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Vitacost.com, Inc. (NASDAQ:VITC)

Q4 2012 Earnings Call

February 28, 2013 10:00 AM ET

Executives

Kathy Reed – Director, IR

Jeff Horowitz – CEO

Brian Helman – CFO

Analysts

Dan Kurnos – The Benchmark Company

George Kelly – Craig-Hallum

Operator

Greetings, and welcome to the Vitacost.com Incorporated Fourth Quarter and Full Year End 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Kathy Reed, Director of Investor Relations for Vitacost.com Incorporated. Thank you, Ms. Reed. You may begin.

Kathy Reed

Good morning, ladies and gentlemen, and welcome to Vitacost.com’s earnings call to discuss our results for the fourth quarter and full year ended December 31, 2012. On the call with me today are Jeff Horowitz, our Chief Executive Officer; and Brian Helman, our Chief Financial Officer. By now, everyone should have access to the financial release we issued this morning, which provides details on the Company’s operating performance. If you have not received the release, it is available on our Investor Relations website at investor.vitacost.com.

We’ve also provided an updated table of our e-commerce metrics, which can also be found on the homepage of our Investor Relations website, which now includes data for the fourth quarter of 2012. This table shows our e-commerce metrics from our core vitacost.com site and including sales through partner channel. Further detail on our financial results can be found in today’s press release in our 2012 10-K.

Before we begin, we would like to remind everyone that today’s remarks contain forward-looking statements. Any statements that are not statements of historical fact should be considered to be forward-looking statements. Forward-looking statements, which include statements regarding the Company’s long-term growth rates and strategy, international growth prospects, product introduction plans and mix, customer acquisition strategy and expectations regarding the pace of customer growth, expectations regarding improved productivity and cost reductions, expectations regarding the timing and benefits associated with the upgrade of the company’s existing distribution centers, expectations regarding recent management changes, and expectations regarding fulfillment, G&A, and sales and marketing expenses involve known and unknown risks and uncertainties, which may cause the company’s actual results in current or future periods to differ materially from those anticipated or projected herein.

Those and other risks are more fully described in the company’s filings with the Securities and Exchange Commission, including the Company’s Form 10-K for the year ended December 31, 2012 and in the company’s subsequent filings with the Securities and Exchange Commission made after the date hereof.

On today’s call, Jeff will first discuss how we performed relative to our long-term growth initiative, and then provide an update on our fulfillment center upgrade project. Brian will review our fourth quarter operating performance with you and we will then open the call for your questions.

And with that, I would like to the turn the call over to the company’s Chief Executive Officer, Jeff Horowitz.

Jeff Horowitz

Thank you, Kathy. During 2012, we continued to execute on our strategy to grow our customer base, expand our product offerings into faster growing non-VMH categories and accelerate growth of our proprietary Vitacost brand. In addition, our mobile, international and Set & Save or AutoShip channels all showed positive momentum, which Brian will describe in more detail. First, we added nearly 940,000 new customers during the year on our Vitacost.com website, up 45% year-over-year. We ended the year with 1.7 million active customers on Vitacost.com, up 30% for the year.

Strong customer growth translated into volume growth as we shipped 4.3 million orders this past year from our Vitacost.com website, up 26% year-over-year. We continue to be successful in gaining and retaining new customers due to our attractive value proposition. Our discounted pricing model resonates well with customers who are cost-conscious and able to easily compare prices across multiple sites with a click of a button. Offering a wide selection of products at attractive price also helps to create a superior customer experience for shoppers in addition to speedy and accurate order fulfillment and delivery.

We are especially pleased that we rank number three out of the top 100 online retailers for customer satisfaction this past holiday year by ForeSee research behind only Amazon and L.L.Bean. In addition, I am very pleased to say that in December we also notified that we achieved Google Trusted Store status for our excellent customer service and reliable shipping. We are the only large e-commerce company in the health and wellness industry that has achieved this distinction from Google.

Second, we delivered on our goal to broaden our product selection to become a true one-stop shop for all our customers’ health and wellness needs. During the year, we added over 5,000 net new SKUs across all of our main categories with a special focus on our faster growing categories such as food, beauty and sports nutrition.

Over the past three years, we have added 17,000 SKUs to our website, ending 2012 with nearly 40,000. And we have doubled the number of brands we carry to more than 2,000 today. Approximately 41% of the SKUs that we carry are VMHS; 17% each for beauty and food; and 8% for sports nutrition, and our smaller categories combined accounts for the remainder.

Last quarter, I told you that the VMHS products account for all but half of all our products sold and that the trend continued in the fourth quarter with 54% of all units shipped being non-VMHS products. Our broader product selection is important to help us expand our customer profile by attracting a younger demographic to shop on our website. We are quickly becoming the leading destination for health and wellness shoppers on the web today.

During 2012, we launched several specialty stores, including a new Cruelty-Free Store, a Spice Store and we recently launched a new Non-GML Store to make it even easier for health and socially conscious customers to find the products they need.

Our product expansion and category diversification has served us well as sales for our food products increased 87%. Sports nutrition was up 59%, beauty increased 24%, and our other smaller categories such as baby, pet and household were up a combined 68% year-over-year in 2012.

Our core VMHS business also remained strong with sales increasing 15% for the full year. Vitacost is truly much more than a vitamin company and our diversified product offerings have allowed us to attract new customers and cross-sell to our existing base.

Third, we continue to focus on growing our proprietary Vitacost brand as we launched 176 new products for the full year and are off to a solid start in 2013. Proprietary products remain a core part of our business accounting for 23% of the total product sales in 2012.

Growth in our proprietary line has accelerated increasing 90% for the full year, up from 3% in 2011 and only 1% in 2010. We ended the year with 975 proprietary SKUs live on our website and we’re focused and continuing to expand our proprietary line in 2013. All of these initiatives I have just discussed resulted in strong revenue growth with sales up 26% year-over-year to a record of $85 million in the fourth quarter of 2012; and total sales up 27% for the full year of 2012 to $331 million.

Now let me quickly discuss the management changes we elected to make last week. We announced that our COO, Bert Wegner is leaving the company effective today. Bert has built a great team in fulfillment with our senior level managers having extensive experience from Amazon and other online logistic companies. Michael Oldman who previously ran our North Carolina facility will now oversee both of our fulfillment centers and will report directly to me. We expect this to be a smooth transition and view both of these management changes as a positive to our organizational structure.

I would like to spend a few moments to provide you with an update on our fulfillment center upgrade project. During the first half of 2012, we completed the capacity upgrade to our two facilities, increasing the stores’ capability from 40,000 SKUs at each location to more than 50,000.

In the third quarter of last year, we began making enhancements to our warehouse management system through software and technology upgrades and this process is still going on. We are working to optimize our accounts system and believe this is the best path to creating more efficient fulfillment operations in the near-term, while maintaining a high level of customer satisfaction.

Although we do expect to achieve some efficiencies this year, we firmly believe it is much more important for the long-term success of our business to have happy customers rather than forced cost savings at the risk of impacting the customer experience.

During 2013, we will continue to execute on the sales initiatives previously outlined and focus on growing our customer base, product offerings and proprietary line and believe our strategy will lead to continue high rates of growth in the years to come. We are also focused on improving the efficiency of our operation and expect to realize improvement this year.

Now, I would like to turn the call to Brian to provide more detail on our results.

Brian Helman

Thanks, Jeff. In the fourth quarter of 2012, total net sales increased 26% over last year to a quarterly record of $85 million, as third-party product sales grew 27% and proprietary product sales grew 22% in the quarter. Excluding Amazon, sales on our core Viacost.com site were up 27% year-over-year and 5% sequentially.

In the fourth quarter, we added 227,000 new customers to our Vitacost.com website, up 28% year-over-year. We shipped 1.1 million orders placed through our Vitacost.com website, a 23% increase compared to last year. AOV on our Vitacost.com website, excluding our Refer-A-Friend campaign was $76.44 in the fourth quarter of 2012, up slightly year-over-year and flat with the third quarter.

As Jeff mentioned earlier, we continue to see strong growth in our mobile initiatives, as the number of mobile orders increased 24% sequentially in the fourth quarter. We also saw strong growth in our Set & Save program, which was re-launched in July of last year, as orders grew nearly 70% sequentially in the fourth quarter from third quarter levels. While this business is still small, we still believe Set & Save sets a strong foundation for our loyalty program by guaranteeing the lowest prices available on our website.

Sales from our international business increased 41% year-over-year in the fourth quarter and 30% sequentially, due to successful promotional efforts. International sales accounted for 7% of total company sales in the quarter, up from 6% in the fourth quarter of 2011 and 5% in the previous quarter. We continue to believe international represents a significant long-term opportunity for Vitacost.

Finally, our Amazon channel continues to account for a smaller portion of our overall business. Sales through Amazon accounted for 3% of total sales and 8% of total orders in the fourth quarter, down from 4% of total sales and 9% of orders in both the fourth quarter of 2011 and the third quarter of 2012.

Moving on to gross profit, fourth quarter 2012 gross profit was $19.2 million, a 23% increase over last year. Gross margin in the quarter was 22.6%, down slightly from the third quarter and down 60 basis points year-over-year. The year-over-year and sequential decline in gross margin was primarily attributable to increased shipping cost per order as a larger percentage of orders required fulfillment from both warehouses.

Now on to fulfillment, in the fourth quarter of 2012, fulfillment expense was 10.4% of sales, compared to 9.9 % of sales in the fourth quarter of 2011. As we have stated in the past, included in fulfillment expense are fees related to our freight savings program. We entered into this arrangement in the third quarter of 2011 and the current program is set to expire in mid-2014. Therefore, excluding fees related to our freight savings program, fulfillment expense was 9.5% of sales in the fourth quarter of 2012, compared to 9% of sales in the fourth quarter of 2011.

On a per order basis, again excluding fees related to the freight savings program, fulfillment cost per order was up slightly sequentially and increased 9% year-over-year. The increased cost per order resulted from increased labor cost needed to maintain quick order fulfillment time in order to maintain our high level of customer service.

Next, sales and marketing expense was 8.4% of sales, down from 9% of sales in the fourth quarter of 2011. We continue to improve the productivity of our marketing spend with variable customer acquisition costs, excluding Amazon related fees down slightly year-over-year on a per customer basis in the fourth quarter of 2012, while driving a 28% year-over-year increase in new Vitacost.com customers.

As a percentage of sales, sales and marketing decreased to 140 basis points sequentially from the third quarter, as we reduced our spending on paid search during the quarter due to seasonality as well as also benefited from increased sales leverage.

Moving on, G&A expense was 7.6% of sales compared to 9.1% of sales in the fourth quarter of 2011 excluding certain items. G&A as a percentage of sales also declined 160 basis points sequentially from 9.2% of sales reported in the third quarter of 2012, as we continued to gain leverage on our administrative infrastructure. Please see today’s earnings release for a reconciliation of the expenses excluded from G&A.

Turning to our bottom line performance, my comments exclude all expenses detailed in our EBITDA reconciliation in today’s press release. Adjusted EBITDA for the fourth quarter of 2012 was a loss of $1 million compared to a loss of $1.7 million in the previous year. It is important to note – it is important to point out that this includes fees related to our freight savings program, which again is set to expire in mid-2014. Those fees amounted to approximately $700,000 this quarter.

Additionally, EBITDA in the current quarter was positively impacted by a $1.1 million reversal of previously accrued bonuses. Non-GAAP net loss for the fourth quarter of 2012 was $3.2 million, flat year-over-year. This translates to a loss of $0.09 per share for the current quarter versus a net loss of $0.12 per share in the prior year. Earnings per share for the fourth quarter of 2012 reflect a higher share count than the fourth quarter of 2011 due to the private placement offering in February of last year.

Now for a few balance sheet highlights. We ended the fourth quarter of 2012 with cash and cash equivalents of $32.2 million. Inventory increased $2.1 million sequentially to $33.3 million, as we added over 2,000 new third-party SKUs to our website during the fourth quarter and added stock in advance of the seasonally strong January period.

Inventory turns remain high at 7.6 times as of December 31, flat with the third quarter, and up from 6.2 times for the full year ended 2011. Total CapEx in the quarter was $1.6 million with approximately $800,000 relating to our fulfillment center upgrade project. CapEx was $6.4 million for the full year 2012 with $4.5 million spent on the fulfillment centers.

In summary, we believe our core value proposition of offering a wide product selection, low prices and great service is resonating extremely well with consumers as evidenced by our solid top line results. During 2013, we will continue to execute on our growth strategy as we focus on expanding our customer base and achieving operational efficiencies.

Now, we would be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session (Operator Instructions) Our first question comes from Dan Kurnos with The Benchmark Company. Please proceed with your question.

Dan Kurnos – The Benchmark Company

Yeah, good morning guys. Let me just start on the new customer side. Your new customer growth definitely moderated pretty significantly in the quarter. I know you had some more difficult comparisons when you talked about reducing your spend on paid search due to seasonality. So, maybe combine this with how we should look at marketing spend going forward and whether you’re going to continue to be equally aggressive on the customer acquisition front?

Brian Helman

Good morning, Dan. New customers for the quarter were 227,000. I mean that on Vitacost.com were excluding Amazon that compares to 236,000. Yes, fourth quarter is seasonably a little slow for us and that’s why we pulled back on some of the paid search. I would not say that that’s indicative of our plan for 2013. I mean, Q1 is seasonably a strong quarter for us and we’ve resumed our normal spending with regards to customer acquisition.

We believe customer acquisition is incredibly important. We’re pushing hard on that front. With regards to marketing spend, and as we said, if we look at customer – if we look at variable marketing expenses, which is a proxy for customer acquisition cost on a per customer basis, it was flat. We still measure the marketing returns on all of our acquisition vehicles and acquisition tools. So, we’re focused on that, but we’re looking to maximize the number of new customers that we have this year.

Dan Kurnos – The Benchmark Company

And let me just follow-up on that Brian, that’s very good color. In terms of mobile, are you guys actually marketing on mobile, and if so, are you seeing any impact from the new Google policy changes that were basically trying to force advertisers to bundle across platforms, maybe see an increase in CPC rates there?

Brian Helman

So, we do advertise on mobile, but mobile is not a huge channel for us yet. As we said, it’s growing quickly, but it’s not a huge advertising channel for us yet. So, we haven’t been impacted by any of the changes to-date.

Dan Kurnos – The Benchmark Company

Okay, thanks. And then, Jeff just moving on to the proprietary side, you guys did have good year-over-year growth, but you also had a really easy comparison. I’m just curious how you felt about your performance in proprietary in Q4? And maybe if you could give us some more color on the timing of new product roll-out. I mean, you talked about a little bit in your prepared remarks, but just curious about how rapidly you plan to expand SKUs on the proprietary side? Thanks.

Jeff Horowitz

Thank you, Dan. We did very well in proprietary in 2012, and we continue to be rolling out at a high level for 2013. I believe that proprietary is one of the most important channels in our company and we’re not backing down, we’re actually pushing very hard on all the different channels of proprietary. So, I don’t have the exact number yet of how many items will be coming out or SKUs that will be coming out, but it will be a significant amount.

Dan Kurnos – The Benchmark Company

Okay. And then, just one quick housekeeping question and I’ll get back in queue. But Brain, just remind me, because I think I might have missed it, what was the CapEx for the year and just how should we think about CapEx in 2013?

Brian Helman

CapEx for the year was $6.4 million. And I think that when you look at 2013, we don’t have any significant projects, although we are going to invest in our data center, we’re going to invest in the fulfillment centers. So, I think we’re likely to trend a little bit from where we were in 2012.

Dan Kurnos – The Benchmark Company

Okay, great. Thanks, I’ll get back in the queue.

Operator

(Operator Instructions). Our next question comes from George Kelly with Craig-Hallum. Please proceed with your question.

George Kelly – Craig-Hallum

Hi guys. So, a couple of quick ones and then an accounting follow-up. Could you talk a little bit just about the competitive dynamics in the quarter, wondering if anything changed? And then secondly, could you talk about gross margin expectations for 2013, if there will be anything different compared to 2012 there?

Jeff Horowitz

Thanks, George. Competitive-wise, we don’t see any pressure at the present time. At GNC our volume is over three times there – our dot-com business I was lucky, over six times their business. In Vitamin Shoppe, way over three times their direct channel. So, at the present time, we don’t see any great pressure mounting against us. Not being cavalier, we’re constantly looking, growing and making sure we’re out there being the leaders in price. And so, at the present time, no.

Brian Helman

And with regards to gross margin expectation, our gross margin, we really focus on maximizing gross profit dollars. And so, we’re a little less focused on our margin percentage. We’ve provided a range of gross margin of 22% to 25% long-term. But as we operate the business day-to-day, we’re focused on the maximization of gross profit dollars. And if that means that slightly lower margin yields more dollars as we’re more competitive, then that’s what we’re going to do.

George Kelly – Craig-Hallum

Okay, great. Thanks. And then, one last question, you mentioned $1.1 million reversal, so did that in effect to lower the G&A expense in the quarter?

Brian Helman

G&A was the primary impact of that, yes.

George Kelly – Craig-Hallum

Okay. Thank you.

Operator

We have a follow-up question from Dan Kurnos with The Benchmark Company. Please proceed with your question.

Dan Kurnos – The Benchmark Company

Yeah, thanks. Just to maybe touch again on that – to follow-up on that particular question. So, G&A once you exclude the reversal, it’s still, I mean, it’s kind of pacing similar, it’s like – are you expecting to build out more head count going into 2013 or should we expect head count to be sort of flat?

Brian Helman

Within our fixed cost infrastructure G&A and then, some on the sales and marketing side, I think there will be moderate head count increases this year. We are investing in some areas of the business in IT specifically. So, we’ll have moderate, but I think that we have the opportunity and long-term we do expect a lot of leverage within G&A.

Dan Kurnos – The Benchmark Company

Okay, great. And then, just one more follow-up for Jeff. You guys are getting some decent traction in international, so maybe if you could just give us some more color on how you’re proceeding with your international strategy this year? Thanks.

Jeff Horowitz

As we pointed out that we believe that the international channel is a great growth vehicle. We are building individual country sites, which will be launching soon and we have a whole team, marketing getting ready to launch some interesting – obviously we can’t talk about it at this present time, but international as Brain said, is a channel that we’re really excited about.

Dan Kurnos – The Benchmark Company

All right. Thanks, guys.

Operator

There are no further questions in the queue at this time. I would like to turn the call back over to Ms. Kathy Reed for closing comments.

Kathy Reed

Thanks everyone for joining us today, and we look forward to speaking to you again on our first quarter 2013 call. Thanks very much. Bye-bye.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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