancement to the external appearance of the skin. Structure/function claims are generally prohibited for cosmetic products as are disease prevention and treatment claims. It is possible that cosmetic product ingredients now commonly in use that are derived from nanotechnology may be restricted or prohibited in future. It is also possible that claims now commonly in use concerning cosmetic reduction in the external appearance of aging, the effect of cosmetic ingredients on fine lines and wrinkles, or on other aspects of appearance may in the future be deemed prohibited, implied disease treatment claims.
Animal foods and food additives are also regulated by FDA and each state’s department of agriculture. DSHEA does not apply to substances used for animals, and thus, products marketed to humans as dietary supplements are categorized as food, food additives, animal drugs, or generally recognized as safe (“GRAS”) when marketed to animals, depending upon their intended use. Animal drugs require FDA preapproval. Specifically, an animal drug must be shown safe and effective for its intended use as established by adequate data from controlled scientific studies submitted as part of its New Animal Drug Application. Unapproved animal drugs are adulterated and subject to FDA enforcement. Examples of claims that will render a product an animal drug include a claim that the product is intended to affect the structure of the body other than as food, which is the case when the product is not being primarily consumed for its taste, aroma, or nutritive value, or a claim that the product is intended to diagnose, cure, mitigate, treat, or prevent disease. FDA, however, generally exercises enforcement discretion and allows some animal foods to make bear meaningful health information. However, there is no legal authority in the FDCA for animal foods to make those types of claims. The Nutrition Labeling and Education Act of 1990 (“NLEA”), which allows health claims to be made for human food, does not apply to animal food. It is possible in the future that FDA may consider all health claims prohibited. Food additives also require FDA preapproval, which can be obtained by submitting a food additive petition to FDA that demonstrates that the food additive has utility and is safe for its intended use. If an animal food contains an unapproved food additive, it is adulterated. FDA, however, has exercised its enforcement discretion to not require food additive petitions for a substance that does not raise a safety concern. In such an instance, FDA requests that a company submit the information required to list the ingredient in the
Official Publication of the Association of American Feed Control Officials
(“AAFCO”), an annual manual that sets out labeling requirements, approved ingredients, and nutrient needs for particular animal types including companion animals. At this time, FDA has agreed to not take regulatory action against ingredients used under its regulatory discretion, even though they are technically unapproved food additives, so long as the labeling is consistent with the accepted intended use and does not drug claims, and no new data calls into question the safety or utility of the ingredient. FDA could revoke this informal policy at any time and take enforcement action against products containing unapproved food additives. Substances that are GRAS for their intended use are exempt from the definition of a “food additive” and do not require FDA preapproval. Companies can make their own GRAS determination and may voluntarily notify FDA of the determination. FDA may disagree with a company’s GRAS determination and prohibit the use of the substance for a particular intended use.
Medical devices that we sell are OTC and not subject to pre-market approval but may be subject to a notification requirement (called a 510k) or a premarket compliance requirement, like an OTC monograph. Manufacturers of medical devices must register and list their products with FDA annually whether they are located domestically or overseas. All medical devices must be manufactured under good manufacturing standards called “quality assurance” standards set by FDA. Medical devices must be labeled in accordance with FDA’s general device labeling requirements and whatever particular label requirements FDA may designate for that type of device. When a company receives a positive response to a 510k notification, if the company promotes the product with any deviation from the labeling and claims that were submitted to the agency, the agency may consider the product misbranded. Similarly, if the company changes the design or performance of the device in any way from the notification then FDA may consider the product adulterated.
Conventional food manufacturing, labeling and distribution are also under FDA jurisdiction. Manufacturers must ensure their products are produced in a clean environment to prevent adulteration by contamination in compliance with applicable GMPs and must manufacture their products with either approved food additives or ingredients that are “generally recognized as safe” (“GRAS”). Conventional foods must meet FDA’s labeling requirements including a Nutrition Facts statement. Conventional foods may make structure/function statements, like dietary supplements but unlike dietary supplements are not required to file notice of those statements with FDA, and such statements must be limited to effects derived from nutritive value. Conventional foods may also bear approved health claims. Like dietary supplements, infant formulas are regulated by FDA as a type of food with their own requirements for manufacturing and labeling. Infant formulas, however, are required to go through a preapproval process, manufacturing inspection prior to product launch, and are held to a nutritional sufficiency standard unlike other foods due to the nature of this type of product.
Conventional foods and dietary supplements must also comply with the Organic Act (for the designation of organic ingredients) enforced by the US Department of Agriculture and the Food Allergen Labeling and Consumer Protection Act of 2004 (“FALCPA”) enforced by the FDA. Under the Organic Act there are specific requirements for the certification of ingredients as “organic” and requirements on how to use the term “organic” in labeling, whether for an ingredient or a complete product. USDA has also issued an enforcement policy applying the use of the term “organic” to cosmetics and their ingredients (“USDA”) even though there is no law authorizing that use. Under FALCPA, all packaged foods (including supplements) containing any of the eight identified major food allergens (milk, egg, fish, crustacean shellfish, tree nuts, wheat, peanuts, and soybeans) must declare such allergens, at least once, by their common or usual name in the ingredient list or in a “CONTAINS” statement immediately following the ingredient list in bold. A packaged food “contains” an allergen for the purposes of the law when any intentionally added ingredient contains an allergen. Thus, even if an allergen is present only in a coloring or flavoring, FALCPA applies. Likewise, the law applies even if an allergen is present only in a small amount of an “incidental” (but intentionally added, non-cross-contact) additive, like a releasing agent. Disclosure in this case is required even though such an ingredient usually could be omitted altogether from the ingredients list. If a manufacturer believes that no allergen is present there is a preapproval process to seek an exception. Failure to comply with the FALCPA may lead to civil sanctions, criminal penalties, or both under the FDCA. In addition, the FDA is authorized to seize non-conforming products controlled by a company and issue a recall of products already on the market.
Although the FDA and the USDA have issued statements about the appropriate use of the word “natural,” there is no single, U.S. government-regulated definition of the term “natural” for use in the food industry, including dietary supplements. Additionally, the FDA recently refused to provide guidance on whether foods produced using biotechnology can bear “natural” claims. The uncertainty surrounding “natural” claims has resulted in consumer confusion and lawsuits. Plaintiffs have filed actions against food companies that market “natural” products, alleging false, misleading and deceptive advertising and labeling claims. If we become subject to similar claims, consumers may avoid purchasing products from us or seek alternatives, even if the basis for the claim is unfounded. Negative publicity about these matters may discourage some consumers from purchasing our products. The cost of defending against any such claims could be high. Further, a loss in consumer confidence in the truthfulness of our labeling claims would be difficult and costly to overcome and may significantly reduce our brand value. Uncertainty about our ingredients, regardless of the cause or validity, may have a substantial and adverse effect on our brand and our business, results of operations and financial condition.
The FDA has broad authority to enforce the provisions of the FDCA concerning all of the products it regulates, including powers to issue a public “warning letter” to a company to quarantine and prohibit the sale of products deemed adulterated or misbranded, to publicize information about illegal products, to request a voluntary recall of illegal products from the market, to request that the Department of Justice initiate a seizure action, an injunction action or a criminal prosecution in U.S. courts, and to seek disgorgement from a federal court of all proceeds received from the sale of products deemed misbranded or adulterated.
The FTC exercises jurisdiction over the advertising of dietary supplements, OTC drugs, medical devices, and cosmetics. In recent years, the FTC has instituted numerous enforcement actions against dietary supplement companies for making false or misleading advertising claims and for failing to adequately substantiate claims made in advertising. These enforcement actions have often resulted in consent decrees and the payment of civil penalties and/or restitution by the companies involved. The FTC also regulates other aspects of consumer purchases including, but not limited to, promotional offers of savings compared policies, telemarketing, continuity plans, and “free” offers.
We are also subject to regulation under various state, local and international laws that include provisions governing, among other things, the formulation, manufacturing, packaging, labeling, advertising and distribution of dietary supplements, animal foods, medical devices, conventional foods, and OTC drugs. For example, under Proposition 65 in the State of California, there is a list of substances that are deemed to pose a risk of carcinogenicity or birth defects at or above certain levels. If any such ingredient exceeds the permissible levels in a dietary supplement, cosmetic, or drug, the product may be lawfully sold in California only if accompanied by a prominent warning label alerting consumers that the product contains an ingredient linked to cancer or birth defect risk. Private attorney general actions as well as California attorney general actions may be brought against non-compliant parties and can result in substantial costs and fines. Additionally, California has a law called the “Consumers Legal Remedies Act” (Cal. Civ. Code § 1750 et seq) that allows private parties to assert a class action claim for false or deceptive advertising. It is typically asserted in combination with claims for false advertising and unfair competition under the California Business and Professions Code. California law firms specializing in this type of consumer class action claims have recently been targeting dietary supplement and OTC homeopathic drug makers and sellers of products sold in California, claiming injury based on the products’ failure to deliver results as claimed in product labeling and promotion.
Government regulations in foreign countries may prevent or delay the introduction, or require the reformulation, of certain of our products. Compliance with such foreign governmental regulations is generally the responsibility of our distributors in those countries. These distributors are independent contractors whom we do not control.
In addition, from time to time in the future, we may become subject to additional laws or regulations administered by the FDA, the FTC, or by other federal, state, local or foreign regulatory authorities, to the repeal of laws or regulations that we generally consider favorable, such as DSHEA, or to more stringent interpretations of current laws or regulations. We are not able to predict the nature of such future laws, regulations, repeals or interpretations, and we cannot predict what effect additional governmental regulation, if and when it occurs, would have on our business in the future. Such developments could, however, require reformulation of certain products to meet new standards, recalls or discontinuance of certain products not able to be reformulated, additional record-keeping requirements, increased documentation of the properties of certain products, additional or different labeling, additional scientific substantiation, additional personnel or other new requirements. Any such developments could have a material adverse effect on our business.
Europe
. The European Union (“EU”) is responsible for the development of legislation governing foods, nutritional supplements, and medicines sold in Europe. Member States of the EU (“Member States”) are authorized to develop local legislation governing these products, provided such legislation is not more restrictive than the legislation promulgated by the EU. Member States are responsible for enforcement of the applicable legislation. In 2002, the EU established a process for Member States to bring this regulating legislation in line with a published directive of the EU, which addressed the labeling and marketing of vitamins and minerals, what nutrients are permitted or not permitted and other packaging requirements. In 2004, the EU established standards for the manufacture and marketing of herbal medicines with the Traditional Herbal Medicinal Products Directive. This requires, among other things, manufacturers of herbal medicinal products to comply with Pharmaceutical Group Standards, and only requires proof of safety, not efficacy.
In 2006, the EU adopted its Commission Directive 2006/37/EC, amending its Directive 2002/46/EC. Under the amended directive, only nutrients listed in Annex II, or approved by subsequent order of the EU, may be lawfully sold in Member States. The EU also regulates labels, labeling, and advertising associated with the promotion and sale of dietary supplements in Europe. These regulations may make it unlawful for us to sell in Europe certain products lawfully labeled and sold in the United States, adversely affecting the finances of the business.
In the United Kingdom, the principal governing legislation is the Food Safety Act of 1990 (governing safety of food products) and the Medicines Act of 1968 (governing licensing and sale of medicine). Further guidance is provided by numerous Statutory Instruments addressing the formulation, purity, packaging, advertising and labeling of such products. Medicinal products are regulated and enforced by the Medicines and Healthcare Products Regulatory Agency (MHRA), an agency of the Department of Health. The MHRA determines if an herbal remedy is medicinal by virtue of its “presentation” or “function.” Food products are regulated by the Food Standard Agency (FSA), which reports to the Department of Health and to the Department of Environment, Food and Rural Affairs. Vitamin and mineral supplements and soup products with herbal ingredients are generally considered food supplements and are subject to the purview of the FSA. Additional legislative standards have been adopted in the other EU countries, typically similar in scope to the UK. The regulatory scheme in Canada is similar but not identical to that of the U.S. concerning medicines and healthcare products or material health products and is regulated by Health Canada.
Employees
As of December 31, 2013, we had 790 full-time employees. Additionally, we maintain temporary employees primarily in our fulfillment centers to meet changing demands of that function. None of our employees are covered by a collective bargaining agreement and we are unaware of any union organizing efforts. We consider our relationship with our employees to be good.
Geographic Information
During our last three years, the majority of our revenue was generated within North America, and all of our long-lived assets are located within the United States. However, we believe international represents a large long-term opportunity for us with international revenue accounting for 8%, 6%, and 5% of total revenue in 2013, 2012 and 2011, respectively.
Available Information
Our Web site is
www.vitacost.com
. The information posted on our website is not incorporated into this Annual Report on Form 10-K. We have made available through our Web site, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the Securities and Exchange Commission. In addition, they are available directly on the website for the Securities and Exchange Commission.
Item 1A. Risk Factors
We operate in a rapidly changing environment that involves significant risks, a number of which are beyond our control. In addition to the other information contained in this Annual Report on Form 10-K, the following discussion highlights some of these risks and the possible impact of these factors on our business, financial condition and future results of operations. If any of the following risks actually occur, our business, financial condition or results of operations may be adversely impacted. In addition, these risks and uncertainties may impact the forward-looking statements described elsewhere in this Form 10-K and in the documents incorporated herein by reference. They could affect our actual results of operations, causing them to differ materially from those expressed in forward-looking statements.
Risks Relating to Our Business
If we are unable to effectively manage our growth plan, our business strategy, financial condition, results of operations, or cash flows could be materially adversely affected.
Our growth plan requires significant management time and operational and financial resources. There is no assurance that we have the operational and financial resources to successfully manage our growth. In addition, rapid growth in our headcount and operations may place a significant strain on our management and our administrative, operational and financial infrastructure. Failure to adequately manage our growth could have a material adverse effect on our business, financial condition, results of operations, or cash flows.
We operate in a highly competitive industry, and our failure to compete effectively could materially adversely affect our market share, financial condition and growth prospects.
The U.S. health products industry is a large and highly fragmented industry. Our competitors include specialty retailers, supermarkets, drugstores, mass merchants, multi-level marketing organizations, online merchants, mail-order companies and a variety of other participants in the industry. The principal elements of competition in the industry are price, selection and distribution channel offerings. We believe that the market is also 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 for sales with heavily advertised national brands manufactured by large pharmaceutical and food companies, as well as other retailers. In addition, as some products gain market acceptance, we experience increased competition for those products as more participants enter the market. Certain of our competitors are larger than us and have longer operating histories, larger customer bases, greater brand recognition and greater resources for marketing, advertising and product promotion. They may be able to secure inventory from vendors on more favorable terms, operate with a lower cost structure or adopt more aggressive pricing policies. In addition, our competitors may be more effective and efficient in introducing new products. We may not be able to compete effectively, and our attempt to do so may require us to increase marketing and/or reduce our prices, which may result in lower margins. Failure to effectively compete could materially adversely affect our market share, financial condition and growth prospects.
If we are unable to sufficiently increase our revenue to offset increased costs as we expand our business, we may experience operating losses, net losses or negative cash flows.
We expect operating expenses and working capital requirements to increase substantially as we expand our business. We expect our costs of product development, sales and marketing, research and development and general and administrative expenses to increase substantially as a result of our growth. If we are unable to continue to sufficiently increase our revenue to offset these increased costs, we will not maintain profitability and may experience operating losses, net losses or negative cash flows.
If we are unable to retain key personnel, our business, financial condition or results of operations could be materially adversely affected.
Our success depends to a significant degree upon the continued contributions of our executive officers and other key personnel. Although we have employment agreements with our executive officers, we cannot guarantee that such persons will remain affiliated with us. If any of our key personnel were to cease their affiliation with us, our operating results could suffer. Further, we do not maintain key person life insurance on any of our executive officers. If we are unable to retain the services of key personnel, our business, financial condition or results of operations could be materially and adversely affected.
Our network and communications systems are vulnerable to system interruption and damage, which could limit our ability to operate our business and could have a material adverse effect on our business, financial condition or results of operations.
Our ability to receive and fulfill orders promptly and accurately is critical to our success and largely depends on the efficient and uninterrupted operation of our computer and communications hardware and software systems. We experience periodic system interruptions that impair the performance of our transaction systems or make our website inaccessible to our customers. These system interruptions may prevent us from efficiently accepting and fulfilling orders, sending out promotional emails and other customer communications in a timely manner, introducing new products and features on our website, promptly responding to customers, or providing services to third parties. Frequent or persistent interruptions in our services could cause current or potential customers to believe that our systems are unreliable, which could cause them to avoid our website, drive them to our competitors, and harm our reputation. To minimize future system interruptions, we must continue to improve our systems and network infrastructure to accommodate increases in website traffic and sales volume and to replace aging hardware and software. We may be unable to promptly and effectively upgrade and expand our systems and integrate additional functionality into our existing systems. In addition, upgrades to our systems may cause existing systems to fail or operate incorrectly. Any unscheduled interruption in our services could result in fewer orders, additional operating expenses, or reduced customer satisfaction, any of which would harm our business, financial condition and operating results. In addition, the timing and cost of upgrades to our systems and infrastructure may substantially affect our ability to maintain profitability.
Our systems and operations and those of our suppliers and Internet service providers are vulnerable to damage or interruption from fire, flood, earthquakes, power loss, server failure, telecommunications and Internet service failure, acts of war or terrorism, computer viruses and denial-of-service attacks, physical or electronic break-ins, sabotage, human error and similar events. Any of these events could lead to system interruptions, order fulfillment delays, and loss of critical data for us, our suppliers, or our Internet service providers, and could prevent us from accepting and fulfilling customer orders. Any significant interruption in the availability or functionality of our website or our customer processing, distribution, or communications systems, for any reason, could seriously harm our business, financial condition, and operating results.
We depend primarily upon search engines and other online sources to increase traffic to our website, and need to convert this traffic into customers in a cost-effective manner; our failure to do so could have a material adverse effect on our business, financial condition or results of operations.
Our success depends on our ability to attract visitors to our website and convert them into customers in a cost-effective manner. We utilize search engines and other online sources as a means to direct traffic to our website. Our website is included in search results as a result of both paid search listings, where we purchase specific search terms that result in the inclusion of our website in the search result, and algorithmic searches that depend upon the searchable content in our website. Search engines and other online sources revise their algorithms from time to time in an attempt to optimize their search results.
If one or more of the search engines or other online sources which we use to direct traffic to our website were to modify its general methodology for how it displays our website, fewer visitors may visit our website, which could have a material adverse effect on our business and results of operations. Further, if any free search engine which we use to direct traffic to our website begins charging fees for listing or placement, or if one or more of the search engines or other online sources on which we rely for purchased listings, modifies or terminates its relationship with us, the traffic to our website could decrease and our expenses could increase which could have a material adverse effect on our business, financial condition or results of operations.
Taxation risks could subject us to liability for past sales, increase our costs and cause our future sales to decrease.
One or more states or foreign countries may seek to impose sales or other tax collection obligations on out-of-jurisdiction eCommerce companies. Certain states have imposed such a sales tax obligation requirement on online retailers that use residents of that state to directly or indirectly refer potential customers, via a link on an Internet website or otherwise, to the online retailer. A successful assertion by one or more states or foreign countries that we should collect sales or other taxes on the sale of merchandise or services could result in substantial tax liabilities for past sales, decrease our ability to compete with traditional retailers and otherwise harm our business, financial condition or results of operations.
We do not collect sales or other taxes on shipments into most states in the U.S. Currently, U.S. Supreme Court decisions restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet. However, a number of states, as well as the U.S. Congress, have been considering initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales. If any of these initiatives were successful, we could be required to collect sales and use taxes in additional states. The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us, reduce our competitive advantage over traditional retailers and decrease our future sales. Our warehousing centers, and any future expansion of them, along with other aspects of our evolving business, may result in additional sales and other tax obligations.
We rely on third-party carriers as part of our inventory fulfillment and order delivery processing, and these third parties may fail to meet shipping schedules or requirements, which could damage our reputation and reduce our sales and our margins.
We cannot control all of the factors that might affect our timely and cost-effective procurement of products from our vendors and delivery of our products to our customers. We rely on third-party carriers both for the delivery of inventory and for the shipment of our products to our customers. Consequently, we are subject to risks associated with these carriers, including increased fuel costs, security concerns, labor disputes, union organizing activity and inclement weather. Any disruption in the ability of these carriers to timely deliver products to us and to our customers could damage our reputation and brand and result in customer dissatisfaction. This could, in turn, materially and adversely affect our business, financial condition or results of operations.
We could be harmed by data loss or other security breaches.
Our servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions and delays in our service and operations as well as loss, misuse or theft of data. Any attempts by hackers to disrupt our service or our internal systems, if successful, could harm our business, be expensive to remedy and damage our reputation. Although we have developed systems and processes that are designed to protect customer information and prevent data loss and other security breaches, such measures cannot provide absolute security. In addition, we rely on third party technology and systems in certain aspects of our businesses, including encryption and authentication technology to securely transmit confidential information. Any significant disruption to our service or internal computer systems could adversely affect our business and results of operations.
Complying with new and existing government regulation, both in the U.S. and abroad, could significantly increase our costs.
The processing, formulation, packaging, labeling, advertising, distribution and sale of our products are subject to regulation by several U.S. federal agencies, including the FDA, the FTC, the Postal Service, the Consumer Product Safety Commission, the Department of Agriculture and the Environmental Protection Agency, as well as various state, local and international laws and agencies of the localities in which our products are sold. Government regulations may prevent or delay the introduction or require the reformulation of our products.
The FDA regulates, among other things, the manufacture, composition, safety, labeling, marketing and distribution of dietary supplements (including vitamins, minerals, herbs, and other dietary ingredients for human use), OTC drugs (allopathic and homeopathic), conventional foods, infant formulas, animal foods, medical devices, and cosmetics. The FDA may not accept the evidence of safety we present for new dietary supplements we wish to market, or they may determine that a particular dietary supplement or ingredient that we currently market presents an unacceptable health risk. If that occurs, we could be required to cease distribution of and/or recall supplements or products containing that ingredient. In July 2011 the FDA introduced a draft Guidance Document called
“Guidance for Industry: Dietary Supplements: New Dietary Ingredient Notifications and Related Issues
” relating to pre-market safety notifications. In it FDA identified standards of proof for safety and “grandfathering’ that would impose new burdens on the dietary supplement industry and may impact the legality of some of our existing products. FDA has accepted industry comments on the guidance but has not yet published its response or otherwise finalized the draft.
A draft guidance is not considered a final rule by the FDA. In June 2012, the FDA stated that it planned to issue a revised draft guidance to clarify controversial points in the original version. Nevertheless, in enforcement actions taken by the agency, it has adhered to the basic interpretation expressed in the draft guidance even before the draft guidance has been finalized. Consequently, ingredients previously considered lawfully saleable without submission of a notice containing proof of safety may now need to be considered adulterated and unsaleable unless and until FDA fails to object on grounds of safety to a New Dietary Ingredient notice.
The FDA and the Federal Trade Commission (FTC) may also determine that certain labeling, advertising and promotional claims, statements or activities are not in compliance with applicable laws and regulations and may determine that a particular statement is an unapproved health claim, an unacceptable drug claim, a false or misleading label claim, or a deceptive advertising claim. Failure to comply with FDA or other regulatory requirements could prevent us from marketing particular dietary supplement products or subject us to administrative, civil or criminal penalties.
Legislation has been introduced in the U.S. Senate seeking to provide the FDA with increased authority to regulate dietary supplements and increase labeling requirements with respect to dietary supplements. The Food Safety Modernization Act (“FSMA”) now requires food companies, including dietary supplement companies, to register with the agency and renew those registrations biannually. The FSMA permits summary revocation of registrations (and elimination of the right to sell products in interstate commerce) based on findings by the FDA that a product might present an unreasonable risk of serious illness, injury, or death. Legislation introduced but not passed by Congress would require the FDA Commissioner to obtain a list of all ingredients and claims for dietary supplements and distinguish from among them which products are potentially unsafe and which claims are misleading. FDA and FTC are cooperating in joint enforcement projects, including the issuance of warning and enforcement letters by both agencies. The FTC staff has demanded two clinical trials as a condition precedent for the making of certain categories of claims, such as those concerning weight loss and those concerning immune support, which position, while struck down by an FTC Administrative Law Judge, is pending on appeal before the Federal Trade Commission.
The FTC exercises jurisdiction over the advertising of dietary supplements and has instituted numerous enforcement actions against dietary supplement companies for failing to have adequate substantiation for claims made in advertising or for using false or misleading advertising claims. The FTC routinely polices the market for deceptive dietary supplement advertising and accepts and reviews complaints from the public concerning such advertising.
The FTC also regulates deceptive advertising claims and promotional offers of savings compared to “regular” prices. The National Advertising Division (“NAD”), of the Council of Better Business Bureaus oversees an industry-sponsored self-regulatory system that permits competitors to resolve disputes over advertising claims, including promotions for savings off of regular prices. The NAD has no enforcement authority of its own but may refer promotions to the FTC that the NAD views as violating FTC guidelines or rules. Violations of these orders could result in substantial monetary penalties.
In Europe, non-compliance by us or others of relevant legislation can result in regulators bringing administrative or, in some cases, criminal proceedings. For example, in the U.K., it is common for regulators, including the Medicines and Healthcare Products Regulatory Agency Enforcement & Intelligence Group, to prosecute retailers and manufacturers for non-compliance with legislation governing foodstuffs and medicines. European Union (EU) regulations and directives are implemented and enforced by individual member states and, so, enforcement priorities and applicable law can occur in multiple countries at one time. Failure by us, the manufacturers or suppliers to comply with applicable legislation could result in prosecution and have a material adverse effect on our business, financial condition and results of operations.
Europe has adopted broad regulations and directives on health and nutrition claims. These regulations cover claims that can be made for foods (including supplements). Certain claims, such as those regarding general well-being, behavioral functions and weight-loss, may be prohibited or require prior approval. Unless subject to derogation, products that include certain claims cannot be lawfully marketed in EU member states absent preapproval. Applicable derogations under EU directives can enlarge the period within which we may seek approval for products containing claims up through January 19, 2014. An approval must proceed through the European Food Safety Authority (EFSA), and the process includes the submission of a detailed dossier in support of the product claims. Lengthy delays within the new EU framework have been reported. This may severely impact our European marketing and expansion efforts. As of December 14, 2012, the transitional period ends for products which were on the market when Regulation 1924/2006 entered into force in 2007, but which did not comply with its provisions. The currently adopted list of claims includes 222 approved general function claims for use in the European Union. Claims considered “on hold” pending a final decision may continue to remain in the market under the responsibility of the food business operator in question, provided those claims comply with applicable national provisions. Presently, the assessments of health claims for plant and herbal substances—the so-called “botanical” substances—are “on hold.”
We are also anticipating the implementation of an EU directive relating to food supplements, which could significantly impact the formulation of our products. The implementation of this directive is expected to include dosage restrictions for certain vitamin and mineral supplements and may lead to some of our products being recalled or discontinued. Thus far, the maximum and minimum levels of vitamins and minerals present in food supplements per daily portion consumed have not been harmonized and, so, national legislation of Member States remains significant.
In addition, an EU Directive governing product safety requires manufacturers to notify regulators about unsafe products and gives regulators in each member state the power to order product recalls. As a result, the number of product recalls in Europe has increased substantially. A product recall in Europe could have a material adverse effect on our business, financial condition and results of operations.
Our ability to access capital markets may be adversely affected which could limit our ability to fund our operating costs if we do not generate sufficient cash from operations.
From time to time, we may need to access debt or equity capital markets in order to execute on our growth strategy. Any restriction on our ability to access capital markets could limit our ability to pursue our growth strategy and could materially adversely affect our business, financial condition or results of operations.
The current global economic climate could adversely affect our industry and, therefore, restrict our future growth.
The current global economic climate could negatively affect our sales because many consumers consider the purchase of our products discretionary. If the markets for our products significantly deteriorate due to the economic climate, our business, financial condition or results of operations could be materially and adversely affected.
Our failure to efficiently respond to changing consumer preferences and demand for new products and services could significantly harm our product sales, inventory management and customer relationships and our business, results of operations and financial condition could be materially adversely affected.
Our continued success depends, in part, on our ability to anticipate and respond to changing consumer trends and preferences. We may not be able to respond in a timely or commercially appropriate manner to these changes. Our failure to accurately predict these trends could negatively impact our inventory levels, sales and consumer opinion of us as a source for the latest products. The success of our new product offerings depends upon a number of factors, including our ability to:
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accurately anticipate customer needs,
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innovate and develop new products,
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successfully commercialize new products in a timely manner,
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competitively price our products,
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procure and maintain products in sufficient volumes and in a timely manner; and
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differentiate our product offerings from those of our competitors.
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If we do not introduce new products, make enhancements to existing products or maintain the appropriate inventory levels to meet customers’ demand in a timely manner, our business, results of operations and financial condition could be materially adversely affected.
Unfavorable changes to government regulations or adverse consumer attitudes about online commerce could have a material adverse effect on our business, financial condition or results of operation by impeding the growth and use of the Internet and thereby decreasing revenue.
As the role and importance of online commerce has grown in the U.S., there have been continuing efforts to increase the legal and regulatory obligations and restrictions on companies conducting commerce through the Internet, primarily in the areas of taxation, consumer privacy, restrictions on imports and exports, customs, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, the provision of online payment services, broadband residential Internet access and the characteristics and quality of products and services, which could increase the cost of conducting business over the Internet. In addition, consumer unwillingness or inability to use the Internet to conduct business, due to adverse regulation, security concerns, service interruptions or otherwise, could materially reduce our growth. Governmental laws and regulations or adverse attitudes about online commerce could increase the costs and liabilities associated with our online commerce activities, increase the price of our product to consumers, or reduce traffic to our website. Unfavorable resolution of these issues could have a material adverse effect on our business, financial condition or results of operations.
Laws or regulations relating to privacy and data protection may materially adversely affect the growth of our business or our marketing efforts, which could reduce our sales and cause us to incur significant costs.
We are subject to increasing regulation at the federal, state and international levels relating to privacy and the use of personal user information. For example, we are subject to various telemarketing laws that regulate the manner in which we may solicit future suppliers and customers. Such regulations, along with increased governmental or private enforcement, may increase the cost of growing our business. In addition, many jurisdictions have laws that limit the use of personal information gathered online or offline or require companies to establish privacy policies. The FTC has adopted regulations regarding the collection and use of personal identifying information obtained from children under thirteen years of age. Proposed legislation in this country and existing laws in foreign countries require companies to establish procedures to notify users of privacy and security policies, obtain consent from users for the collection and use of personal information, and/or provide users with the ability to access, correct and delete personal information stored by us. From time to time, Congress has proposed legislation regarding data security and privacy protection. Any enacted data protection regulations may restrict our ability to collect demographic and personal information, which could be costly or harm our marketing efforts, and could require us to implement new and potentially costly processes, procedures and/or protective measures.
Third parties could use our trademarks as keywords in Internet search engine advertising programs, which may direct potential customers to competitors’ websites, which, in turn, could result in decreased sales and could harm our reputation.
Competitors and other third parties could infringe on our trademarks and confusingly similar terms as keywords in Internet search engine advertising programs and in the resulting sponsored link advertisements which may divert potential customers to their websites. Preventing such unauthorized use is difficult. Further, the legal precedent on whether such activity infringes on our intellectual property varies significantly within the United States and in other countries. If we are unable to protect our trademarks or confusingly similar terms from such unauthorized use, competitors and other third parties could drive potential online customers away from our website, which could result in a loss of sales and have a material adverse effect on our business, financial condition or results of operations.
We are subject to a number of risks related to credit card payments we accept which, if we fail to be in compliance with applicable credit card rules and regulations, will result in additional fees, fines and ultimately the revocation of the right to use the credit card company, which could have a material adverse effect on our business, financial condition or results of operations.
For credit and debit card payments, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our profit margins. We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers. In addition, we have and may continue to suffer losses as a result of orders placed with fraudulent credit and debit card data. We do not carry insurance against the risk of credit card fraud, so the failure to adequately control fraudulent credit card transactions could reduce our net revenue and our gross profit percentage. We have implemented technology to help us detect the fraudulent use of credit card information. Under current practices, a merchant is liable for fraudulent credit card transactions when the merchant does not obtain a cardholder’s signature. A failure to adequately control fraudulent credit card transactions would result in significantly higher credit card-related costs and could have a material adverse effect on our business, financial condition or results of operations.
The content of our website and direct mailing pieces could expose us to significant liability which could reduce our profits.
Because we post product information and other content on our website and in our direct mailing pieces, we face potential liability for, among other things, copyright infringement, patent infringement, trademark infringement, defamation, unauthorized practice of medicine, false or misleading advertising and other claims based on the nature and content of the materials we post. Although we maintain general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to cover us for all liability that may be imposed. Any imposition of liability that is not covered by insurance, or is in excess of insurance coverage, could materially adversely affect our business, financial condition or results of operations.
Our failure to protect our intellectual property rights could reduce our sales and increase our costs.
We have applied for or registered all relevant trademarks with the U.S. Patent and Trademark Office, including our Vitacost, Nutraceutical Sciences Institute, Cosmeceutical Sciences Institute, Best of All, Walker Diet, Smart Basics, Take the Cost out of Healthy Living, Momonomics and Wellness Times trademarks, among others. We believe our trademarks to be valuable and are identified strongly with our brands. Issuance of a federally registered trademark creates a rebuttable presumption of ownership of the mark; however, it is subject to challenge by others claiming first use in the mark in some or all of the areas in which it is used. We have also applied for foreign protection of certain of our trademarks in the European and Asian markets in which we operate and have registered Vitacost, NSI and Nutraceutical Sciences Institute in certain countries in these regions.
Federally registered trademarks have a perpetual life, as long as they are maintained and renewed on a timely basis and used properly as trademarks, subject to the rights of third parties to seek cancellation of the trademarks if they claim priority or confusion of usage. We believe our trademarks are valuable and provide us certain benefits in marketing our products. We intend to actively protect our trademarks, trade secrets and other intellectual property.
We may in the future be subject to intellectual property litigation and infringement claims, which could cause us to incur significant expenses, be involved in protracted litigation or prevent us from selling or using some aspect of our products. Claims of intellectual property infringement may also require us to enter into costly royalty or license agreements. Alternatively, we may be unable to obtain necessary royalty or license agreements on terms acceptable to us, if at all. Claims that our technology or products infringe on intellectual property rights of others could be costly and would divert the attention of our management and key personnel, which in turn could materially adversely affect our business, financial condition or results of operations.
Our inventory is concentrated in two warehouse locations, which exposes us to the risk of natural disasters or other force majeure events. Losses at either location could materially adversely affect our product distributions, sales and consumer satisfaction.
Our two distribution warehouses are located in Lexington, North Carolina and Las Vegas, Nevada. Any significant disruption in either of these locations for any reason, such as a power failure, equipment breakdown, workforce disruption, or natural or similar disasters, could materially adversely affect our product distributions, sales and consumer satisfaction.
Insurance coverage, even where available, may not be sufficient to cover losses we may incur, which could increase our costs and lower our profits.
Our business exposes us to the risk of liabilities arising out of our products and operations. For example, we may be liable for claims brought by users of our products or by employees, customers or other third parties for personal injury or property damage occurring in the course of our operations. Our operations are subject to closure and loss due to power outages, Internet and telephone line failures, work stoppages and acts of nature. We seek to minimize these risks through various insurance policies from third-party insurance carriers. However, our insurance coverage is subject to large individual claim deductibles, individual claim and aggregate policy limits and other terms and conditions. Our estimate of retained-insurance liabilities is subject to change as new events or circumstances develop that might materially impact the ultimate cost to settle these losses. We cannot assure you that our insurance will be sufficient to cover our losses. We do not view insurance, by itself, as a material mitigant to these business risks. Any losses that are not completely covered by our insurance could have a material adverse effect on our business, financial condition or results of operations.
The insurance industry has become more selective in offering certain types of liability insurance coverage, and we may not be able to maintain our existing coverage or obtain increased coverage in the future, which could increase our costs and reduce our profits.
The insurance industry has become more selective in offering certain types of insurance, including product liability, product recall and property casualty insurance. While we believe our current insurance policies provide us adequate coverage for our current business operations, there can be no assurance that we will be able to maintain such coverage or obtain comparable coverage on terms and conditions favorable to us, if at all. Further, as we expand our business, we expect to correspondingly increase our insurance coverage, and there can be no assurance that we will be able to obtain such increased coverage if and when needed.
We may not be able to maintain the uniqueness of our domain name, which may result in confusion to existing and new customers and lost sales and, therefore, could have a material adverse effect on our business, financial condition or results of operations.
Maintaining our Internet domain name is critical to our success. Under current domain name registration practices, no other entity may obtain an identical domain name but can obtain a similar or identical name with a different suffix, such as “.net” or “.org,” or with a different country designation, such as “.jp” for Japan.
We have not registered our domain name with each of the suffixes or jurisdictions available. As a result, third parties may use domain names that are similar to our domain name, which may result in confusion to existing and new customers and lost sales. Failure to maintain our domain name’s uniqueness could have a material adverse effect on our business, financial condition or results of operations.
Our quarterly results of operations may fluctuate in the future. As a result, we may fail to meet the expectations of investors or securities analysts, which could cause our stock price to decline.
Our quarterly revenue and results of operations may fluctuate as a result of a variety of factors, many of which are outside of our control. If our quarterly revenue or results of operations fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Fluctuations in our results of operations may be due to a number of factors, including, but not limited to, those listed below and identified throughout this “Risk Factors” section in this Annual Report:
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our ability to retain and increase sales to existing customers and attract new customers;
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changes in the volume and mix of dietary supplements and health and wellness products sold in a particular quarter;
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the timing and success of new dietary supplement introductions or reformulations by us or our competitors;
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changes in our pricing policies or those of our competitors;
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competition, including entry into the market by new competitors including traditional brick and mortar retailers and new product offerings by existing competitors;
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the amount and timing of expenditures related to expanding our operations, research and development or introducing new products;
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changes in the payment terms for our products and services; and
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the purchasing cycles of our customers.
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Most of our expenses are relatively fixed in the short-term, and our expense levels are based in part on our expectations regarding future revenue levels. As a result, if revenue for a particular quarter is below our expectations, we may not be able to proportionally reduce operating expenses for that quarter, causing a disproportionate effect on our expected results of operations for that quarter.
Healthcare reform measures and related changes in applicable federal and state laws could materially adversely affect our business.
The efforts of governmental and third-party payers to contain or reduce the costs of healthcare may adversely affect our business, operating results, and financial condition. We expect that there will continue to be a number of legislative and regulatory proposals aimed at changing the healthcare system, which could include restructuring the tax benefits available through flexible spending accounts and/or health savings accounts. If the laws or regulations are changed to limit further the tax benefits through these accounts, such a change could have a material adverse effect on our business by reducing revenues and eroding our margins.
The Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 imposes certain obligations on the senders of commercial emails, which could minimize the effectiveness of our email marketing campaign, and establishes financial penalties for non-compliance, which could increase the costs of our business and, could have a material adverse effect on our business, financial condition or results of operations.
In December 2003, the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003, or the CAN-SPAM Act, was enacted. The CAN-SPAM Act establishes certain requirements for commercial email messages and penalizes commercial email message transmissions that are intended to deceive the recipient as to source or content. The CAN-SPAM Act, among other things, requires that senders of commercial emails allow recipients to opt out of receiving future emails from the sender. The ability of our customers to opt out of receiving commercial emails may minimize the effectiveness of our email marketing campaign. Moreover, non-compliance with the CAN-SPAM Act carries significant financial penalties. If we were found to be in violation of the CAN-SPAM Act, applicable state laws not preempted by the CAN-SPAM Act, or foreign laws regulating the distribution of commercial email, we could be required to pay penalties, which could have a material adverse effect on our business, result of operations, financial condition and cash flows.
Certain stockholders own a significant amount of our common stock, which could discourage an acquisition of Vitacost.com or make removal of incumbent management more difficult.
Great Hill Investors, LLC, Great Hill Equity Partners III, L.P. and Great Hill Equity Partners IV, L.P. (collectively, “GHP”) beneficially own approximately 19.16% of our outstanding stock. Because GHP owns a significant percentage of our capital stock, it could significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions.
Risks Relating to Our Products
We may incur product liability claims, which could increase our costs and/or materially adversely affect our business, reputation, financial condition or results of operations.
As a retailer and formulator of products designed for human consumption or use on or in the body, we are subject to product liability claims if the use of our products is alleged to have resulted in illness or injury or if our products include inadequate instructions or warnings. Our products generally consist of vitamins, minerals, herbs and other ingredients that are classified as foods, OTC drugs, dietary supplements, medical devices, and cosmetics and generally are not subject to pre-market regulatory approval or clearance in the U.S. by the FDA or other governmental authorities. Our products could contain spoiled or contaminated substances, and some of our products contain ingredients that do not have long histories of human consumption. Previously unknown adverse reactions resulting from human consumption of these ingredients could occur. Furthermore, as a distributor of products manufactured by third parties, we may also be liable for various product liability claims for products that we do not manufacture. We could be subject to product liability claims, including among others, that our products include insufficient instructions for use or inadequate warnings concerning possible side effects or interactions with other substances. Any product liability claim against us could result in increased costs and adversely affect our reputation with our customers, which in turn could materially adversely affect our business, financial condition or results of operations.
We depend upon certain suppliers and manufacturers; if these suppliers or manufacturers do not provide us materials or products when and as needed and we are unable to efficiently obtain alternative supply sources, we could be unable to meet the demand for our products, and our business, financial condition or results of operations may be materially adversely affected.
We rely upon suppliers for certain of our products. Furthermore, we engage manufacturers to produce our proprietary products. Disruption in the operations of any such supplier or manufacturer can occur for a number of reasons, many of which are beyond our control, such as regulatory requirements, import restrictions, loss of certifications, power interruptions, fires, hurricanes, drought or other climate-related events, war or other events. If any of our suppliers or manufacturers become unable or unwilling to continue to provide us supplies or products in the required volumes and quality levels or in a timely manner, we would be required to identify and obtain acceptable replacement supply or product sources. If we are unable to efficiently obtain alternative sources, our business, financial condition or results of operations may be materially adversely affected.
Unfavorable publicity or consumer acceptance of our products or of nutritional supplements generally could reduce our sales.
We are highly dependent upon consumer acceptance of the safety, efficacy and quality of our products, as well as similar products distributed by other companies. Consumer acceptance of products can be significantly influenced by scientific research or findings, national media attention and other publicity about product use. A product may initially be received favorably, resulting in high sales associated with that product that may not be sustainable as consumer preferences change. In addition, recent studies have challenged the safety or benefit of certain nutritional supplements and dietary ingredients. Future scientific research or publicity could be unfavorable to our industry or any of our particular products and may not be consistent with earlier favorable research or publicity. Any research or publicity that is perceived by our consumers as less than favorable or that questions earlier favorable research or publicity could have a material adverse effect on our ability to generate revenue. Adverse publicity in the form of published scientific research, statements by regulatory authorities or otherwise, whether or not accurate, that associates consumption of our products or any other similar products with illness or other adverse effects, or that questions the benefits of our or similar products, or that claims that such products are ineffective could have a material adverse effect on our business, reputation, financial condition or results of operations.
An unexpected interruption or shortage in the supply or significant increase in the cost of raw materials could limit our ability to secure a sufficient supply of products, which could reduce our sales and our margins.
An unexpected interruption of supply or a significant increase in the cost of raw materials for any reason, such as regulatory requirements, import restrictions, loss of certifications, disruption of distribution channels as a result of weather, terrorism or acts of war, or other events, could result in significant cost increases and/or shortages of our products. Our inability to obtain a sufficient amount of products or to pass through higher cost of products we offer could have a material adverse effect on our business, financial condition or results of operations.
If we experience product recalls, we may incur significant and unexpected costs and damage to our reputation which in turn could have a material adverse effect on our business, financial condition or results of operations.
We may be subject to product recalls, withdrawals or seizures if any of the products we formulate or sell are believed to cause injury or illness or if we are alleged to have violated governmental regulations in the labeling, promotion, sale or distribution of our products. A recall, withdrawal or seizure of any of our products could materially and adversely affect consumer confidence in our brands and lead to decreased demand for our products. In addition, a recall, withdrawal or seizure of any of our products would require significant management attention, would likely result in substantial and unexpected expenditures and could materially adversely affect our business, financial condition or results of operations.
Our inability to comply with health and safety regulations could materially and adversely affect our business, financial condition or results of operations.
Our operations are subject to environmental and health and safety laws and regulations, and some of our operations require environmental permits and controls to prevent and limit pollution of the environment. We could incur significant costs as a result of violations of, or liabilities under, environmental laws and regulations, or to maintain compliance with such environmental laws, regulations, or permit requirements.
Risks Related to Our Common Stock
If we are unable to comply with rules and regulations of the NASDAQ Stock Market, our common stock could be delisted from NASDAQ.
On December 7, 2010, trading in our common stock was temporarily suspended by NASDAQ for failure to comply with rules and regulations relating to the timely filing of SEC reports. On December 21, 2010, we received a letter from The NASDAQ Stock Market indicating that based on its review of the Company, the NASDAQ staff had determined that continued listing of our securities on NASDAQ was no longer warranted. In accordance with the procedures set forth in the NASDAQ Listing Rules, we timely appealed the staff determination, and requested a hearing before a NASDAQ Hearings Panel (the “Panel”). The hearing was held on February 3, 2011. On February 28, 2011, we received a written notice from NASDAQ indicating that the Panel had determined to grant our request to remain listed on NASDAQ, subject to certain conditions, including that (1) on or before June 20, 2011, we become current in our filing obligations, and demonstrated compliance with all quantitative requirements for continued listing, and (2) on or before July 5, 2011, we have solicited proxies and held our annual meeting. On June 20, 2011, trading of our securities on NASDAQ resumed. On July 6, 2011, we received a letter from NASDAQ indicating that we had met the requirements of the Panel’s decision and the applicable listing requirements and that accordingly the Panel had determined to continue listing our securities on the NASDAQ Stock Market. If we are unable to comply with the NASDAQ requirements in the future, our common stock could again be suspended from trading or be delisted from NASDAQ. A trading suspension or delisting of our common stock could negatively impact us by reducing the liquidity and market price of our common stock and the number of investors willing to hold or acquire our common stock, which could negatively impact our stock price and ability to raise equity financing.
Volatility of our stock price could materially adversely affect an investment in our common stock.
The market price of our common stock could fluctuate significantly as a result of, among other things:
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quarterly and annual variations in our operating results,
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the level and quality of research analyst coverage for our common stock, changes in financial estimates or investment recommendations by securities analysts following our business or failure to meet such estimates,
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the financial disclosure we may provide to the public, any changes in such disclosure or our failure to meet such disclosure,
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the public’s response to our press releases, our other public announcements and our filings with the Securities and Exchange Commission,
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various market factors or perceived market factors, including rumors, whether or not correct, involving us, our customers, our suppliers or our competitors,
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changes in accounting standards, policies, guidance, interpretations or principles,
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sales of common stock by our directors, officers or significant stockholders,
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introductions of new products or new pricing policies by us or by our competitors,
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recruitment or departure of key personnel,
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developments with respect to intellectual property rights,
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acquisitions or strategic alliances by us or our competitors,
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changes in shipping costs,
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short sales, hedging and other derivative transactions in shares of our common stock,
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the operating and stock price performance of other companies that investors may deem comparable to us,
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broad market conditions and trends in the eCommerce industry and the economy as a whole; and,
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other events or factors, including those resulting from war, incidents of terrorism or responses to such events.
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Fluctuations in the price of our common stock could contribute to the loss of all or part of a stockholder’s investment. Any of the factors listed above could have a material adverse effect on an investment in our common stock. In addition, stocks of Internet-related and eCommerce companies have historically experienced significant price and volume fluctuations that may have been unrelated or disproportionate to these companies’ operating performance. Public announcements by us or other such companies concerning, among other things, performance, accounting practices or legal problems could cause the market price of our common stock to decline regardless of our actual operating performance. We could be the subject of securities class action litigation due to future stock price volatility, which could divert management’s attention and materially adversely affect our results of operations.