UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

(Mark One)

For the quarterly period ended September 30, 2013

OR

Commission File Number: 001-34468

(561) 982-4180

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒    No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ☐    No ☒

As of November 1, 2013, the registrant has 33,644,148 shares of common stock outstanding.

Vitacost.com, Inc. Form 10-Q

Table of Contents

PART I.         FINANCIAL INFORMATION

ITEM 1.         FINANCIAL STATEMENTS

VITACOST.COM, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

VITACOST.COM, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

VITACOST.COM, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

 VITACOST.COM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

 VITACOST.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1.  Nature of Business, Significant Accounting Policies and Recent Accounting Guidance

Nature of Business  

Vitacost.com, Inc.  (“Vitacost” or the “Company”) is a leading online retailer of healthy living 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. Vitacost was incorporated in 1994 and began its online retail activity in 1999. Vitacost sells a proprietary line of healthy living products as well as a wide selection of other manufacturers’ brand-name goods.  The Company ships products from two distribution centers located in Lexington, North Carolina and Las Vegas, Nevada.

Basis of presentation 

The accompanying unaudited consolidated financial statements of Vitacost as of September 30, 2013, and for the three and nine months ended September 30, 2013 and 2012, have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information along with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles (“GAAP”) for annual financial statements. In management’s opinion, Vitacost has made all adjustments (consisting of normal, recurring and non-recurring adjustments) during the quarter that were considered necessary for the fair statement of the financial position and operating results of the Company. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. In addition, the results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results for the entire fiscal year ending December 31, 2013, or for any other period. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes, together with management’s discussion and analysis of financial position and results of operations, contained in Vitacost’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 (the “Form 10-K”).

Significant Accounting Policies

Principles of consolidation:

The consolidated financial statements include the accounts of Vitacost and its wholly-owned subsidiary. All intercompany accounts and transactions have been eliminated in consolidation.

Earnings per share:

The Company computed earnings per share by dividing its net loss by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by giving effect to all potentially dilutive common shares, including stock options and warrants. The following table reconciles basic weighted-average shares outstanding to diluted weighted-average shares outstanding for the three and nine months ended September 30, 2013 and 2012:

For the periods where the Company reported losses, all common stock equivalents are excluded from the computation of diluted earnings per share, since the result would be antidilutive. Securities that were not included in the calculation of diluted earnings per share because to do so would have been antidilutive for the periods presented are as follows:

Restricted cash:

Restricted cash consists of cash pledged as collateral to secure vendor obligations.

Fair value of financial instruments:

Existing accounting guidance defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and requires disclosures about fair value measurements. The guidance applies to all assets and liabilities that are being measured and reported on a fair value basis. It requires disclosure that establishes a framework for measuring fair value in GAAP and about fair value measurements. This guidance enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. Assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

The carrying amounts of other financial instruments, including cash, cash equivalents, accounts receivable, other receivables and accounts payable approximate fair value due to the short maturity of these instruments. Cash and cash equivalents are a Level 1 instrument within the fair value hierarchy.

 
Concentration of credit risk:

The Company’s cash and cash equivalents were held by one major financial institution and for certain accounts exceed federally insured limits. These cash and cash equivalent balances could be impacted if this financial institution fails or is subjected to other adverse conditions in the financial markets. To date, the Company has experienced no loss or lack of access to its cash and cash equivalents.

Recently Adopted and Recently Issued Accounting Guidance

The Company did not adopt any accounting guidance nor was there any new accounting guidance issued during the period that had or would have had a material impact on the Company’s consolidated financial statements.

2. Private Placement

On February 16, 2012, the Company entered into a purchase agreement (the “Purchase Agreement”) by and among Vitacost, JHH Capital, LLC, an entity affiliated with Jeffrey Horowitz, our Chief Executive Officer (“JHH”), Great Hill Equity Partners III, L.P. (“Great Hill III”), Great Hill Equity Partners IV, L.P. (“Great Hill IV”), Great Hill Investors, LLC (“Great Hill Investors”), Freshford Partners, LP (“Freshford Partners”), Freshford Master Fund, Ltd (“Freshford Master Fund”) and Baron Small Cap Fund (“Baron” and, together with JHH, Great Hill III, Great Hill IV, Great Hill Investors, Freshford Partners, Freshford Master Fund, collectively, the “Investors”) pursuant to which the Investors purchased, and Vitacost sold, an aggregate of 4.9 million shares of the Company’s common stock at a purchase price of $7.04 per share, and warrants to purchase an aggregate of 1.7 million shares of the Company’s common stock for an aggregate purchase price of $34.8 million. The warrants have an exercise price of $7.04 per share and a term of four years. The net proceeds of $33.6 million, after the deduction of fees of $1.2 million incurred in connection with the transaction, were allocated between common stock and warrants based on their relative fair values as of the purchase date.

3. Inventory

Inventory consists of the following as of September 30, 2013 and December 31, 2012:  

4. Property and Equipment

Property and equipment consists of the following as of September 30, 2013 and December 31, 2012:

5. Stock Option Plan

In September 2011, the Company obtained shareholder approval of the 2011 Incentive Compensation Plan (the “Plan”), which replaced the 2007 Stock Award Plan (the “2007 Plan”). The 2007 Plan, however, will continue to govern awards previously granted under it. The Plan share reserve includes the sum of 6.0 million shares of the Company’s common stock, plus (i) any shares of its common stock which have been reserved but not issued pursuant to any awards granted under the 2007 Plan, and (ii) the number of shares subject to outstanding awards under the 2007 Plan that expire or otherwise terminate without having been exercised in full, or are forfeited to or repurchased by the Company.

A summary of the Company’s stock option activity related to common stock for the nine months ended September 30, 2013 and 2012 is as follows:

As of September 30, 2013, there was $6.8 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock options granted under the Company’s stock incentive plans, which is expected to be recognized over a weighted average period of 3.52 years.

6.    Contingencies

Securities Class Action:

On May 24, 2010, a punitive class action complaint was filed in the United States District Court for the Southern District of Florida against the Company and certain current and former officers and directors by a stockholder on behalf of herself and other stockholders who purchased Vitacost common stock between September 24, 2009 and April 20, 2010, captioned Miyahira v. Vitacost.com, Inc., Ira P. Kerker, Richard P. Smith, Stewart Gitler, Allen S. Josephs, David N. Ilfeld, Lawrence A. Pabst, Eran Ezra, and Robert G. Trapp, Case 9:10-cv-80644-KLR. After being appointed to represent the purported class of shareholders, the lead plaintiffs filed an amended complaint asserting claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder against Vitacost, its current and former officers and directors, and the underwriters of its initial public offering (“IPO”). On December 12, 2011, the Court granted defendants’ motion to dismiss the complaint, and granted plaintiffs leave to amend.

On January 11, 2012, lead plaintiff filed its second amended complaint asserting claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 against Vitacost, its current and former officers and directors, and its underwriters. Lead plaintiff purported to bring its action on behalf of investors who purchased stock in connection with or traceable to the Company’s IPO between September 24, 2009 and April 20, 2010. The complaint alleged that the defendants violated the federal securities laws during the period by, among other things, disseminating false and misleading statements and/or concealing material facts concerning the Company’s current and prospective business and financial results. The complaint also alleged that as a result of these actions the Company’s stock price was artificially inflated during the class period. The complaint sought unspecified compensatory damages, costs, and expenses.

On June 25, 2012, the Southern District of Florida entered its order granting defendants’ motion to dismiss in full and dismissing the second amended complaint with prejudice. On July 23, 2012, lead plaintiff filed a notice of appeal to the Eleventh Circuit of the order granting defendants’ motion to dismiss. On May 5, 2013, the Eleventh Circuit issued its opinion affirming the dismissal. The deadline to file a petition for writ of certiorari with the U.S. Supreme Court passed on August 5, 2013, and lead plaintiff did not file a petition.

Sales or Other Taxes:  

A number of states have sought to impose sales or other tax collection obligations on online retailers. Certain states have imposed such a sales tax obligation requirement on remote online retailers that use residents of that state to directly or indirectly refer potential customers, via a link on an internet website or other means, to the online retailer for a commission-based fee. There is still significant uncertainty as to whether or how existing laws governing these matters apply to Vitacost and how these laws will be interpreted for the Company and other online retailers. As a result, it is currently not possible to determine the ultimate outcome as to whether such potential obligations apply to the Company under its specific facts and circumstances. Because the Company does not believe that it is probable such potential obligations are applicable to its specific facts and circumstances, it has not accrued for such potential obligations as of September 30, 2013. The Company is also currently unable to estimate the amount of the loss, if any, should such potential obligations apply. The eventual outcome of a successful assertion by one or more states that the Company should collect sales or other taxes may be materially different from any provisions or disclosures the Company has previously made and could have a material adverse effect on the Company’s financial position, results of operations and cash flows.

Other matters:

In addition to the matters described above, the Company is involved in litigation and administrative proceedings primarily arising in the normal course of its business. In the opinion of the Company, except as set forth above, its liability, if any, under any other pending litigation or administrative proceedings would not materially affect its financial condition, results of operations or cash flows. Furthermore, the Company has not been the subject of any product liability litigation.

7. Income Taxes

The Company evaluates its deferred tax assets on a regular basis to determine if valuation allowances are required. In its evaluation, the Company considers taxable loss carryback availability, expectations of sufficient future taxable income, trends in earnings, existence of taxable income in recent years, the future reversal of temporary differences and available tax planning strategies that could be implemented, if required.  Valuation allowances are established based on the consideration of all available evidence using a more likely than not standard.  Based on the Company’s evaluation, a valuation allowance of $3.7 million was established against its net deferred tax assets for the nine months ended September 30, 2013. This amount was in addition to the $16.8 million valuation allowance that was recorded as of December 31, 2012.

ITEM 2.         MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q.

This Quarterly Report on Form 10-Q contains trend analyses and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenue or performance, capital expenditures, financing needs, expected outcomes of litigation, and other information that is not historical information. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "predict," "intend," "potential," "continue," "seek" or the negative of these terms or other comparable terminology or by discussions of strategy.

All forward-looking statements, including, without limitation, our examination of historical and future operating trends, are based upon our current expectations and various assumptions. We believe there is a reasonable basis for our expectations and beliefs, but they are inherently uncertain. We may not realize our expectations and our beliefs may not prove correct. Actual results could differ materially from those described or implied by such forward-looking statements and are subject to change due to inherent risks and uncertainties such as those disclosed or incorporated by reference to our filings with the Securities and Exchange Commission (“SEC”). Important factors that could cause our actual results, performance and achievements, or industry results to differ materially from the forward-looking statements are incorporated by reference into this Quarterly Report on Form 10-Q, under the heading "Risk Factors" and include, among others:

Overview

We are a leading online retailer of healthy living 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 competitive prices, while providing superior customer service and timely delivery.

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. In September 2009, we completed our 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.

Trends and Other Factors Affecting Our Business

We continue to experience intense competition as the vitamin and supplement industry shifts towards a greater internet presence. This competitive environment continues to drive margin pressure as deep discounting results from aggressive customer acquisition and retention actions. In order to differentiate ourselves from our competitors, we are expanding our product offerings through the introduction of new and diverse products, improving our customer service and support, improving our reliability and speed of delivery and by adjusting our product mix and pricing.

The health and wellness industry continues to benefit from positive demographic trends, with an aging population, trends affecting health and lifestyle preferences, and an increasingly health conscious consumer. In addition, the increasing cost of traditional healthcare has helped bolster demand for natural products to help ward off more expensive medical visits and prescription drugs. Changes in these trends and other factors that we may not foresee may also impact our business, including potential regulatory actions by the Food and Drug Administration (“FDA”) and the Federal Trade Commission (“FTC”) that may affect the viability of certain products that we offer.

Sources of Revenue

We derive our revenue principally through the sale of products and freight billed to customers associated with the shipment of products. Net product sales accounted for approximately 96% of our total net sales for the nine months ended September 30, 2013 and 2012 with freight comprising the remainder.

Cost of Goods Sold and Operating Expenses

Cost of Goods Sold. Cost of goods sold consists primarily of the cost of product sold and the cost of shipping products to the customers.

Fulfillment. Fulfillment expenses include the costs of warehousing and shipping supplies, machinery and equipment, maintenance, employees, professional services and rent.

Sales and Marketing. Sales and marketing expenses include online advertising and promotional expenditures, including third-party content license fees, affiliates and partners’ commissions, traditional media advertising, print expenses and payroll related expenses for personnel engaged in marketing, sales, customer service, merchandising, and website development and maintenance. We expense advertising costs as incurred.

General and Administrative. General and administrative expenses consist of executive compensation, information technology expenses, credit card processing fees, legal fees, professional services, employee expenses and general corporate expenses.

Results of Operations

The following table sets forth certain consolidated statements of operations data as a percentage of net sales for the periods indicated: 

Comparison of Three Months Ended September 30, 2013 to Three Months Ended September 30, 2012

Net Sales.  Net sales increased $8.3 million, or 10.1%, to $90.5 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. Net sales of our third-party products increased $6.7 million, or 10.9%, to $68.2 million for the three months ended September 30, 2013. Net sales of our proprietary products increased $0.8 million, or 4.7%, to $18.7 million for the three months ended September 30, 2013, and freight increased $0.7 million, or 25.5%, to $3.6 million for the three months ended September 30, 2013.

The increase in net sales was primarily the result of an increase in our customer base and the number of shipped orders compared to the three months ended September 30, 2012. As of September 30, 2013, we had 2.1 million active customers, an increase of 5.8% from September 30, 2012. During the three months ended September 30, 2013, we shipped 1.3 million orders which represents a 9.0% increase over the three months ended September 30, 2012. The growth in active customers and the number of shipped orders was due to the continued growth of our core vitacost.com website with revenues up 10.0% and orders up 8.4% period-over-period. Our Amazon.com channel represented 3.5% of net sales for both the three months ended September 30, 2013 and 2012.    

Cost of Goods Sold. Cost of goods sold increased $6.5 million, or 10.2%, to $69.9 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. As a percentage of net sales, cost of goods sold was 77.3% for the three months ended September 30, 2013 compared to 77.2% for the three months ended September 30, 2012.

Gross Profit. Gross profit increased $1.8 million, or 9.7%, to $20.6 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. Gross margin was 22.7% for the three months ended September 30, 2013 compared to 22.8% for the three months ended September 30, 2012.

Fulfillment. Fulfillment expense decreased $0.4 million, or 5.1%, to $8.0 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. As a percentage of net sales, fulfillment expense decreased to 8.9% for the three months ended September 30, 2013 compared to 10.3% for the three months ended September 30, 2012. Notwithstanding a 9.0% increase in shipped orders period-over-period, fulfillment expense decreased primarily due to a reduction in personnel related expenses as we improved labor productivity.

Sales and Marketing. Sales and marketing expense decreased $0.5 million, or 6.8%, to $7.5 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. As a percentage of net sales, sales and marketing expense decreased to 8.3% for the three months ended September 30, 2013 from 9.8% for the three months ended September 30, 2012. The decrease in sales and marketing expense was primarily due to a decrease in online advertising of $0.8 million and print advertising of $0.3 million. This was partially offset by an increase in personnel related expenses of $0.7 million. We believe sales and marketing expense may increase in the future as we invest in additional marketing initiatives to drive additional growth in our customer base.

General and Administrative. General and administrative expense increased $1.2 million, or 15.6%, to $8.6 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. As a percentage of net sales, general and administrative expense increased to 9.6% for the three months ended September 30, 2013 from 9.1% for the three months ended September 30, 2012. Included in the 2012 amount was $0.2 million in severance and executive recruiting expenses offset by $0.3 million for the release of a litigation accrual. Excluding the aforementioned items in 2012, general and administrative expense increased $1.1 million period-over-period. The increase was primarily due to increased personnel related expenses of $0.4 million, increased credit card fees of $0.2 million associated with higher sales volume, and increased other administrative costs of $0.4 million. We believe general and administrative expense may increase in 2014 and beyond as we make additional investments in our personnel and information technology infrastructure to support our future growth.

Comparison of Nine Months Ended September 30, 2013 to Nine Months Ended September 30, 2012

Net Sales.  Net sales increased $39.8 million, or 16.2%, to $285.5 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. Net sales of our third-party products increased $34.7 million, or 19.2%, to $216.0 million for the nine months ended September 30, 2013. Net sales of our proprietary products increased $3.3 million, or 6.0%, to $58.2 million for the nine months ended September 30, 2013, and freight increased $1.7 million, or 18.2%, to $11.3 million for the nine months ended September 30, 2013.

The increase in net sales was primarily the result of an increase in our customer base and the number of shipped orders compared to the nine months ended September 30, 2012. As of September 30, 2013, we had 2.1 million active customers, an increase of 5.8% from September 30, 2012. During the nine months ended September 30, 2013, we shipped 4.1 million orders which represents an 11.2% increase over the nine months ended September 30, 2012. The growth in active customers and the number of shipped orders was due to the continued growth of our core vitacost.com website with revenues up 18.7% and orders up 15.3% period-over-period. This was partially offset by a decline in our Amazon.com channel with revenues down 27.4% and orders down 19.1% period-over-period, as we refined our sales strategy for this channel in March 2012. Our Amazon.com channel represented 3.2% and 5.1% of net sales for the nine months ended September 30, 2013 and 2012, respectively.

Cost of Goods Sold. Cost of goods sold increased $31.8 million, or 16.8%, to $220.6 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. As a percentage of net sales, cost of goods sold increased to 77.3% for the nine months ended September 30, 2013 from 76.8% for the nine months ended September 30, 2012.

Gross Profit. Gross profit increased $8.0 million, or 14.1%, to $64.9 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. Gross margin decreased to 22.7% for the nine months ended September 30, 2013 compared to 23.2% for the nine months ended September 30, 2012. The decrease in gross margin was primarily related to a shift in product mix toward third-party products which typically carry a lower gross margin as well as a reduction in product margin due to increased promotions.

Fulfillment. Fulfillment expense increased $0.9 million, or 3.7%, to $25.6 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. As a percentage of net sales, fulfillment expense decreased to 9.0% for the nine months ended September 30, 2013 compared to 10.1% for the nine months ended September 30, 2012. The increase in fulfillment expense was primarily due to an 11.2% increase in the number of shipped orders in the period. The period-over-period decrease in fulfillment expense as a percentage of sales was primarily attributable to improved labor productivity, a higher average order value, as well as reduced packaging costs.

Sales and Marketing. Sales and marketing expense decreased $0.7 million, or 2.6%, to $24.5 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. As a percentage of net sales, sales and marketing expense decreased to 8.6% for the nine months ended September 30, 2013 from 10.2% for the nine months ended September 30, 2012. The decrease in sales and marketing expense was primarily due to decreased broadcast advertising and partnership fees of $1.4 million, decreased Amazon.com fees of $0.7 million, decreased print advertising of $0.3 million and decreased other sales and marketing expenses of $0.5 million. This was partially offset by increased personnel related expenses of $1.2 million and online advertising of $1.1 million. We believe sales and marketing expense may increase in 2014 and beyond as we continue to invest in additional marketing initiatives to drive additional growth in our customer base.

General and Administrative. General and administrative expense increased $2.6 million, or 11.4%, to $25.8 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. As a percentage of net sales, general and administrative expense decreased to 9.0% for the nine months ended September 30, 2013 from 9.4% for the nine months ended September 30, 2012. Included in the 2012 amount were $0.5 million in expenses consisting primarily of the following: $0.4 million in severance and executive recruiting expenses, $0.2 million in fees associated with the financing in the first quarter of 2012, $0.1 million in legal expenses associated with the class action lawsuit, partially offset by $0.3 million for the release of a litigation accrual. Excluding the aforementioned items in 2012, general and administrative expense increased $3.1 million period-over-period. The increase was primarily attributable to increased credit card fees of $0.9 million associated with higher sales volume, increased personnel related expenses of $0.9 million, increased depreciation expense of $0.7 million, increased legal fees of $0.2 million and increased other administrative costs of $0.4 million. We believe general and administrative expense may increase in 2014 and beyond as we make additional investments in our personnel and information technology infrastructure to support our future growth.

Liquidity and Capital Resources

Liquidity. The significant components of our working capital are cash and cash equivalents, inventory and accounts receivable, primarily from credit card processors, reduced by accounts payable and accrued expenses. Cash and cash equivalents consist of cash and money market accounts.  The working capital characteristics of our business allow us to collect cash from sales to customers within a few business days of the related sale. At September 30, 2013, we had working capital of $24.3 million.

Cash flows from operating activities. Net cash used in operating activities was $10.0 million and $8.0 million for the nine months ended September 30, 2013 and 2012, respectively. The $2.0 million change in cash flows from operating activities was primarily due to an increase in the period-over-period change in inventory partially offset by the reduction in our net loss, the period-over-period change in other receivables and the period-over-period change in accounts payable.   

Cash flows from investing activities. Net cash used in investing activities was $3.7 million and $4.8 million for the nine months ended September 30, 2013 and 2012, respectively. The $1.1 million change in cash flows from investing activities was primarily due to a decrease in capital expenditures.

Cash flows from financing activities. Net cash provided by financing activities was $0.8 million and $35.0 million for the nine months ended September 30, 2013 and 2012, respectively. The $34.2 million change in cash flows from financing activities was primarily due to the net proceeds of $33.6 million from our financing in the first quarter of 2012 and a decrease in proceeds from the exercise of stock options of $0.5 million.

Amounts deposited with third party financial institutions exceed the Federal Deposit Insurance Corporation, or FDIC, and Securities Investor Protection Corporation, or SIPC, insurance limits, as applicable. These cash and cash equivalent balances could be impacted if the underlying financial institutions fail or are subjected to other adverse conditions in the financial markets. To date we have experienced no loss or lack of access to our cash and cash equivalents; however, we can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets.

Our future capital requirements will depend on many factors, including:

On February 16, 2012, we entered into the Purchase Agreement pursuant to which the Investors purchased, and we sold, an aggregate of 4.9 million shares of our common stock at a purchase price of $7.04 per share, and warrants to purchase an aggregate of 1.7 million shares of common stock for an aggregate purchase price of $34.8 million. The warrants have an exercise price of $7.04 per share and a term of four years. A portion of the proceeds from the private placement is being used to expand and optimize our distribution network. We spent $4.5 million on the expansion and upgrade of our fulfillment centers in 2012 and have spent additional amounts in 2013. We expect to continue investing in our facilities in 2014 and intend to use the remaining proceeds from the private placement for general operations. 

At September 30, 2013, we had $19.2 million in cash and cash equivalents. For the nine months ended September 30, 2013, our net cash used in operating activities was $10.0 million. We are investing in our growth strategy, which includes increasing our brand and company awareness, expanding our customer base, growing our product assortment and expanding and optimizing our fulfillment centers. We are also working to increase our customers’ lifetime value by increasing the frequency of purchases and improving customer retention, while also improving our operating efficiencies. We believe the implementation of our growth strategy will reduce our net loss and our net cash used in operations in the future.

We believe that our cash and cash equivalents currently on hand and our net cash flows from operations will be sufficient to continue our operations for the next twelve months, although we may require additional financing in the future in order to execute our operating plan. We cannot predict whether future financing, if any, will be in the form of equity, debt, or a combination of both. We also may not be able to obtain additional funds on a timely basis, on acceptable terms or at all.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles of the U.S. (GAAP).

The preparation of these financial statements requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Critical accounting policies are those that are the most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our significant accounting policies are described in more detail in the notes to our consolidated financial statements, and our most critical accounting policies, pertain to revenue recognition, income taxes, stock-based compensation, contingencies, inventories and goodwill. In applying such policies, we exercise our best judgment and best estimates. Actual results may differ from these estimates under different assumptions or conditions. For a further discussion of these Critical Accounting Policies and Estimates, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K, as filed with the SEC on March 4, 2013 for the year ended December 31, 2012.

Recently Issued Accounting Standards

Refer to Note 1 to our consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information regarding recently issued accounting standards applicable to us, if any.

ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of changes in the value of market risk sensitive instruments caused by fluctuations in interest rates, foreign exchange rates and commodity prices. Changes in these factors could cause fluctuations in the results of our operations and cash flows. However, we do not believe that a change in market interest rates would have a material effect on our results of operations or financial condition. Although we derive a portion of our sales outside of the U.S., our sales are primarily denominated in U.S. dollars. We have limited exposure to financial market risks, including changes in interest rates and foreign currency exchange rates. Inflation generally affects us by increasing costs of raw materials, labor and equipment. We do not believe that inflation had any material effect on our results of operations in the periods presented in our financial statements.

ITEM 4.         CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e), as of the end of the period covered by this report. Based upon such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that those controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rule 13a-15 during the quarter ended September 30, 2013 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Vitacost have been detected.

PART II.       OTHER INFORMATION

ITEM 1.         LEGAL PROCEEDINGS

Refer to Note 6 Contingencies, of our consolidated financial statements included in Part I, Item I of this Quarterly Report on Form 10-Q for a discussion on the nature of the legal proceedings against us, which is incorporated herein by reference.

ITEM 1A.    RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2012, which we hereby incorporate by reference into this Quarterly Report on Form 10-Q, and which could materially affect our business, financial condition or operating results.  While we  believe that there have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K, the risks described in our Annual Report on Form 10-K are not the only risks facing the Company.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 2.         UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.         DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.         MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.         OTHER INFORMATION

None.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

INDEX TO EXHIBITS

Exhibits