IPO Analysis: Vitacost.com Does a Great Job Increasing Profits in a Competitive Landscape

Sep.25.09 | About: Vitacost.com, Inc. (VITC)

On September 17, Bill Simpson wrote an analysis of Vitacost.com (NASDAQ:VITC) to TradingIPOs subscribers. In its market debut Wednesday, September 23, the company priced shares for $12 each, within the estimate range. Vitacost.com sold 11 million shares and raised $132 million.

The text of Mr. Simpson's original writeup follows:

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Vitacost.com plans on offering 11 million shares at a range of $11-$13. Insiders will be selling 6.6 million shares in the offering. If the over-allotments are exercised, the deal size will be 12.6 million shares offered with insiders selling 7.6 million shares. Jefferies and Oppenheimer are leading the deal with Needham and Roth Capital co-managing. Post-ipo VITC will have 28.1 million shares outstanding for a market cap of $337 million on a pricing of $12. Approximately 50% of ipo proceeds will be used for capital expenditures, the remainder for debt repayment and general corporate purposes.

Founder and former CEO Wayne Gorsek will own 17% of VITC post-ipo. Mr. Gorsek is selling approximately 40% of his stake in the company on ipo. Note that the SEC found Mr. Gorsek liable for security fraud in 2003 in connection with the promotion of penny stocks. For VITC to be listed on the Nasdaq, Mr. Gorsek had to give up his role of CEO and Chairman of the Board. Mr. Gorsek is still a paid consultant for VITC.

From the prospectus:

'We are a leading online retailer and direct marketer, based on annual sales volume, of health and wellness products, including dietary supplements such as vitamins, minerals, herbs or other botanicals, amino acids and metabolites (which we refer to as "vitamins and dietary supplements"), as well as cosmetics, organic body and personal care products, sports nutrition and health foods.'

The company is an online discount vitamin and health & wellness product retailer, founded in 1994 as a catalog third-party retailer of vitamins. In 1999 VITC launched website Vitacost.com and since has done bulk of sales via that site.

VITC offers 23,000 SKUs from over 1,000 third-party brands, such as New Chapter, Atkins, Nature’s Way, Twinlab, Burt’s Bees and Kashi. In addition VITC has their own brands: Nutraceutical Sciences Institute (NSI), Cosmeceutical Sciences Institute (CSI), Best of All, Smart Basics and Walker Diet. VITC completed construction of a manufacturing facility in North Carolina and now manufactures most of their own labeled products.

VITC claims prices on their website are 30%-60% lower than manufacturers suggested retail prices. While technically this may be true, a quick run through their website would seem to indicate third party products are roughly in-line with the big box stores. In this day and age it is hard to undercut the large grocery chains, Target (NYSE:TGT) and Wal-Mart (NYSE:WMT). What VITC does offer is a large selection in one online spot with click-to-buy ordering as well as their own label brands.

As of 6/30/09, VITC has approximately 957,000 active customers, an increase of 37% year over year. VITC defines 'active customer' as a customer who has made a purchase from VITC in the prior 12 month period. On average, active customers make purchases 2-3 times a year with average ticket between $72-$77. Approximately 50% of visitors to Vitacost.com arrive via non-paid sources. Average conversion rate per visitor to site in 2008 was 15%, which seems to me to be rather solid.

VITC's margins are far stronger on sales of their own label products. Sales of VITC labels had gross margins in '08 of 53% while gross margins were just 24% on sales of third-party products.

Sector - Even as the US economy slowed, online sales continued to grow as more and more people become comfortable with ordering/purchasing online. US online retail sales were $141 billion in 2008 and expected to grow 11% in 2009. Also US sales overall of dietary supplements are expected to grow 5% year over year through 2013. Sales of dietary supplements through the Internet grew 24.8% in 2007 and are expected to grow double digits over the next few years.

86% of orders were placed online via VITC's website. 98% of revenues are generated from US customers.

Customer acquisition costs are $10.16. In 2008, 74% of orders were from repeat customers.

VITC has the capability to ship 20,000 orders per day. 93% of orders are shipped same day.

Competition is fierce. Retailers include GNC, Vitamin World, Vitamin Shoppe, Walgreen (WAG), CVS, Rite Aid (NYSE:RAD), Wal-Mart, Target and supermarket chains. Online competitors include Amazon.com (NASDAQ:AMZN) and Drugstore.com (NASDAQ:DSCM).

Financials

$1 per share in cash (minus debt) post ipo.

Revenue growth has been very strong. VITC even notes in the prospectus: 'To date, we have not been adversely effected by the current recession and resulting downturn in consumer confidence and discretionary spending.' Quarterly revenues have shown a sequential increase for at least eight quarters in a row.

VITC's own label products accounted for 33% of product sales through the first six months of 2009.

VITC has been operationally profitable since 2006. In 2009, however, VITC has been able to increase the bottom line significantly due to growing customer base and very solid operating expense management. In a very competitive landscape, VITC has done an excellent job increasing revenues and profits.

2008 - Revenues were $143.6 million. Gross margins were 26.5%. Operating expense ratio was 25%. Operating margins were 1 1/2%. Net margins (after tax and debt interest) were 1/2 of 1%. EPS was $0.02.

2009 - VITC has had a fantastic first half of 2009 as they've increased revenues and margins sharply. Full year revenues should be $196 million, a 36% increase over 2009. VITC should achieve this growth while keeping sales/marketing expenses flat compared to 2008. For an online retailer this is impressive organic growth. Normally when you see sharp growth from an online retailer, it also comes with sharp increase in sales and marketing expenses, notably internet advertising. That isn't the case here at all as it appears returning customers are creating a nice economy of scale. VITC seems to be providing a quality service based on the numbers here. Gross margins should be 32%. Operating expense ratio should be 19%, putting operating margins at 13%. Net margins should be 8%. Earnings per share should be $0.56. On a pricing of $12, VITC would trade 21 X's 2009 earnings.

Conclusion - The trends look strong for VITC. Nothing proprietary here but VITC is doing a very nice job of increasing its customer base while holding down expenses. The result is a nice move into profitability in 2009, which should lead to increased EPS for '10. The customer base has grown from 270,000 at the end of 2005 to approximately 957,000 as of June 30, 2009. This growth has come without ramping operating expenses. Bottom line: Solid vitamin/supplement manufacturer and online retailer, definite recommend in range.

Disclosure: Tradingipos.com is currently long VITC at an average price of $11.40.