UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)
x		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

Or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from  to 

Commission file number: 001-34468

 

VITACOST.COM, INC.

(Exact name of registrant as specified in its charter)

Delaware		37-1333024
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

5400 Broken Sound Blvd., NW, Suite 500 Boca Raton, Florida		33487
(Address of principal executive offices)		(Zip Code))

Registrant’s telephone number, including area code: (561) 982-4180

 

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class:		Name of Each Exchange on Which Registered
Common Stock, $0.00001 par value		The NASDAQ Stock Market LLC (NASDAQ Global Market)

Securities registered pursuant to Section 12(g) of the Act:

Preferred Stock Rights

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x

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 o No x

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 o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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.

Large Accelerated Filer o		Accelerated Filer x		Non-Accelerated Filer o		Smaller Reporting Company o

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

As of June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting equity held by non-affiliates of the registrant was approximately $151.0 million. Shares of the registrant’s common stock held by each executive officer and director have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of June 16, 2011, the registrant has 27,790,453 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None

VITACOST.COM, INC. FORM 10-K
  
TABLE OF CONTENTS

		Page
PART I
Item 1. Business			1
Item 1A. Risk Factors			15
Item 1B. Unresolved Staff Comments — Not Required for Registrant			26
Item 2. Properties			27
Item 3. Legal Proceedings			27
Item 4. Removed and Reserved			27
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities			28
Item 6. Selected Financial Data			29
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk — Not Required for Registrant			38
Item 8. Financial Statements and Supplementary Data			39
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			64
Item 9A Controls and Procedures			64
Item 9B. Other Information			64
PART III
Item 10. Directors, Executive Officers, and Corporate Governance			65
Item 11. Executive Compensation			69
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			85
Item 13. Certain Relationships and Related Transactions			87
Item 14. Principal Accountant Fees and Services			91
PART IV
Item 15. Exhibits			93
Signatures			94
Exhibit 31.1 Certification of CEO Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of CFO Pursuant to Section 302 of Sarbanes-Oxley Act of 2002

EXPLANATORY NOTE

Along with the filing of this Annual Report on Form 10-K, Vitacost.com, Inc., or Vitacost is also filing with the Securities and Exchange Commission, or SEC, its delayed Quarterly Reports on Form 10-Q for the interim quarterly periods ended September 30, 2010 and March 31, 2011.

Unless the context otherwise requires, references in this Annual Report on Form 10-K to “Vitacost.com, Inc.,” “Vitacost,” “Company,” “we,” “us,” or “our” refer to Vitacost.com, Inc., a Delaware corporation.

We have not amended any of our Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for periods prior to September 30, 2010.

Background

In October 2010, pursuant to a request from a member of our board, our audit committee initiated an internal review into the methodologies and procedures used by the Company to calculate the value, for financial reporting purposes, of certain stock-based compensation grants and awards and the classification of certain non-cash expense items previously reported in the Company’s financial statements in connection therewith. The internal review was conducted by the audit committee with the assistance of outside independent professional advisors and consultants.

On November 15, 2010, in connection with the ongoing internal review, we issued a press release announcing that we had filed a Form 12b-25 with the SEC related to the delayed filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010. We contacted The NASDAQ Stock Market (“NASDAQ”) and informed NASDAQ of the delayed filing. On November 16, 2010, we received a letter from NASDAQ indicating that we were not in compliance with NASDAQ Listing Rule 5250(c) because we had not timely filed our Form 10-Q for the quarter ended September 30, 2010.

On December 7, 2010, we announced that, in connection with the ongoing internal review, our board had voted to postpone our 2010 Annual Meeting of Stockholders previously scheduled to be held on Thursday, December 9, 2010. On December 21, 2010, we received a letter from NASDAQ indicating that based on its review of the Company and pursuant to NASDAQ Listing Rule 5101, the NASDAQ staff had determined that continued listing of our securities on The NASDAQ Stock Market was no longer warranted. On January 3, 2011, we received a letter from NASDAQ indicating that we had not held our annual meeting of stockholders within the required timeframe and this would serve as an additional basis for delisting our securities from NASDAQ.

In response to our appeal of the decision to delist, NASDAQ set a delisting hearing for February 3, 2011. On February 3, 2011, we requested an exception through June 20, 2011 in which to resolve our corporate governance, share, organizational and formation issues and file our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010. In addition, we requested an exception through July 5, 2011 in which to solicit proxies for and hold our 2010 Annual Meeting of Stockholders. On February 28, 2011, we received a letter from NASDAQ granting both requests. The letter provided that we would not be delisted, subject to certain conditions.

On January 14, 2011, Michael Sheridan resigned as Director of the Company, and as the Chairman of the Company’s Audit Committee. On that same day, Mark Jung also resigned as a Director of the Company and as a member of its Audit Committee. On February 22, 2011, we received another letter from NASDAQ indicating that we were not in compliance with NASDAQ’s audit committee requirements as set forth in NASDAQ Listing Rule 5605 because our committee only comprised of two members. This would be an additional basis for delisting our securities from NASDAQ. On February 28, 2011, we announced the appointment of Edwin J. Kozlowski and Stuart Goldfarb to our Board. Mr. Kozlowski was also named as the Chairman of the Audit Committee and Mr. Goldfarb as a member of the Audit Committee. As a result of the appointment of the two board members, we regained compliance with NASDAQ’s audit committee requirements.

On April 7, 2011 and May 18, 2011, respectively, we received letters from NASDAQ indicating that we were not in compliance with NASDAQ Listing Rule 5250(c) because (i) we had not timely filed our Annual Report on Form 10-K for the year ended December 31, 2010 and (ii) we had not timely filed our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011.

On June 16, 2011, we filed this Form 10-K and our Quarterly Reports on Form 10-Q for the quarters ended September 30, 2010 and March 31, 2011.

Audit Committee Findings

During the course of the internal review, our audit committee and its advisors discovered certain defects in our corporate organizational and formation documents and certain corporate transactions that may not have been authorized in accordance with all requirements of applicable Delaware corporate law, including, without limitation, certain stock splits and stock option and other stock issuance transactions. In order to address these issues and to quiet title to all outstanding shares of common stock and stock options, as part of the settlement of our pending derivative suit in the Circuit Court of the Fifteenth Judicial District, Palm Beach County, Florida (the “Court”), captioned Kloss v. Kerker et al., we requested that the Court enter a final order recognizing and quieting title to all outstanding Vitacost shares of stock and stock options for and as of the twelve (12) month period ending December 31, 2004 through the six (6) month period ending June 30, 2009. On May 27, 2011, the Court issued an order and final judgment (the “Order”) approving the settlement of the derivative lawsuit. The Order also quiets title to all our outstanding shares of stock and stock options for all audited periods since 2004 through June 30, 2009 pursuant to the inherent equitable powers of the Court and the Uniform Commercial Code. The Order further provides that our certificate of incorporation, as amended, is the valid and effective certificate of incorporation of the Company, until validly amended in accordance with applicable Delaware law and our certificate of incorporation and bylaws.

On June 6, 2011, our audit committee concluded its internal review and determined that no restatement of the Company’s previously issued financial statements was required.

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K contains trends 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 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 operating trends, are based upon our current expectations and various assumptions and we do not assume any obligation to update any of these statements. 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 the inherent risks and uncertainties, such as those disclosed or incorporated by reference in our filings with the SEC. Important factors that could cause our actual results, performance and achievements, or industry results to differ materially from the forward-looking statements are set forth in this Annual Report on Form 10-K under Part I, Item 1a — Risk Factors and Part II, Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operation, under the heading “Factors Influencing Future Operating Results” and include, among others:

Forward-looking statements in this Annual Report on Form 10-K speak only as of the date hereof, and forward-looking statements in documents attached that are incorporated by reference speak only as of the date of those documents. We do not undertake any obligations to update or release any revisions to any forward-looking statement or to report any events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, except as required by law.

PART I

Item 1. Business.

Vitacost.com, Inc.

We are a leading internet-based retailer and distributor of nutritional substitutes, 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. We sell these products directly to consumers through our website, www.vitacost.com. We strive to offer our customers the broadest product selection supported by current scientific and medical research at the best value, while providing superior customer service and timely and accurate delivery.

We offer our customers a selection of approximately 32,000 stock keeping units (“SKUs”) from over 1,600 third-party brands, such as New Chapter, Atkins, Nature’s Way, Twinlab, Burt’s Bees, Kashi, BSN, Cytosport and MuscleTech in addition to our own proprietary brands which are Nutraceutical Sciences Institute (NSI), Cosmeceutical Sciences Institute (CSI), Best of All, and Smart Basics. Beginning in March 2011 we began transitioning our (NSI) brand to a new Vitacost label. We support our operations through our call center, our manufacturing and testing facility and our two distribution centers, delivering what we believe are industry-leading order fulfillment and customer satisfaction results. Our website allows customers to easily browse and typically purchase products at prices from 30% to 60% lower than manufacturers’ suggested retail prices. Our website also serves as an educational resource for consumers seeking information on healthy living, including medical developments and practices, health issues and the attributes of health and wellness supplements.

We believe our direct-to-consumer business model combined with our in-house manufacturing capabilities provide us competitive advantages over traditional, store-based and other direct-to-consumer retailers. For example, we do not incur most of the operating and investment costs of traditional, store-based retailers and we are able to serve a global market through centralized operations allowing us to capitalize on our investments in content, marketing and technology, while providing a unified and consistent message to our customers. Furthermore, our direct-to-consumer business model enables us to support our sales through reduced personnel, while offering a greater breadth of inventory to our customers at lower retail prices than traditional retail competitors. Additionally, our manufacturing capabilities allow us to generate higher gross margins on our proprietary products due to our ability to obtain quantity discounts from our suppliers while selling directly to consumers, bypassing the traditional supply chain and associated product mark-ups at each stage.

As of December 31, 2010, we had approximately 1.1 million active customers. We define an “active customer” as a customer who has made a purchase from us within the past 12 months. We shipped a total 2.9 million orders in 2010, up 16% from 2.5 million shipped in 2009 with Average Order Value (“AOV”) ranging from $73 to $80.

Corporate Information

We were incorporated in Delaware in May 1994 and became a public company in September 2009. Our principal executive office is located at 5400 Broken Sound Boulevard, NW, Suite 500, Boca Raton, Florida 33487, and the telephone number at that address is (561) 982-4180. Our internet address is www.vitacost.com. Vitacost, Nutraceutical Sciences Institute, Cosmeceutical Sciences Institute, Best of All, Walker Diet, Smart Basics, OcuPower, CardioLift, NeuroPower, ArthriPower and Mega EFA are trademarks of Vitacost.com, Inc. This Annual Report on Form 10-K also includes other trademarks of Vitacost and of other companies.

We began operations in 1994 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 under our NSI brand. We began operations under the name Vitacost.com, Inc. in 2000. In 2006, we were inducted into Inc. magazine’s “Inc. 500 Lifetime Hall of Fame,” as one of the U.S.’s 500 fastest growing privately-held businesses for five consecutive years (2001 – 2005). In April 2008, we completed construction of our manufacturing facility located in Lexington, North Carolina and began

manufacturing most of our proprietary products. During 2010 we completed an expansion project to meet our needs for additional space and additional distribution capabilities using proceeds of our initial public offering for the lease and build-out of a new distribution facility in Las Vegas, Nevada. We also began a similar project in our North Carolina facility in the Spring of 2010, with the building completed in the first quarter of 2011. The facilities provide redundancy in the event of work interruptions due to power outages, natural disasters or other events.

Industry Overview

The expansion of the Internet has benefited 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.

Online Commerce.  The Internet’s rapid expansion continues to increase its influence over communication, content and commerce. According to Forrester, U.S. online retail sales were $176.2 billion in 2010, a 12.6% increase from 2009. Forrester projects online retail sales to grow at a 10% CAGR to $278.9 billion by 2015. We believe several factors will contribute to this increase including convenience, expanded range of available products and services, improved security and electronic payment technology, increased access to broadband Internet connections and widespread consumer confidence and acceptance of the Internet as a means of commerce.

U.S. Dietary Supplement Market.  According to a survey conducted by Ipsos-Public Affairs for the Council for Responsible Nutrition (CRN), 66% of U.S. adults used dietary supplements in 2010. According to the Nutrition Business Journal’s (NBJ) 2010 U.S. Nutrition Industry Overview, U.S. sales of dietary supplements (including vitamins, herbs, meal supplements and sports nutrition and specialty supplements) grew 6.0% to $26.9 billion in 2009. NBJ is forecasting U.S. sales of dietary supplements to grow at a 6.0% rate per year for the next four years reaching $34 billion by 2013. 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 grew significantly faster than the overall category increasing approximately 18% in 2009 to $1.2 billion and accounted for an estimated 4.3% of the total U.S. dietary supplement category. According to the NBJ 2010 Direct-to-Consumer Selling Report, internet sales of dietary supplements are expected to grow at an 18% CAGR over the next four years, reaching $2.3 billion by 2013.

Our Value Proposition to Our Customers

We strive to offer our customers the broadest product selection supported by current scientific and medical research at the best value, while providing superior customer service and timely and accurate delivery.

Broad Third-Party and Proprietary Product Selection.  We offer approximately 32,000 SKUs representing over 1,600 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, baby boomers, the elderly and those with specific health concerns or goals. Our proprietary products are researched and developed by our knowledgeable in-house proprietary brands department. As consumer preferences evolve, our proprietary brands team works to develop new proprietary products and reformulate existing products to anticipate and fulfill expected consumer demand.

Consistently Superior Value.  We offer vitamins, dietary supplements and health and wellness products at savings to our customers with discounts ranging typically from 30% to 60% off manufacturers’ suggested retail prices. We provide even greater savings to our customers through proprietary products that we manufacture and we impose no minimum order or membership requirements.

User-Friendly Shopping Experience.  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 health concern. Our website and catalogs include educational content such as articles and news relating to medical and scientific data, health topics and the attributes of health and wellness supplements, which help our customers

make informed purchases. Our website uses secure encryption technology designed to protect our customers’ personal and credit card information and to prevent its unauthorized use. Our customer service representatives take orders and answer product and technical questions through our toll-free telephone number. Customers are also able to reach our customer service representatives via email or the live chat feature on our website. We seek to respond within 24 hours to all email requests received between Monday and Friday. We also facilitate repeat customer orders through our AutoShip! feature, which provides additional discounts on our proprietary products to customers who elect to receive automated, recurring shipments.

Accurate, Timely and Efficient Order Fulfillment.  We operate two highly automated distribution centers, which use wireless, paperless systems to achieve efficient, quality order fulfillment and distribution. Orders are received and picked on high-speed automated lines using pick-to-light and carousel technologies.

Growth Strategy

The key elements of our new growth strategy, which we believe over time will increase net sales while maintaining or increasing our gross margins include:

Expand Our Product Offerings.  We believe offering a broad range of products drives traffic to our website and increases orders and revenue. We currently offer approximately 32,000 SKUs, up from approximately 4,120 SKUs as of December 31, 2004. Additionally, we currently offer approximately 850 proprietary SKUs up from 137 proprietary SKUs as of December 31, 2004. We have made this expansion quickly and efficiently, in part because we were able to offer products that are not in our physical inventory, but that our third-party suppliers maintain in stock. We have referred to this as our virtual inventory. Although this virtual inventory allowed us to increase SKU selection without requiring a corresponding increase in our warehouse facilities, we have decided our customers will be better served through the elimination of virtual SKUs in order to accelerate order fulfillment and delivery time. We expect over time the need for increased SKUs and their inventory values will be offset by increased sales of our inventory during the year.

Expand Our Customer Base.  We continue to expand our customer base by attracting new visitors to our website and converting these visitors into customers. We plan to identify and cost-effectively acquire new customers by expanding our online advertising efforts. We aim to increase the rate of conversion of visitors to our website into purchasing customers by providing detailed product descriptions and product efficacy information, focusing on website design and providing excellent customer service.

Maximize Customer Loyalty and Retention.  Our revenue growth depends, in part, on repeat orders from existing customers. We believe we have a highly loyal customer base, because customers view us as a valuable source of health and wellness products and healthy living selections. Our customers, on average, order from us two to three times per year. In order to facilitate repeat customers, we encourage our regular customers to sign up for our AutoShip! program, which provides automatic shipping and billing of recurring orders at a 5% discount for our proprietary products. Additionally, we focus on expanding our base of repeat customers by improving our customers’ shopping experience through our customer service initiatives. We continue to refine the customer service we provide at every step of the purchase process from the content we deliver on our website to our customer support and fulfillment operations.

Expand and Optimize Our Distribution Platform.  We operate two distribution centers, one in Lexington, NC and a second in Las Vegas, NV. While we expect our current facilities will allow us to meet our product distribution requirements through 2011, during 2010 we completed an expansion project to meet our needs for additional space and additional distribution capabilities using proceeds of our initial public offering for the lease and build-out of a new distribution facility in Las Vegas, Nevada. We also began a similar project in our North Carolina facility in the Spring of 2010, with the building completed in the first quarter of 2011. The facilities provide redundancy in the event of work interruptions due to power outages, natural disasters or other events.

Continue to Develop Our Manufacturing Capability.  In April 2008, we began manufacturing our proprietary products in our state-of-the-art manufacturing facility in North Carolina. We currently manufacture over 60% of our proprietary products in this facility. Additionally, manufacturing our own products allows us to better control product quality, react to trends in the industry and bring new products to market significantly

faster than our current development cycle with third-party manufacturers. Currently, we only have the capability to manufacture products in the form of capsules and tablets.

Expand Internationally.  We currently ship products to foreign countries including Canada, Hong Kong, Japan, Taiwan and the United Kingdom, despite limited marketing efforts outside the United States. International sales accounted for approximately 3% of our sales in 2010, up from 2% in 2009. We believe that opportunities exist to market our products more aggressively in English-speaking countries outside the United States. We have recently begun to translate our website into multiple languages which will allow us to better market our products in non-English speaking countries in Asia, Europe and Latin America.

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 or other botanicals, amino acids and metabolites, as well as cosmetics, organic body and personal care products, sports nutrition and health foods. We offer products in a wide range of potency levels and dosage forms such as tablets, capsules, vegi-capsules, softgels, gelcaps, liquids 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 both popular third-party brands, such as New Chapter, Atkins, Nature’s Way, Twinlab, Burt’s Bees and Kashi, as well as our proprietary brands. We offer products that encompass four main categories: Vitamins, Minerals, Herbs and Supplements; Bodybuilding and Sport Products; Natural Care Products; and Natural and Organic Food Products.

Vitamins, Minerals, Herbs and Supplements (“VMHS”).  VMHS products are generally taken to maintain or improve health and address specific health conditions. The FDA classifies these products under the term “dietary supplements.” In this category, we offer our NSI and Vitacost products as well as third-party brands such as Nature’s Way, Twinlab, Jarrow, Carlson and Rainbow Light.

Bodybuilding and Sport Products.  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, sport 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 Optimum Nutrition, CytoSport and BSN as well as our NSI-branded sports nutrition products.

Natural Personal Care Products.  Natural personal care products consist 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 JASON, Burt’s Bees and Kiss My Face, as well as our CSI-branded products. These products appeal to allergen-conscious and environmentally-conscious consumers seeking products that are made without harsh chemicals and additives.

Natural and Organic Food Products.  Natural and organic food products consist of diet and weight management products, as well as 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 Atkins, Kashi, Eden Foods and Amy’s Organic, as well as our Best of All natural food products and Walker Diet weight management products.

In 2010 and 2009, our proprietary brands accounted for approximately 27% and 30% of our net sales, respectively. Our proprietary brands include:

Merchandising & New Product Development

We believe we carry most major domestic brands of vitamins, dietary supplements and minerals, 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 32,000 SKUs at each distribution center and are in the final steps of eliminating virtual inventory. Currently, no single SKU represents more than 2% of our net sales. In developing new proprietary products, our proprietary department, together with members of our management team:

Marketing

Our marketing strategy is designed to increase brand awareness and drive highly targeted new and repeat customers to our website. We use a multi-channel approach which includes search engine marketing, email campaigns, and affiliate programs to acquire and retain our customer base.

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 operate an affiliate program aimed at creating brand awareness through websites who participate in the LinkShare network.

Email Campaigns — Our weekly email marketing campaigns distribute information on new arrivals, promotional discounts and product information to customers.

Direct Mail and Promotional Inserts — We have scaled back direct mail marketing initiatives and are focused on creating efficiencies with our online initiatives. Direct mail is used on a limited basis to remind key customer segments to reorder.

Manufacturing

Proprietary Manufacturing.  We have designed and implemented full-featured solid dose (capsule and tablet) manufacturing and packaging operations at our North Carolina facility, which provide efficient high speed production and aggregate capacities in excess of our present demand requirements. Under our present configuration, we produce over 60% of our proprietary products in-house.

Our in-house manufacturing capabilities have enabled us to achieve greater efficiencies and cost savings, as well as strict control over the entire manufacturing cycle including raw material procurement, finished goods production and logistics optimization. Additionally, we have implemented lean manufacturing practices, statistical process control and just-in-time procedures throughout our facility. In 2010, we produced over 443 million tablets and capsules and packaged over 3 million bottles. In addition to providing us with greater volume and flexibility, our in-house manufacturing provides us with the opportunity to improve market response time, reduces the risk of out-of-stock situations, limits finished goods obsolescence and improves overall operating margins.

Our manufacturing lines include hard-shell encapsulation machines. Tableting operations include automatic tablet compression machines with a computerized high volume coating system. We ensure precise adherence to our formulations through computer-controlled bin blending systems, and remove under-filled capsules during production through an integrated capsule reject system. Additionally, all manufactured products are subject to inspection through one of two inspection lines.

We package finished products on a packaging line which starts with an automatic bottle un-scrambler and ionized air rinse prior to filling. We use a counting system with a capacity of up to 120 bottles per minute which individually measures tablet dimensions as tablets are counted and disbursed into the bottle.

Contract Manufacturing.  All of our proprietary products not in the solid dose category, including softgels, liquids and powders, are manufactured by pre-selected contract manufacturers specializing in the respective dosage form. As of December 31, 2010, our third party manufacturers provided approximately 40% of total production and 100% of finished soft gel, liquid and powder products. No single third party manufacturer, however, manufactured more than 6% of such products. Each of our contract manufacturers is required to maintain high standards of quality control consistent with federal regulatory guidelines and to 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.

Raw Materials.  All raw materials and ingredients for our proprietary products are selected for purchase from a group of third-party suppliers specializing in raw material manufacturing and processing and specialty distribution. We maintain multiple supply and purchasing relations throughout the raw materials marketplace to provide an uninterrupted supply for our manufacturing requirements. We employ similar strategies throughout the supply chain operations, leveraging our production volume in all raw materials procurement operations.

Quality Control.  Our quality assurance unit establishes process controls and documents and tests every stage of the manufacturing process to ensure we meet product specifications and that finished dietary supplements contain the correct ingredients, purity, strength, and composition in compliance with FDA regulations. We test incoming raw materials and finished goods to ensure they meet or exceed FDA and U.S. Pharmacopeia standards including quantitative and qualitative assay and microbial and heavy metal contamination. Additionally, we perform ingredient analysis and assay using procedures which include High Performance Liquid Chromatography, Ultraviolet/Visible Spectroscopy, Near Infra-Red Spectroscopy, and Inductively Coupled Plasma Mass Spectrometry.

Our plant quality and production standards are designed to meet or exceed the latest FDA regulations. To ensure the highest quality, our manufacturing operations are audited by NSF International for independent cGMP (current Good Manufacturing Practice) certification. NSF International is an independent, not-for-profit

organization which offers programs and services to augment and support the work of regulatory officials around the country, including standards development, product testing and certification, as well as onsite audits and inspections. Our NSF certification indicates that NSF has reviewed our operations and determined that our operations comply with FDA and NSF cGMP standards and protocols. As part of its certification and compliance program, NSF conducts random compliance audits of our operations not less than two times per year.

Our in-house laboratory decreases manufacturing cycle times by performing rapid testing we believe is not achievable through third-party labs. Most of our contaminant analyses testing procedures have faster average in-house turnaround times than outside laboratories.

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 contact 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.

Fully Staffed Contact Center.  Our contact center operations serve as the primary customer service contact between our customers and Vitacost. We operate a contact center in Lexington, North Carolina and utilize a third-party call center primarily for after-hours support. Contact Center agents are available to answer customer questions and to accept customer orders. Both contact center locations use identical ERP systems to provide a seamless customer experience through our toll-free telephone number, email or live chat feature. These call centers are staffed with specialists who 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. In order to provide consistency, speed and accuracy, our specialists use an internal, standardized question and answer database in responding to customer inquiries. Our specialists also have access to real time inventory data to know if a product is in stock to properly manage customer expectations.

During 2010, our contact center processed over $20 million in orders or 9.1% of total revenue. Historically, our contact center volume has increased correspondingly with our overall revenue growth. In 2010 our call center volume reached over 922,000 calls, up from over 770,000 in the prior year.

In 2010, the contact center processed over 305,000 orders compared to over 255,000 in 2009. We will continue to expand our call center operations as required.

Our 5-Star Guarantee.  Our 5-Star Guarantee makes it easy, convenient and safe for customers to purchase our products. Under the Guarantee we:

We value frequent communication with and feedback from our customers in order to continue to improve our offerings and services. Based on surveys we conducted in 2010, customers have indicated approximately 96% satisfaction with our products and service while the probability of reorder is approximately 94%.

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 technology infrastructure allows 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 manufacturing processes, inventory, order fulfillment, customer service and marketing through state-of-the-art technologies that allow us to condense and distribute customer and sales data as part of our business intelligence model. From this data, our marketing and product development teams are able to analyze and project market trends and consumer demands.

Our technology infrastructure uses highly scalable, fully fault tolerant enterprise-class technology. Coupled with the use of virtual and cloud-based capabilities that provide redundant coverage and virtually eliminate the risk of downtime, our infrastructure provides a set of strategic, high-availability systems that we believe rival those of larger companies. We maintain strategic partnerships with vendors to ensure that we can rapidly deploy new products and information technology solutions that we believe are key to our success.

We maintain three secure internal data centers that support product development, quality control and office and distribution center infrastructure. Our data centers are also collocated through a third-party provider with locations in Atlanta and Seattle for redundancy, which has provided us with 100% service availability since 2007.

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 that can 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 reorders a majority of the products we sell, minimizing out-of-stock situations. We consistently evaluate low volume items in order to minimize losses due to product expiration or obsolescence as well as to efficiently manage our capital and warehouse space.

Competition

The dietary supplement, natural health and wellness 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:

We believe we compete favorably, however 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, OcuPower, CardioLift, NeuroPower, ArthriPower and Mega

EFA 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 market and Asian market 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 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.

We have obtained a number of U.S. patents on some product formulations and have applications pending for others. We also intend to file more patent applications. 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.

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:

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 apply 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 an adverse effect on our results of operations.

Our products are subject to extensive regulation in the U.S. and abroad. The FDA enforces the Federal Food, Drug and Cosmetic Act, or 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, and over-the-counter, or OTC, drugs, and prohibit the sale of misbranded and adulterated dietary supplements and dietary supplements that by the intention of the manufacturer or distributor or label or labeling claims are unapproved new drugs. The Federal Trade Commission, or FTC, enforces the Federal Trade Commission Act, or FTCA, and related regulations, which govern the advertising and advertising acts and practices associated with the promotion and

sale of these products. The U.S. Postal Inspection Service enforces federal laws governing fraudulent use of the mails. Regulation of certain aspects of the dietary supplement business at the federal level is also governed by the Consumer Product Safety Commission (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 dose 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 prevention, but not treatment, of a disease or health-related condition), unless the claim is pre-approved by the FDA. The FDA prohibits entirely disease 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 statement and must be accompanied by an FDA mandated label disclaimer that “This statement has not been evaluated by the Food and Drug Administration. 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 is implementing Good Manufacturing Practices, or GMPs, specifically for dietary supplements. These GMPs impose extensive process controls on the manufacture, holding, labeling, packaging, and distribution of dietary supplements. They require that every dietary supplement be made in accordance with a master manufacturing record, 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 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 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 own manufacture, holding, labeling, packaging, and 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. It is possible that the FDA will find one or more of the process controls implemented by us, 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 manufacture, 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.” 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 OTC drug products pursuant to a “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 drugs that we sell are regulated as non-prescription, over-the-counter drugs. These products must generally meet the standards set forth in the Homeopathic Pharmacopeia of the United States and claims made for them must not deviate from those contained in specific homeopathic treatises recognized by the FDA as appropriate for use. If these requirements are not met, the FDA can consider the products unapproved new drugs and prohibit their sale.

The FDA has broad authority to enforce the provisions of the FDCA concerning dietary supplements and OTC drugs, 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.

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 uses 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.

The FTC exercises jurisdiction over the advertising of dietary supplements, OTC drugs 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.

Further, under the Food Allergen Labeling and Consumer Protection Act of 2004 (“FALCPA”) all packaged foods 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. 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.

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.

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 and OTC drugs. For example, under Proposition 65 in the State of California, a list of substances are deemed ones that 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.

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 Commission. 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. Registration of products is subject to a phase-in period which began in October 2005, and which terminated in April 2011, at which point all herbal medicinal products must be registered with Member States.

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, 2010, we had 411 full-time and 4 part time employees. We employed 96 full-time employees at our Florida corporate headquarters and 2 part time employees, 232 full-time and 2 part-time employees at our North Carolina facility and 83 full-time employees at our Nevada facility. Additionally, from time to time, we hire temporary contract employees. None of our employees is 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, substantially all of our revenue was generated within North America, and all of our long-lived assets are located within the United States.

Available Information

Our Web site is http://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

We may incur product liability claims, which could increase our costs and/or adversely affect our business, reputation, financial condition or results of operations.

As a retailer, formulator and manufacturer of products designed for human consumption, we are subject to product liability claims if the use of our products, whether manufactured by us or by our third-party manufacturer, is alleged to have resulted in illness or injury or if our products include inadequate instructions or warnings. Our products consist of vitamins, minerals, herbs and other ingredients that are classified as foods or dietary supplements 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. In addition, some of our products are produced by third-party manufacturers. 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, therefore, adversely affect our reputation with our customers, which in turn could adversely affect our business, financial condition or results of operations.

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 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. A future research report 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.

If we lose or are unable to obtain 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 lose or are unable to obtain the services of key personnel, our business, financial condition or results of operations could be materially and adversely affected.

If we are unable to effectively manage our growth plan, we could be unable to implement our business strategy.

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 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 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 manufacture our products, which could reduce our sales and our margins.

An unexpected interruption of supply or a significant increase in the cost of raw materials, whether to us or to our contract manufacturers 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.

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 limit our ability to manufacture our products, which could 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 raw materials and inventory and for the shipment of our products to our customers. Consequently, we are subject to risks of 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 raw materials to us and products 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.

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.

Instability in financial markets could adversely affect our ability to access capital markets which could limit our ability to fund our operating costs if we do not generate sufficient cash from operations.

As a result of current economic conditions, the availability of capital has been severely restricted. From time to time, we may access debt or equity capital markets. Any restriction on our ability to access capital markets could limit our ability to pursue our growth strategy and could negatively affect our business, financial condition or results of operations.

We depend upon certain third-party 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 manufacture our products, and our business, financial condition or results of operations may be materially adversely affected.

We rely upon third-party suppliers for certain ingredients and raw materials. The principal ingredients or raw materials required in our operations are vitamins, minerals, herbs and packaging components. We purchase these materials from third-party suppliers located in the U.S., Japan, China, India, Italy, Spain, France and Germany. Furthermore, although we manufacture many of our proprietary products in-house, we engage third-party manufacturers to produce our proprietary products that are in the form of soft-gels, liquids

and powders. Disruption in the operations of any such third-party 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 third-party 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.

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 indemnify 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.

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 reduce our sales.

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.

We may not be able to maintain 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.

If we experience product recalls, we may incur significant and unexpected costs and damage to our reputation and, therefore, 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, manufacture or sell are believed to cause injury or illness or if we are alleged to have violated governmental regulations in the manufacture, 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 and adversely affect our business, financial condition or results of operations.

Our inability to safely and efficiently conduct manufacturing operations or comply with health and safety regulations could materially and adversely affect our business, financial condition or results of operations.

Manufacturing a significant portion of our products at our manufacturing facility in Lexington, North Carolina concentrates our risk in the event there is any significant disruption in our operations or shutdown of this facility. Further, 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. Any disruptions in our manufacturing operations would have a material adverse effect on our business, financial condition or results of operations and 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.

Complying with new and existing government regulation, both in the U.S. and abroad, could significantly increase our costs and limit our ability to manufacture our products.

The processing, formulation, manufacturing, 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). 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.

The FDA may also determine that certain 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 unacceptable drug claim or an unauthorized version of a food or dietary supplement “health 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.

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, or 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 guides 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.

In Europe, broad regulations and directives on health and nutrition claims were recently adopted. 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. 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. We also anticipate the enactment of legislation that could significantly impact the formulation of our products. The legislation is expected to include dosage restrictions for certain vitamin and mineral supplements. The legislation may lead to some of our products being recalled or discontinued.

In addition, a European Union 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.

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.

Taxation risks could subject us to liability for past sales, increase our costs and cause our future sales to decrease.

We do not collect sales or other taxes on shipments of most of our goods into most states in the U.S. Proposed federal legislation would subject each facility used in the manufacture and distribution of dietary supplements to an annual tax and reporting requirement. The proceeds of the tax would be dedicated to increased inspections of companies that manufacture, distribute and hold dietary supplements. Taxes of this kind could adversely affect our ability to remain in business, could restrict the type or kind of products we sell or could require significant expenditures to ensure compliance. 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 and expected manufacturing centers, and any future expansion of them, along with other aspects of our evolving business, may result in additional sales and other tax obligations. One or

more states or foreign countries may seek to impose sales or other tax collection obligations on out-of-jurisdiction eCommerce companies. Effective June 2008, New York imposed such a sales tax obligation requirement on online retailers that use New York residents 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.

Unfavorable changes to government regulations, service interruptions 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, service interruptions 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.

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 systems 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 add software and hardware and 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 system 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. The occurrence of any of these factors could 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.

We may incur significant costs to protect our customers’ personal information, and may incur liability if such personal information is misappropriated, which could increase our costs, harm our reputation and reduce our sales.

If our customers’ personal or credit card information is misappropriated by us or third parties that breach our network security, we could be subject to liability. This liability could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims or damages for alleged violations of state or federal laws governing security protocols for the safekeeping of customers’ personal or credit card information. This liability could also include claims for other misuses of personal information, including unauthorized marketing purposes. These claims could result in litigation against us. Liability for misappropriation of this information could adversely affect our business, financial condition or operating results. In addition, the FTC and state agencies have been investigating various Internet companies regarding their use of customers’ personal information. We could incur additional expenses if new regulations regarding the use of personal information are introduced or if government agencies investigate our privacy practices.

We rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary to effect secure transmission of confidential information such as customer credit card numbers. We cannot provide assurance that advances in computer capabilities, new discoveries in the field of cryptography or other events or developments will not result in a compromise or breach of the algorithms that we use to protect our customers’ transaction data. If any such compromise of our security were to occur, it could harm our reputation, business, prospects, financial condition and results of operations. A party who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against such security breaches or to resolve problems caused by such breaches. We cannot assure you that our security measures will prevent security breaches or that failure to prevent such security breaches will not harm our business, financial condition or results of operations.

Laws or regulations relating to privacy and data protection may adversely affect the growth of our Internet 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.

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 (USPTO), including our Vitacost, Nutraceutical Sciences Institute, Cosmeceutical Sciences Institute, Best of All, Walker Diet, Smart Basics, OcuPower, CardioLift, NeuroPower, ArthriPower and Mega EFA 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 market and Asian market 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 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.

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 manufacturing, 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 adversely affect our business, financial condition or results of operations.

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 purchase 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 operate in a highly competitive industry, and our failure to compete effectively could adversely affect our market share, financial condition and growth prospects.

The U.S. vitamins and dietary supplements 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 U.S., 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. Our manufacturing operations compete with manufacturers of third-party nutritional supplements. 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 adversely affect our market share, financial condition and growth prospects.

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 and 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:

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 and adversely affected.

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.

Our manufacturing operations are located in a single location and 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 adversely affect our manufacturing operations, product distributions, sales and consumer satisfaction.

We house our manufacturing operations and one of our two distribution warehouses at a facility located in Lexington, North Carolina. We also operate a distribution and warehouse facility located in Las Vegas, Nevada. Any significant disruption in either of these locations for any reason, such as a fire, flood, hurricanes, earthquakes or similar events, could adversely affect our manufacturing operations, product distributions, sales and consumer satisfaction.

Our quarterly results of operations may fluctuate in the future. As a result, we may fail to meet or exceed 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:

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.

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, manufacturing 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.

Healthcare reform measures and related changes in applicable federal and state laws could 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. Recently, there have been, and we expect that there will continue to be, a number of legislative and regulatory proposals aimed at changing the healthcare system, including for example, restructuring the tax benefits available through flexible spending accounts and/or health savings accounts by limiting the eligibility of non-prescription products. If the laws or regulations are changed to limit further the tax benefits through these accounts, such a change could have an adverse effect on our business by reducing revenues and eroding our margins.

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 19.5% of our outstanding stock. Because this entity 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. Furthermore, because of the substantial equity stake in Vitacost.com, potential acquirers could decide not to merge with, or acquire us.

Risks Related to Our Common Stock

Prior to September 24, 2009, there was no public market for our common stock, and it is possible that no trading market will be maintained. On December 7^th, 2010, trading in our stock was halted.

Prior to our initial public offering and listing on The NASDAQ Global Market on September 24, 2009, there had not been a public market for our common stock. Therefore, stockholders should be aware that they cannot benefit from information about prior market history as to their decision to invest. There can be no assurance that a trading market will develop for our common stock or, if such a market does develop, how liquid that market might become or whether it will be maintained. In addition, the recent suspension of trading in our securities on NASDAQ may have an adverse effect on our stock price and reduce the liquidity of our common stock.

The trading of our common stock has been suspended for failure to comply with rules and regulations of the NASDAQ Stock Market relating to timely SEC filings and our common stock could be delisted from NASDAQ.

On December 21, 2010, we received a letter from The NASDAQ Stock Market indicating that based on its review of the Company and pursuant to NASDAQ Listing Rule 5101, 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 (1) on or before June 20, 2011, we shall have 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 shall have solicited proxies and held our annual meeting. While we believe we will be able to comply with the NASDAQ requirements in the applicable time periods, no assurances can be made that we will in fact be able to comply and that our common stock will remain listed on NASDAQ. If we are not able to comply with the NASDAQ requirements in the applicable time periods, our common stock will be delisted from NASDAQ. A 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 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:

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 adversely affect our results of operations.

We have not declared or paid any cash dividends on our common stock, nor do we intend to do so, which could depress the trading price of our common stock.

We have not declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings and do not expect to pay any dividend in the foreseeable future. As a result, investors may only receive a return on investment in our common stock if the market price of our common stock increases.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties.

We conduct our operations through three facilities:

We believe that our existing facilities and offices are adequate to meet our current requirements. See Note 9, Leases, of our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for more information about our lease commitments.

Item 3. Legal Proceedings.

Refer to Note 13, Contingencies, of our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for a discussion on the nature of the legal proceedings against us, which is incorporated herein by reference.

Item 4. Removed and Reserved

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.

Our common stock, par value $0.00001 per share, is listed on The NASDAQ Global Market under the symbol VITC and has been included for listing thereon since September 24, 2009. As previously reported, NASDAQ halted trading of our stock on December 7, 2010.

The following table sets forth for the indicated periods the high and low sales prices per share for our common stock on the NASDAQ Global Market:

		High				Low
Year Ended December 31, 2010:
Fourth quarter		$	6.94			$	5.70
Third quarter		$	10.23			$	5.60
Second quarter		$	13.19			$	8.34
First quarter		$	13.02			$	8.76
Year Ended December 31, 2009:
Fourth quarter		$	10.99			$	6.95

Holders of Record

At June 16, 2011, our common stock was held by approximately 61 holders of record.

Dividends

We have never declared or paid any dividends on our common stock, and our Board of Directors does not contemplate doing so in the near future. Any decisions as to future payment of dividends will depend on our earnings and financial position and such other factors, as our Board of Directors deems relevant.

Equity Compensation Plan Information

The following is a summary of our equity compensation plans as of December 31, 2010:

		Number of Securities to Be Issued Upon Exercise of Outstanding Options, Warrants, and Rights				Weighted Average Exercise Price of Outstanding Options, Warrants, and Rights				Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans
Equity Compensation Plans Approved by Security Holders			2,717,530			$	6.42				722,750

Additional information about compensation plans is incorporated by reference from the Notes to our Consolidated Financial Statements included elsewhere in this Form 10-K.

Performance Graph

The graph set forth below compares the cumulative total stockholder return on our common stock between September 24, 2009 and December 7, 2010, the day NASDAQ halted trading of our common stock, with the cumulative total return of the (i) Russell 2000 Index, (ii) the NASDAQ Composite Index, and (iii) the NASDAQ Internet Index, and, (iv) a custom selected Peer Group Index. This graph assumes the investment of $100 on September 24, 2009 in our common stock, the Russell 2000 Index, the NASDAQ Composite Index, the NASDAQ Internet Index, and a custom selected Peer Group Index. We have added the NASDAQ Internet Index and a custom Peer Group Index consisting of the following companies: Blue Nile, Shutterfly, Vitamin Shoppe, Overstock.com, Herbalife Ltd., 1-800-FLOWERS.COM, Nu Skin Enterprises, Whole Foods Market, US Auto Parts, GNC Holdings, Stamps.com, USANA, Pet Meds and NutriSystem. Beginning next year we will not include the NASDAQ Composite as a broad-based index as the Russell 2000 is the most appropriate broad-based index for our company. Note that historic stock price performance is not necessarily indicative of future stock price performance.

Item 6. Selected Financial Data

The selected consolidated financial data presented below has been derived from our consolidated financial statements. The statement of operations data for each of the fiscal years ended December 31, 2010, 2009, and 2008 and the balance sheet data at December 31, 2010 and 2009 are derived from our audited financial statements that are included in this annual report. The statement of operations data for the years ended December 31, 2007 and 2006 and the balance sheet data at December 31, 2008, 2007 and 2006 are derived from audited 2008, 2007, and 2006 financial statements that are not included in this annual report. The historical results presented below, which give effect to a four-for-five reverse stock split of our common stock effected on September 17, 2009, are not necessarily indicative of the results to be expected in any future period.

This information should be read in connection with Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations and our financial statements and the related notes included elsewhere in this annual report.

		Year Ended December 31,
		2010				2009				2008				2007				2006
		(in thousands, except shares and per share data)
Consolidated Statement of Operations Data:
Net sales		$	220,680			$	191,807			$	143,602			$	99,290			$	66,356
Cost of goods sold			164,206				130,605				105,529				70,381				47,067
Gross profit			56,475				61,202				38,073				28,909				19,289
Operating expenses:
Fulfillment			17,354				8,954				8,393				6,629				4,140
Sales and marketing			18,728				14,284				13,147				10,845				6,991
General and administrative			33,919				29,083				14,871				11,116				8,004
Total operating expenses			70,000				52,321				36,411				28,590				19,134
Operating income (loss)			(13,525	)			8,881				1,662				319				155
Interest expense, net			(213	)			(401	)			(1,150	)			(515	)			(17	)
Other income (expense), net			38				250				(13	)			743				24
Income tax benefit (expense)			(1,491	)			(2,836	)			(482	)			1,279				11
Net income (loss)		$	(15,191	)		$	5,894			$	17			$	1,826			$	173
Net income (loss) per share:
Basic		$	(0.55	)		$	0.24			$	—			$	0.08			$	0.01
Diluted		$	(0.55	)		$	0.24			$	—			$	0.08			$	0.01
Weighted average number of shares outstanding
Basic			27,703,710				24,216,942				23,188,380				23,188,380				22,086,780
Diluted			27,703,710				24,674,248				23,975,068				24,087,978				22,900,322
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	14,593			$	8,658			$	61			$	1			$	101
Inventory			29,828				28,097				21,663				14,710				8,864
Working capital (deficit)			22,377				49,599				(5,990	)			(6,535	)			(1,895	)
Total assets			102,105				107,679				46,869				36,662				15,527
Deferred revenue			2,134				1,919				2,379				1,213				901
Total debt			59				9,405				18,232				12,340				700
Stockholders’ equity			62,186				74,500				6,965				6,153				3,458

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the Company’s financial condition and results of operations should be read in connection together with Item 6, Selected Financial Data and Item 8, Financial Statements and Supplementary Data of this Annual Report on Form 10-K. The Company does not believe that its historical operating results will be indicative of future operating results. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The Company’s actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those under the headings “Risk Factors” and “Forward-Looking Information” of the Annual Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We are a leading internet-based retailer, 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. We sell these products directly to consumers through our website, www.vitacost.com. We strive to offer our customers the broadest product selection supported by current scientific and medical research at the best value, while providing superior customer service and timely and accurate delivery.

We offer our customers a selection of approximately 32,000 SKUs from over 1,600 third-party brands, such as New Chapter, Atkins, Nature’s Way, Twinlab, Burt’s Bees, Kashi, BSN, Cytosport and MuscleTech in addition to our own proprietary brands, Nutraceutical Sciences Institute (NSI), Cosmeceutical Sciences Institute (CSI), Best of All, and Smart Basics. Beginning in March 2011 we began transitioning our (NSI) brand to a new Vitacost label. We support our operations through our call center, our manufacturing and testing facility and our two distribution centers, delivering what we believe are industry-leading order fulfillment and customer satisfaction results. Our website allows customers to easily browse and typically purchase products at prices from 30% to 60% lower than manufacturers’ suggested retail prices. Our website also serves as an educational resource for consumers seeking information on healthy living, including medical developments and practices, health issues and the attributes of health and wellness supplements.

Our success is driven primarily by our ability to attract new customers 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 12 months, has steadily increased from approximately 270,000 at the end of 2005 to approximately 1.1 million as of December 31, 2010. On average, our customers make purchases from us two to three times a year and during 2010, approximately 79% of our orders were placed by repeat customers.

We began operations in 1994 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 under our NSI brand. In 2000, we began operations under the name Vitacost.com, Inc. During 2008, we began manufacturing certain proprietary products in-house and currently have the capacity to produce in excess of one billion tablets and capsules annually.

Trends and Other Factors Affecting Our Business

The Company’s litigation climate, in connection with our equity capitalization issue, and the potential de-listing of our common stock from the NASDAQ exchange, has resulted in our vendors accelerating payment terms. This has had a negative impact on our liquidity and cash flow.

Competition has increased as the vitamin and supplements 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.

The dietary supplement industry and our performance are affected by demographic trends as well as trends affecting health and lifestyle preferences and consumer spending. Changes in these trends and other factors that we may not foresee may also impact our business, including potential regulatory actions by the FDA and the FTC that may affect the viability of a given product that we offer. Our business allows us to respond to changing trends by introducing new products and adjusting our product mix and pricing. We will continue to expand our product offering and diversify our product lines.

We intend to continue our focus on meeting the demands of an increasingly aging population, as well as a rapidly growing fitness conscious public, and the effects of increasing costs of traditional healthcare.

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 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. While our significant accounting policies are described in more detail in the notes to our consolidated financial statements, our most critical accounting policies, discussed below, 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, as well as a description of our other significant accounting policies, see Note 1, Nature of Business and Significant Accounting Policies, of our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.

Revenue Recognition.  Revenue from the sale of vitamins, nutritional supplements and other related products is recognized when all the following criteria are met: a customer executes an order, the sales price and the shipping and handling fee have been determined, credit card authorization has occurred and collection is reasonably assured and the product has been received by the customer. Our internet sales are made to customers permitting certain limited rights of return for a 30-day period. It has been our experience that such returns have been insignificant.

Income Taxes.  Income taxes are computed under an asset and liability approach whereby deferred tax assets and liabilities are recognized based on the difference between the financial statement amounts and the tax basis of assets and liabilities using tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. 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 the 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. The Company’s deferred tax assets for which it has not established a valuation allowance relate to amounts than can be realized through future reversals of existing taxable temporary differences. The Company’s deferred tax asset valuation allowance will be reversed if and when it becomes more likely than not that the Company can generate sufficient taxable income in the future to utilize the tax benefits of the related deferred tax assets.

Stock-based Compensation.  Our stock-based compensation uses a fair value-based method to recognize non-cash compensation expense for share-based transactions. Under the fair value recognition provisions, we recognize stock-based compensation net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest on a straight line basis over the requisite service period of the award.

Contingencies.  On an ongoing basis, we assess potential liabilities related to lawsuits or claims brought against us. While it is typically very difficult to determine the timing and ultimate outcome of such actions, we use our best judgment to determine if it is probable that we will incur an expense related to the settlement or final adjudication of such matters and whether a reasonable estimation of such probable loss, if any, can be made. In assessing probable losses, we take into consideration estimates of the amount of insurance recoveries, if any. We accrue a liability when we believe a loss is probable and the amount of loss can be reasonably estimated. Due to the inherent uncertainties related to the eventual outcome of litigation and potential insurance recoveries, it is possible that certain matters may be resolved for amounts materially different from any provisions or disclosures that we have previously made. For a further discussion of contingencies, see Note 13, Contingencies, of our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.

Inventory.  Inventory, consisting primarily of nutritional supplements, is primarily stated at the lower of cost or market on a first in, first out (FIFO) method. Management determines the inventory reserve by regularly reviewing and evaluating individual inventory items and movement history. Inventory is written off

when deemed obsolete or unsellable. Future factors, such as changes in consumer demand and reports in the media deemed negative to certain products we market and sell, could impact management’s inventory reserve estimates.

Goodwill.  We review goodwill for impairment annually or, when events or circumstances dictate, more frequently.

Sources of Revenue

We derive our revenue principally through the sale of product and freight billed to customers associated with the shipment of product. Our primary source of revenue is the sale of products. For 2010, product net sales accounted for approximately 93% of our total net sales, with freight and advertising comprising the remainder.

Cost of Goods Sold and Operating Expenses

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

Fulfillment.  Fulfillment expenses include the costs of warehousing supplies, equipment, maintenance, employees and rent.

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

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

Results of Operations

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

		Year Ended December 31,
		2010				2009				2008
Net sales			100.0	%			100.0	%			100.0	%
Cost of goods sold			74.4				68.1				73.5
Gross profit			25.6				31.9				26.5
Operating expenses:
Fulfillment			7.9				4.7				5.8
Sales and marketing			8.5				7.4				9.2
General and administrative			15.4				15.2				10.4
Total operating expense			31.7				27.3				25.4
Operating (loss) income			(6.1	)			4.6				1.2
Net (loss) income			(6.9	)%			3.1	%			0.0	%

Comparison of Year Ended December 31, 2010 to Year Ended December 31, 2009

		Year Ended December 31,								$ Increase (Decrease)				% Increase
		2010				2009
Third-party products(1)		$	147,064,772			$	119,750,019			$	27,314,753				22.8	%
Proprietary products			59,159,197				58,480,009				679,188				1.2	%
Freight			14,456,528				13,577,001				879,528				6.5	%
Net sales			220,680,497				191,807,029				28,873,468				15.1	%
Cost of goods sold			164,205,657				130,605,493				33,600,164				25.7	%
Gross profit		$	56,474,840			$	61,201,536			$	(4,726,696	)			-7.7	%

Net Sales.  Net sales increased by $28.9 million, or 15.1%, to $220.7 million for fiscal year ended 2010. Sales of third-party products increased $27.3 million or 22.8%, sales of our proprietary products increased $0.7 million or 1.2%, and freight sales increased $0.9 million or 6.5% in 2010. The increase in net sales was primarily the result of an increase in our customer base, number of shipped orders and our average order value compared to the twelve months ended December 31, 2009. Sales growth was negatively impacted during the year by a shortage of our proprietary products that occurred during the first quarter 2010, and an increasingly competitive environment, which began in the latter part of the second quarter, as many of our competitors offered deep discounts. We responded with increased promotional activities, including “free shipping” and other discounts on both proprietary and third party products.

Cost of Goods Sold.  Cost of goods sold increased $33.6 million, or 25.7%, to $164.2 million for 2010. As a percentage of net sales, cost of goods sold increased to 74.4% for 2010 from 68.1% for 2009. The increase is primarily due to a shift in product mix to higher cost third-party products and the use of various shipping discounts including “free shipping” as a promotional activity in response to the augmented competitive environment.

Gross Profit.  As a result of the changes discussed in net sales and cost of goods sold, gross profit decreased $4.7 million, or 7.7%, to $56.5 million in 2010 and gross profit as a percentage of net sales decreased to 25.6% in 2010 from 31.9% in 2009.

Fulfillment.  Fulfillment expense increased $8.4 million or 93.8%, to $17.4 million for 2010. As a percentage of net sales, fulfillment expense increased to 7.9% for 2010 from 4.7% for 2009. The increase in fulfillment expense as a percentage of net sales was primarily attributable to operating our expanded distribution center in Las Vegas, Nevada and higher labor costs at both our Las Vegas, Nevada and Lexington, North Carolina distribution centers as a result of operating inefficiencies. The operating inefficiencies were primarily attributable to temporary warehouse systems optimization problems and a significant unanticipated shift to products requiring special handling (e.g. liquids and glass packaging) resulting in higher labor costs. Additionally, these inefficiencies were exacerbated in the fourth quarter due to increased order volume. We understand the requirements to reduce these inefficiencies and have been making the appropriate modifications to address them.

Sales and Marketing.  Sales and marketing expense increased $4.4 million, or 31.1%, to $18.7 million in 2010. As a percentage of net sales, sales and marketing expense increased to 8.5% for 2010 from 7.4% for 2009. Sales and marketing expenses increased due to a $2.5 million dollar increase in total internet advertising spending, a $1.3 million increase in total labor costs and a $0.9 million increase in total print spending, partially offset by $0.3 million in increased co-op advertising revenue.

General and Administrative.  General and administrative expenses increased $4.8 million, or 16.6%, to $33.9 million in 2010. As a percentage of net sales, general and administrative expenses were virtually flat when compared to the twelve months ended December 31, 2009. Included in the 2010 amount were an estimated $10.6 million in expenses consisting of the following: $3.6 million in fees associated with the legal proceedings discussed in Part II, Item 8, Note 13 Contingences, of this Annual Report on Form 10-K, the

proxy solicitation and other matters, $3.5 million accrual for the settlement of the derivative lawsuit discussed in Part II, Item 8, Note 13 Contingences, of this Annual Report on Form 10-K, $1.2 million in accrued severance to our former Chief Executive Officer, $1.1 million in accrued severance to our former Chief Financial Officer, $0.7 million in proxy reimbursement fees to Great Hill Partners and $0.5 million in professional services fees to our independent accountants. Included in the 2009 amount was $10.9 million in stock based compensation incurred in connection with our initial public offering. Excluding these items in both twelve month periods, general and administrative expenses increased $5.1 million year-over-year. This was primarily attributable to an overall increase of $4.1 million in on-going expenses, an increase of $1.4 million in costs associated with being a public company, an increase of $0.8 million in credit card fees due to higher sales, an increase of $0.7 million in higher labor costs, and an additional $0.2 million in stock-based compensation expense. This was partially offset by a decrease of $2.1 million in depreciation expense.

Interest Expense.  Interest expense decreased $157,000, or 31.5%, to $341,000 for the year ended December 31, 2010, from $498,000 when compared to the same period in the prior year. The decrease was primarily a result of the capitalization of interest expense and the pay down of substantially all of our outstanding notes payable and line of credit balances.

Income Tax (Expense).  During 2010 our net deferred tax position, prior to the valuation allowance, increased by approximately $3.3 million. In our assessment of the need for a valuation allowance, in accordance with applicable guidance, we considered our cumulative pre-tax loss after three years, adjusting for permanent items and the potential for accumulated taxable losses in 2011, given our first quarter results. Accordingly, we considered our pattern of recent losses and potential losses in 2011 to be relevant to our analysis. As a result of our assessment, we concluded that a full valuation allowance of $6.3 million was needed as of December 31, 2010, and has been recorded in the accompanying consolidated financial statements.

Income tax expense decreased $1.3 million, or 47.4%, to $1.5 million for the year ended December 31, 2010. This was a result of recognizing a loss before income taxes of $13.7 million and a valuation allowance of $6.3 million for the year ended December 31, 2010 compared to a profit before income taxes of $8.7 million for the year ended December 31, 2009.

Inventory.  Inventory increased $1.7 million, or 6.2%, to $29.8 million as of December 31, 2010. The increase in inventory is a result of the need to maintain more inventory on hand to meet the growth in sales and the reduction of virtual inventory products.

Property and Equipment.  Net property and equipment increased by $16.0 million, or 73.1%, to $38 million as of December 31, 2010. The increase was primarily attributable the build-out and improvements of our North Carolina and Nevada distribution facilities as well as various information technology enhancements.

Debt.  We repaid our line of credit, interest rate swap obligations, and all but one note payable on December 13, 2010. The remaining note payable balance at December 31, 2010 was $0.1 million and will be repaid in 2011.

Comparison of Year Ended December 31, 2009 to Year Ended December 31, 2008

		Year Ended December 31,								$ Increase				% Increase
		2009				2008
Third-party products(1)		$	119,750,019			$	87,264,353			$	32,485,666				37.2	%
Proprietary products			58,480,009				45,504,873				12,975,136				28.5	%
Freight			13,577,001				10,833,053				2,743,948				25.3	%
Net sales			191,807,029				143,602,279				48,204,750				33.6	%
Cost of goods sold			130,605,493				105,529,254				25,076,239				23.8	%
Gross profit		$	61,201,536			$	38,073,025			$	23,128,511				60.7	%

Net Sales.  Net sales increased by $48.2 million, or 33.6%, to $191.8 million for fiscal year ended 2009. Net sales of our proprietary products increased $13.0 million, or 28.5%, from $45.5 million in 2008 to $58.5 million in 2009, and sales of third-party products increased by $32.5 million, or 37.2%, from $87.3 million in 2008 to $119.8 million in 2009. The increase in net sales was primarily the result of the net increase in our customer base and an increase in orders of 565,000, or 28.6%, to $2.54 million in 2009 from $1.97 million in 2008 and an increase in average order value to $75 in 2009 from $73 in 2008. Our customer base increased from approximately 555,000 active customers at December 31, 2007 to approximately 1.1 million active customers at December 31, 2009.

Cost of Goods Sold.  Cost of goods sold increased by $25.1 million, or 23.8%, to $130.6 million for 2009. As a percentage of net sales, cost of goods sold decreased to 68.1% for 2009 from 73.5% for 2008. The decrease is primarily due to our transition from third-party manufacturing to in-house manufacturing of our proprietary products.

Gross Profit.  As a result of the changes discussed in net sales and cost of goods sold, gross profit increased by $23.1 million, or 60.7%, to $61.2 million in 2009 and gross profit as a percentage of net sales increased to 31.9% in 2009 from 26.5% in 2008.

Fulfillment.  Fulfillment expense increased $561,000 or 6.7%, to $9.0 million for 2009. As a percentage of net sales, fulfillment expense decreased to 4.7% for 2009 from 5.8% for 2008. This decrease in fulfillment expense as a percentage of net sales was primarily attributable to better utilization of distribution capacity.

Sales and Marketing.  Sales and marketing expense increased $1.1 million, or 8.6%, to $14.3 million in 2009. The aggregate dollar increase in sales and marketing expense is the result of third-party marketing services and online advertising that are variable and therefore increase as volume increases. As a percentage of sales, however, sales and marketing expense decreased to 7.4% for 2009 from 9.2% for 2008, due primarily to reducing less effective marketing programs.

General and Administrative.  General and administrative expenses increased $14.2 million, or 95.6%, to $29.1 million in 2009. The gross increase in general and administrative expenses in 2009 is primarily due to $10.9 million of stock-based compensation expense recorded in connection with IPO Executive Stock Option Grants as described previously. Excluding this $10.9 million of stock-based compensation expense, general and administration expenses increased $3.3 million, or 22.1% to $18.2 million for 2009 while as a percentage of sales, general and administrative expenses excluding the $10.9 million of stock based compensation decreased to 9.5% for 2009 from 10.4% for 2008, primarily due to better utilization of fixed costs.

Interest Expense.  Interest expense decreased $738,000, or 59.7%, to $498,000 for the year ended December 31, 2009. Approximately $236,000 of the change in interest expense related to the change in the fair value of interest rate swaps. Additionally, the Company utilized part of the IPO proceeds to reduce its debt to $9.4 million as of December 31, 2009 compared to $18.2 million as of December 31, 2008.

Income Tax Benefit (Expense).  Income tax expense increased by $2.4 million, or 489%, to $2.8 million for the year ended December 31, 2009.. The Company had increased operating income to $8.9 million for the year ended December 31, 2009, from $1.7 million for the year ended December 31, 2008.

Inventory.  Inventory increased by $6.4 million, or 29.7%, to $28.1 million as of December 31, 2009. The increase in inventory is a result of the need to maintain more inventory on hand to meet the growth in sales, the transition of sourcing proprietary products from third-party manufacturers to in-house manufacturing, and an increase in the product assortment, resulting in an increase in the number of SKUs maintained.

Property and Equipment.  Net property and equipment increased by $2.7 million, or 13.8%, to $22 million as of December 31, 2009. The increase is primarily related to the build-out of the manufacturing and distribution facility.

Debt.  The line of credit balance decreased by $5.9 million, or 63.3%, to $3.5 million as of December 31, 2009. Additionally, $2.0 million of notes payable to related parties were paid in full during the year ended December 31, 2009. The decrease in debt was funded with proceeds from the IPO.

Historical Cash Flows

Comparison of Year Ended December 31, 2010 to Year Ended December 31, 2009

Net Cash Provided by (Used in) Operating Activities.  For the year ended December 31, 2010, net cash provided by operations was $6.7 million compared to $14.1 million for the year ended December 31, 2009. The decrease in 2010 of $7.4 million was primarily attributable to a decrease in net income of $21.1 million and increases in current assets including income tax receivables and inventory. This was partially offset by increases in short term liabilities including accrued expenses and accounts payable.

Net Cash Provided By (Used In) Investing Activities.  For the year ended December 31, 2010, net cash provided by investing activities was $7.1 million compared to net cash used in investing activities of $46.5 million for the year ended December 31, 2009. During 2010 we generated positive cash inflows primarily due to proceeds from the redemption of our available-for-sale securities. These investing cash inflows were partially offset by expenditures for property and equipment and purchases of available-for-sale securities. Our investing activities consist primarily of investments in securities available-for-sale and the acquisition of property and equipment. Expenditures for property and equipment during 2010 and 2009 related to the acquisition of furniture, fixtures and equipment and technology system infrastructure including software required to expand capacity and improve overall operating efficiency.

Net Cash Provided by (Used In) Financing Activities.  For the year ended December 31, 2010, net cash used in financing activities was $7.9 million compared to net cash provided by financing activities of $41.0 million for the year ended December 31, 2009. During 2010 we paid off our line of credit, notes payable, and our interest rate swaps. During 2009, we received approximately $47.1 million in proceeds, net of issuance costs of $6.0 million for the sale of common stock in connection with our initial public offering which was completed on September 29, 2009.

Liquidity and Capital Resources

Since our formation through 2006, we have primarily funded our operations through the sale of equity securities and cash generated from operations. During 2007 and 2008, we funded operations and investments in manufacturing and distribution facilities, as well as the related equipment, primarily through loan agreements and cash generated from operations. In 2009, the Company received net proceeds of approximately $47.1 million from its initial public offering after deducting underwriting discounts, commissions and offering expenses. During 2010, we primarily funded operations from cash provided by operating activities and through proceeds generated from the sale of available-for-sale securities.

Liquidity.  The significant components of our working capital are cash and cash equivalents, securities available-for-sale, inventory and accounts receivable, primarily from credit cards processors, reduced by accounts payable and accrued expenses. 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. In 2010, we experienced a tightening of credit terms with our suppliers related to the legal proceedings discussed in Part 1 Item 3. At December 31, 2010, we had $14.6 million in cash and cash equivalents, $10.9 million in securities held for sale, and positive working capital of $26.0 million compared to $8.7 million in cash and cash equivalents, $35.8 million in securities held for sale, and working capital of $49.6 million at December 31, 2009.

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

Capital expenditures for the build-out and improvements of our North Carolina distribution facility and information technology enhancements to improve warehousing optimization in 2011 could range from $3.0 million to $5.0 million.

We repaid our line of credit, interest rate swap obligations, and certain notes payable on December 13, 2010. The repayment was funded by liquidating a portion of our securities available-for-sale. Additionally, $3.5 million was paid in May 2011 for the settlement discussed in Part II, Item 8, Note 13 Contingences, of this Annual Report on Form 10-K.

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 may not be able to obtain additional funds on a timely basis, on acceptable terms, or at all.

The repayment of our borrowings, obligations, and settlement as well as the anticipated capital expenditures does not impact our ability to continue our operations.. We believe that our cash and cash equivalents and cash flows from operations will be sufficient to continue our operations for the next twelve months.

Aggregate Contractual Obligations.  A summary of contractual cash obligations as of December 31, 2010 is as follows:

		Payments Due By Period
		Total				Less Than 1 Year				1 to 3 Years				3 to 5 Years				More Than 5 Years
Operating Leases		$	9,113,139			$	1,539,974			$	3,329,005			$	2,253,941			$	1,990,219
Equipment purchase obligations			3,725,229				3,725,229				—				—				—
Notes Payable			58,888				58,888				—				—				—
		$	12,897,256			$	5,324,091			$	3,329,005			$	2,253,941			$	1,990,219

We have various noncancelable operating leases that expire in various years through August 2016 for the rental of office space. Rent expense totaled $2,137,137 and $1,050,021for the years ended December 31, 2010 and 2009, respectively.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Recent Accounting Pronouncements

Refer to Note 1, Nature of Business and Significant Accounting Policies, of our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for a discussion recently issued accounting standards applicable to us, which is incorporated herein by reference.

Item 7A. 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 minor portion of our sales outside of the U.S., all of our sales are 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 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Reports of Independent Registered Public Accounting Firms			41
Consolidated Balance Sheets as of December 31, 2010 and 2009			42
Consolidated Statements of Operations for the Years Ended December 31, 2010, 2009 and 2008			43
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2010, 2009 and 2008			44
Consolidated Statements of Cash Flows for the Years Ended December 31, 2010, 2009 and 2008			45
Notes to Consolidated Financial Statements			46

REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors
of Vitacost.com, Inc.:

In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Vitacost.com, Inc. and its subsidiary (the “Company”) at December 31, 2010, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP
  
PricewaterhouseCoopers LLP
Miami, Florida
June 16, 2011

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Vitacost.com, Inc.

We have audited the accompanying consolidated balance sheet of Vitacost.com, Inc. (the “Company”) as of December 31, 2009, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vitacost.com, Inc. as of December 31, 2009, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2009 in conformity with U.S. generally accepted accounting principles.

/s/ McGladrey & Pullen, LLP
  
Fort Lauderdale, Florida
March 30, 2010, except for Note 16 as to which the date is June 16, 2011

VITACOST.COM, INC.
  
CONSOLIDATED BALANCE SHEETS

		For the year ended December 31,
		2010				2009
Assets
Current Assets
Cash and cash equivalents		$	14,592,803			$	8,658,157
Securities available-for-sale			10,912,392				35,787,227
Accounts receivable, net			440,033				735,355
Other receivables			1,087,311				1,055,372
Inventory			29,827,929				28,096,884
Prepaid expenses			1,361,230				1,988,538
Deferred tax asset			—				1,167,724
Other assets			3,553,089				—
Total current assets			61,774,787				77,489,257
Property and equipment, net			38,011,314				21,961,903
Goodwill			2,200,000				2,200,000
Intangible assets, net			4,946				9,446
Deposits			114,308				4,656,128
Deferred tax asset			—				1,361,817
Total assets		$	102,105,355			$	107,678,551
Liabilities and Stockholders’ Equity
Current Liabilities
Line of credit		$	—			$	3,458,183
Current maturities of notes payable			58,888				1,090,969
Current maturities of capital lease obligations			—				35,452
Accounts payable			26,533,204				18,052,495
Deferred revenue			2,134,305				1,919,352
Accrued expenses			10,671,865				3,282,476
Income taxes payable			—				51,221
Total current liabilities			39,398,262				27,890,148
Notes payable, less current maturities			—				4,820,042
Interest rate swap liability			—				468,719
Deferred tax liability			521,389				—
Total liabilities			39,919,651				33,178,909
Commitments and contingencies
Stockholders’ Equity
Preferred stock, par value $.00001 per share; authorized 25,000,000; no shares issued and outstanding at December 31, 2010 and December 31, 2009			—				—
Common stock, par value $.00001 per share; authorized 100,000,000; 27,780,453 and 27,488,353 shares issued and outstanding at December 31, 2010 and December 31, 2009, respectively			278				275
Additional paid-in capital			74,829,972				71,932,256
Accumulated other comprehensive loss			(20,207	)			—
(Accumulated deficit) Retained earnings			(12,624,339	)			2,567,111
Total stockholders’ equity			62,185,704				74,499,642
Total liabilities and stockholders’ equity		$	102,105,355			$	107,678,551

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

VITACOST.COM, INC.
  
CONSOLIDATED STATEMENTS OF OPERATIONS

		For the year ended December 31,
		2010				2009				2008
Net sales		$	220,680,497			$	191,807,029			$	143,602,279
Cost of goods sold			164,205,657				130,605,493				105,529,254
Gross profit			56,474,840				61,201,536				38,073,025
Operating expenses:
Fulfillment			17,353,699				8,953,592				8,392,639
Sales and marketing			18,727,532				14,283,715				13,146,574
General and administrative			33,918,736				29,082,595				14,871,648
			69,999,967				52,319,902				36,410,861
Operating (loss) income			(13,525,127	)			8,881,634				1,662,164
Other income (expense):
Interest income			127,880				96,544				85,918
Interest expense			(341,026	)			(497,934	)			(1,236,330	)
Other income (expense)			38,063				249,811				(12,717	)
			(175,083	)			(151,579	)			(1,163,129	)
(Loss) income before income taxes			(13,700,210	)			8,730,055				499,035
Income tax expense			(1,491,240	)			(2,836,066	)			(481,628	)
Net (loss) income		$	(15,191,450	)		$	5,893,989			$	17,407
Basic per share information:
Net (loss) income available to common stockholders		$	(0.55	)		$	0.24			$	0.00
Weighted average shares outstanding			27,703,710				24,216,942				23,188,380
Diluted per share information:
Net (loss) income available to common stockholders		$	(0.55	)		$	0.24			$	0.00
Weighted average shares outstanding			27,703,710				24,674,248				23,975,068

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

VITACOST.COM, INC.
  
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME

		Common Stock								Additional Paid-In Capital				Note Receivable from Exercise of Options				Accumulated Other Comprehensive Loss				(Accumulated Deficit) Retained Earnings				Total
		Shares				Amount
Balance at December 31, 2007			23,188,380			$	232			$	10,662,360			$	(1,165,625	)		$	—			$	(3,344,285	)		$	6,152,682
Comprehensive income:
Net income			—				—				—				—				—				17,407				17,407
Comprehensive income																											17,407
Stock options exercised			—				—				—				—				—				—				—
Stock based compensation expense			—				—				794,881				—				—				—				794,881
Balance at December 31, 2008			23,188,380				232				11,457,241				(1,165,625	)			—				(3,326,878	)			6,964,970
Comprehensive income:
Net income			—				—				—				—				—				5,893,989				5,893,989
Comprehensive income																											5,893,989
Stock options exercised			62,000				1				13,810				—				—				—				13,811
Stock repurchased and retired			(360,000	)			(4	)			(499,996	)			—				—				—				(500,000	)
Repayment of note receivable			—				—				—				1,165,625				—				—				1,165,625
Stock issued in initial public offering net of offering costs of $6.0 million			4,597,973				46				47,093,308				—				—				—				47,093,354
Stock based compensation expense			—				—				11,831,331				—				—				—				11,831,331
Income tax benefit from stock options exercised			—				—				2,036,562				—				—				—				2,036,562
Balance at December 31, 2009			27,488,353				275				71,932,256				—				—				2,567,111				74,499,642
Comprehensive income:
Net loss			—				—				—				—				—				(15,191,450	)			(15,191,450	)
Unrealized loss related to securities available-for-sale			—				—				—				—				(20,207	)			—				(20,207	)
Comprehensive loss																											(15,211,657	)
Stock options exercised			292,100				3				851,013				—				—				—				851,016
Stock-based compensation expense			—				—				1,463,413				—				—				—				1,463,413
Income tax benefit from stock options exercised			—				—				583,290				—				—				—				583,290
Balance at December 31, 2010			27,780,453			$	278			$	74,829,972			$	—			$	(20,207	)		$	(12,624,339	)		$	62,185,704

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

VITACOST.COM, INC.
  
CONSOLIDATED STATEMENTS OF CASH FLOWS

		For the year ended December 31,
		2010				2009				2008
Cash Flows From Operating Activities
Net (loss) income		$	(15,191,450	)		$	5,893,989			$	17,407
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Depreciation			5,133,126				3,645,616				2,839,089
Amortization of intangibles			4,500				4,500				25,244
Amortization of premium on debt securities available-for-sale			684,843				—				—
Change in fair value of interest rate swap			(8,843	)			(236,121	)			463,138
Realized gain on the sale of securities available-for-sale			(6,635	)			—				—
Stock-based compensation expense			1,463,413				11,831,330				794,881
Deferred taxes			3,050,930				(1,517,621	)			418,286
Provision for inventory reserve			251,003				25,249				149,615
(Gain) Loss on disposition of property and equipment and other assets			(69,074	)			89,767				(56,937	)
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable			295,322				107,168				(261,414	)
Other receivables			(31,939	)			(409,921	)			(34,958	)
Inventory			(1,982,048	)			(6,459,387	)			(7,102,566	)
Prepaid expenses			627,308				(1,331,563	)			(324,343	)
Other assets			(3,553,089	)			—				—
Increase (decrease) in:
Accounts payable			8,480,709				2,282,586				1,295,341
Deferred revenue			214,953				(459,946	)			1,165,799
Accrued expenses			7,389,389				661,716				(24,114	)
Income taxes payable			(51,221	)			21,969				1,849
Net cash provided by (used in) operating activities			6,701,197				14,149,331				(633,683	)
Cash Flows From Investing Activities
Proceeds from disposition of property, equipment			232,595				1,032,429				118,920
Settlement of interest rate swap			(459,876	)			—				—
Advance to related party			—				—				(215,241	)
Payments for the purchase of property and equipment			(16,965,184	)			(7,423,883	)			(5,153,841	)
Decrease (increase) in deposits			160,945				(4,570,921	)			52,452
Proceeds from repayment of related party advance			—				215,241				—
Purchases of securities available-for-sale			(27,457,228	)			(35,787,227	)			—
Proceeds from maturities of securities available-for-sale			51,633,649				—				—
Net cash provided by (used in) investing activities			7,144,901				(46,534,361	)			(5,197,710	)
Cash Flows From Financing Activities
Principal payments on notes payable			(5,852,123	)			(812,457	)			(975,244	)
Borrowings on related party note payable			—				—				2,575,000
Repayments on related party note payable			—				(2,000,000	)			(575,000	)
Net (repayments) borrowings on line of credit			(3,458,183	)			(5,954,447	)			4,933,153
Repayments on capital lease obligation			(35,452	)			(60,589	)			(65,865	)
Repayments of note receivable from exercise of stock options			—				1,165,625				—
Proceeds from the exercise of stock options			851,016				13,811				—
Tax benefit from stock based compensation			583,290				2,036,564				—
Net proceeds from initial public offering			—				47,093,354				—
Payments for redemption of common stock			—				(500,000	)			—
Net cash (used in) provided by financing activities			(7,911,452	)			40,981,861				5,892,044
Net increase in cash and cash equivalents			5,934,646				8,596,831				60,651
Cash and cash equivalents:
Beginning of year			8,658,157				61,326				675
Ending of year		$	14,592,803			$	8,658,157			$	61,326
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest, net of amount capitalized		$	349,869			$	734,055			$	773,192
Income taxes		$	1,461,330			$	1,229,000			$	120,000
Supplemental Schedule of Noncash Investing and Financing Activities
Property and equipment purchased through accounts payable		$	—			$	—			$	433,105
Equipment purchased not yet paid		$	2,203,439			$	—			$	—
Application of deposits towards purchases of equipment		$	4,380,875			$	—			$	—

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

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies

Nature of Business:  Vitacost.com, Inc. (“Vitacost” or the “Company”) is an internet-based retailer of nutritional supplements. Vitacost was incorporated in 1994 and began internet-based retail activity 1999. Vitacost sells a proprietary and internally developed line of nutraceuticals as well as a selection of other manufacturers’ brand-name vitamin products. The Company distributes products from two primary locations in North Carolina and Nevada.

Initial Public Offering:  On September 23, 2009, the Company’s initial public offering of common stock, in which 11.0 million shares of common stock were sold to the public at an offering price of $12.00 per share, was effective and closed on September 29, 2009. The offering included approximately 4.4 million shares sold by the Company and approximately 6.6 million shares sold by the selling stockholders. The net proceeds to the Company from this offering were approximately $47.1 million, after deducting underwriting discounts, commissions and offering expenses.

A summary of the Company’s significant accounting policies follows:

Earnings per Share:  The Company computes earnings per share by dividing net income 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. The following table reconciles basic weighted-average shares outstanding to diluted weighted-average shares outstanding for years ended December 31, 2010, 2009, and 2008:

		Years Ended December 31,
		2010				2009				2008
Weighted-average shares outstanding – basic			27,703,710				24,216,942				23,188,380
Effect of dilutive securities			—				457,306				786,688
Weighted-average shares outstanding – diluted			27,703,710				24,674,248				23,975,068

For periods where the Company reported income, common stock equivalents related to employee stock-based compensation are not included in the computation of diluted earnings per share to the extent that their exercise price exceeded market value, since the result would be anitdilutive. 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 could potentially dilute earnings per share in the future, but which 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:

		Years Ended December 31,
		2010				2009				2008
Antidilutive common stock equivalents excluded from diluted earnings per share			2,341,188				431,000				698,469

Principles of Consolidation:  The consolidated financial statements include the accounts of Vitacost and any wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Accounting Estimates:  The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates inherent in the preparation of the accompanying consolidated financial statements include

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies  – (continued)

management’s forecast of future cash flows used as a basis to assess recoverability of long-lived assets, including intangible assets and goodwill, the reserve for inventory obsolescence and assumptions used in valuation of the Company’s stock.

Cash and Cash Equivalents:  The Company considers all highly-liquid investments purchased with original maturities of three months or less at the date of purchase to be cash equivalents. The Company maintains its cash and cash equivalents in various bank deposit accounts which, at times, may exceed the federally-insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on such accounts.

Securities Available-for-Sale:  Available-for-sale securities consist of investment grade municipal debt securities not classified as trading or held-to-maturity. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders’ equity. The aggregate fair value of securities available-for-sale as of December 31, 2010 is $10,912,392, which approximates cost. The fair value of available-for-sale securities by contractual maturity as of December 31, 2010, is as follows:

		December 31, 2010
Due within one year		$	7,816,917
Due after one year through three years			3,095,475
		$	10,912,392

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. The Company employs a methodology that considers available evidence in evaluating potential impairment of its investments. In the event that the cost of an investment exceeds its fair value, the Company evaluates, among other factors, the magnitude and duration of the decline in fair value; the expected cash flows of the securities; the financial health of and business outlook for the issuer; the performance of the underlying assets for interests in securitized assets; and the Company’s intent and ability to hold the investment. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in investment income and a new cost basis in the investment is established. The Company determined that its securities were not other-than-temporarily impaired as of December 31, 2010 and 2009.

Accounts Receivable:  Accounts receivable consist of amounts in transit from banks for customer credit card, debit card and electronic benefit transfer transactions that are generally processed by the banks within seven days of authorization. Based on the Company’s historical collection experience and a review of the status of accounts receivable, an allowance for doubtful accounts of $144,253 and $0 has been recorded as of December 31, 2010 and 2009, respectively.

Other Receivables:  Other receivables primarily consist of amounts due from vendors under marketing cooperative arrangements. Amounts recorded relative to these arrangements are classified as a reduction of advertising expense, included in sales and marketing expenses. Pursuant to these agreements, for the years ended December 31, 2010, 2009, and 2008 advertising expense was reduced by approximately $1,635,000, $1,424,000, and $888,000, respectively.

Inventory:  Inventory, consisting principally of nutritional supplements, is primarily stated at the lower of cost or market on a first in, first out (“FIFO”) method. Management determines the inventory reserve by regularly reviewing and evaluating individual inventory items and movement history. Inventory is written off when deemed obsolete or unsellable. Based on its experiences, the Company recorded a reserve of approximately $603,000, and $352,000 at December 31, 2010 and 2009, respectively.

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies  – (continued)

Property and Equipment:  Property and equipment is stated at cost less accumulated depreciation. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the assets or the lease term. Depreciation is computed using the straight-line method over the following estimated useful lives:

		2010 Years
Furniture, fixtures and equipment			3 – 10
Computers			3 – 5
Software			3 – 5
Leasehold and building improvements			3 – 39
Buildings			39

Upon retirement or sale, the cost and accumulated depreciation are eliminated from the accounts and the gain or loss, if any, is included in the consolidated statements of operations.

Goodwill:  The excess of purchase price over fair value of assets acquired and liabilities assumed in business combinations are classified as goodwill. The Company reviews goodwill for impairment annually or, when events or circumstances dictate, more frequently. The Company completed the annual goodwill impairment test as of December 31, 2010 and determined that no impairment existed.

Intangible Assets:  Intangible assets primarily consist of customer lists and internet domain names acquired as a result of business combinations and are being amortized over their estimated useful lives of five to ten years, using the straight-line method.

Long-Lived Assets:  Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the asset with the estimated undiscounted future cash flows associated with the use of the asset and its eventual disposition. Should the review indicate that the asset is not recoverable, the Company’s carrying value of the asset would be reduced to its estimated fair value, which is measured by future discounted cash flows.

Revenue Recognition and Shipping and Handling:  Revenue from the sale of vitamins, nutritional supplements and other related products is recognized when all the following criteria are met: a customer executes an order, the sales price and the shipping and handling fee have been determined, credit card authorization has occurred, collection is reasonably assured and the product has been received by the customer. The Company’s internet sales are made to customers permitting certain limited rights of return for a 30-day period. It has been the Company’s experience that such returns have been insignificant. Based on its experience, the Company recorded a reserve for returns of $148,000 and $103,000 at December 31, 2010 and 2009, respectively.

The Company enters agreements whereby third parties are able to advertise through the Company’s website. The Company is paid and recognizes revenue based upon the contractual agreement, generally upon consummation of a sale by the third party advertiser. Revenue related to these agreements was approximately $770,000, $1,900,000 and $1,500,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

Shipping and handling billed to customers is classified as revenue and totaled approximately $14,457,000, $13,576,000, and $10,833,000 for the years ended December 31, 2010, 2009, and 2008, respectively. Shipping and handling costs are expensed as incurred and recorded as a component of cost of goods sold. Shipping and handling expense totaled approximately $22,963,000, $16,654,000, and $14,751,000 for the years ended December 31, 2010, 2009, and 2008, respectively.

Deferred Revenue:  Deferred revenue represents orders that have been shipped but not yet received by the customer.

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies  – (continued)

Operating Expenses:  The Company’s operating expenses are grouped into three categories: fulfillment, sales and marketing and general and administrative. The following is a brief synopsis of each category:

Fulfillment Expenses:  Fulfillment expenses include the costs of warehousing supplies, equipment, maintenance, employees and rent.

Sales and Marketing Expenses:  Sales and marketing expenses include advertising and promotional expenditures, website referral expenditures, including third-party content license fees, traditional media advertising, print expenses and payroll related expenses for personnel engaged in marketing, sales, customer service, website development and maintenance. We expense advertising costs as incurred. Total advertising expense amounted to approximately $8,690,000, $7,398,000, and $7,355,000, for the years ended December 31, 2010, 2009, and 2008, respectively.

General and Administrative Expenses:  General and administrative expenses consist of management and executive compensation, information technology expenses, credit card fees, professional services and general corporate expenses.

Stock-Based Compensation:  The Company maintains a stock incentive plan, which has 7,000,000 shares of common stock reserved, to grant nonqualified and incentive stock options to employees, officers, directors and certain nonemployees. Under the terms of the plan, options to purchase stock are granted at an exercise price that approximates the fair market value at the time of the grant. Nonqualified options generally become exercisable on the date of grant and expire in ten years. Incentive stock options generally become exercisable over a five-year period and the maximum term of the option may not exceed ten years. Compensation cost related to stock options recognized in earnings in 2010, 2009, and 2008, was approximately $1,463,000, $11,831,000, and $795,000 on a pretax basis, respectively.

The Company recognizes compensation expense for stock awards based on fair value and related tax effects as they vest. The fair value of each option award is estimated on the date of grant using an option valuation method that uses the assumptions noted in the following table. The valuation technique incorporates assumptions for the expected volatility of the stock price, the expected term of the option, expected dividends, forfeitures and risk-free interest rate for the expected term of the option. As a result of its limited trading history, the Company uses expected volatilities based on the historical volatility of a sample of companies in a similar industry and of a comparable size as the Company. The expected term of the option is based on historical experience and represents the time period options actually remain outstanding. The risk-free interest rate takes into account the time-value of money. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at time of grant. The Company estimates forfeitures based on historical pre-vesting forfeitures and revises those estimates in subsequent periods if actual forfeitures differ from those estimates.

The fair value of each option granted was estimated using the following assumptions:

2010

2009

2008

Expected life – employees

7 years

8 years

4.5 – 7.5 years

Expected life – executives

5.75 – 7 years

5 – 6 years

5 years

Volatility percentage

67.9% – 68.8%

67% – 78%

65% – 79%

Interest rate

1.55% – 3.16%

2.40% – 3.30%

1.55% – 3.99%

Dividends

None

None

None

Forfeiture rate – executives

1.00%

1.00%

1.00%

Forfeiture rate – employees

4.00%

4.00%

4.00%

Derivative Financial Instruments:  The Company’s risk management policy is to use derivative financial instruments, as appropriate, to manage the interest expense related to the Company’s debt with variable interest rates. These instruments historically have not been designated as hedges for financial reporting

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies  – (continued)

purposes; accordingly, gains and losses related to fair value are reflected in the statement of operations at each reporting date. During 2007, the Company entered into two interest rate swap agreements with initial notional amounts of $3,360,000 and $1,849,263, respectively. These swaps require the Company to pay a fixed rate of 6.81% and 6.85%, respectively, and receive a floating interest payment based on LIBOR plus 1.4% and 1.75%, respectively. The outstanding notional amount on these swap agreements at December 31, 2009 was $3,122,083 and $1,047,916 respectively. During 2008, the Company entered into another interest rate swap agreement with an initial notional amount of $2,573,884, which required the Company to pay a fixed rate of 6.03%, and receive a floating interest payment based on LIBOR plus 2.5%. The outstanding notional amount on this swap at December 31, 2009 was $1,570,506. As of December 31, 2009 and 2008, these interest rate swaps had a fair value of ($468,719) and ($704,840), respectively and were recognized as a liability on the consolidated balance sheets. Changes in fair value are included in interest expense in the accompanying statements of operations. The Company terminated these swap agreements and repaid in full the obligations outstanding thereunder in connection with the extinguishment of the Company’s notes payable on December 13, 2010.

Fair Value of Financial Instruments:  In September 2006, the Financial Accounting Standards Board (FASB) issued authoritative guidance that defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. The Company adopted the guidance at the beginning of fiscal year 2008. The guidance applies to all assets and liabilities that are being measured and reported on a fair value basis. It requires new disclosure that establishes a framework for measuring fair value in GAAP and expands disclosure 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. The guidance requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:

Level 1:  Quoted market prices in active markets for identical assets or liabilities.

Level 2:  Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3:  Unobservable inputs that are not corroborated by market data.

The Company’s investment in securities available-for-sale are valued based on observable market based inputs that are corroborated by market data and are therefore considered a level 2 item.

The Company’s interest rate swaps were pay-fixed, receive-variable interest rate swaps based on LIBOR swap rate. The LIBOR swap rate is observable at and therefore is considered a level 2 item. For the year ended December 31, 2009, the application of valuation techniques applied to similar assets and liabilities has been consistent. For the year ended December 31, 2010 the Company settled all agreements related to and paid off its interest swaps.

The carrying amounts of other financial instruments, including cash, cash equivalents, accounts receivable, other receivables, accounts payable and short-term borrowings approximate fair value due to the short maturity of these instruments. The carrying amount of long-term debt as of December 31, 2009 approximated its fair value because the interest rates fluctuate with market interest rates or the fixed rates are based on current rates offered to the Company for debt with similar terms and maturities.

Income Taxes:  Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Significant Accounting Policies  – (continued)

On January 1, 2007, the Company adopted authoritative guidance that clarified the accounting for uncertainty in an enterprise’s financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The guidance requires management to evaluate its open tax positions that exist on the date of initial adoption in each jurisdiction. The Company has determined that there were no material uncertain tax positions and accordingly no associated interest and penalties were required to be accrued at December 31, 2010 and 2009, respectively.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.

Contingencies:  On an ongoing basis, the Company assesses potential liabilities related to lawsuits or claims brought against it. While it is typically very difficult to determine the timing and ultimate outcome of such actions, the Company’s management use their best judgment to determine if it is probable that it will incur an expense related to the settlement or final adjudication of such matters and whether a reasonable estimation of such probable loss, if any, can be made. In assessing probable losses, the Company takes into consideration estimates of the amount of insurance recoveries, if any. The Company accrues a liability when it believes a loss is probable and the amount of loss can be reasonably estimated. Due to the inherent uncertainties related to the eventual outcome of litigation and potential insurance recoveries, it is possible that certain matters may be resolved for amounts materially different from any provisions or disclosures that the Company has previously made.

Recent Accounting Pronouncements:

In January 2010, authoritative guidance was issued requiring enhanced disclosures for fair value measurements. Entities are required to separately disclose the amounts and reasons of significant transfers in and out of the first two levels of the fair value hierarchy. Entities are also required to present information about purchases, sales, issuance and settlements of fair value measurements within the third level of the fair value hierarchy on a gross basis. As this guidance is disclosure related only, the adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

Note 2. Inventory

Inventory consists of the following as of December 31, 2010 and 2009:

		December 31,
		2010				2009
Raw materials		$	2,907,192			$	4,734,772
Work in process			4,585,946				3,687,426
Finished goods			22,937,551				20,026,443
			30,430,689				28,448,641
Less: Inventory reserve			602,760				351,757
		$	29,827,929			$	28,096,884

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Property and Equipment

Property and equipment consists of the following as of December 31, 2010 and 2009:

		December 31,
		2010				2009
Buildings and building improvements		$	8,072,716			$	7,904,870
Furniture, fixtures and equipment			20,830,220				12,912,917
Computers			2,334,427				3,644,992
Software			5,836,948				4,800,157
Leasehold improvements			2,379,597				1,117,712
Land			460,000				460,000
			39,913,908				30,840,648
Less accumulated depreciation			(10,488,361	)			(9,374,019	)
			29,425,547				21,466,629
Construction-in-progress			8,585,767				495,274
		$	38,011,314			$	21,961,903

The increases to furniture, fixtures and equipment primarily related to the expansion of the Company’s Las Vegas, Nevada distribution facility that was completed in 2010.

Construction-in-progress primarily related to the expansion of the Company’s Lexington, North Carolina distribution facility. The project is expected to be completed in 2011.

Note 4. Intangible Assets

Definite life intangible assets consist of the following as of December 31, 2010 and 2009:

		2010				2009
Customer lists			580,000				580,000
Internet domain names			66,750				66,750
			646,750				646,750
Less accumulated amortization			641,804				637,304
			4,946				9,446

The future estimated aggregate amortization expense on intangible assets as of December 31, 2010 is as follows:

Year Ending December 31,		Amount
2011		$	4,500
2012			446
		$	4,946

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5. Accrued Expenses

Accrued expenses consist of the following at December 31, 2010 and 2009:

		December 31,
		2010				2009
Derivative action settlement (Note 13)		$	3,500,000			$	—
Severances			2,266,544				—
Salaries			1,396,094				1,002,646
Professional services			1,305,761				121,511
Deferred rent			508,604				536,000
Leasehold improvement liability			321,395				264,122
Advertising			25,720				509,108
Other			1,347,747				849,089
		$	10,671,865			$	3,282,476

Note 6. Notes Payable

In February 2007 and in connection with the purchase of a new distribution center in North Carolina, the Company entered into a promissory note agreement in the amount of $3,360,000. The promissory note was to be repaid in monthly payments of principal and interest at a rate equal to one-month LIBOR plus 1.4% (1.63% as of December 31, 2009) with final payment of $2,688,166 due on February 14, 2014. The loan was collateralized by the property purchased. The note contained certain restrictive covenants, which required minimum financial ratios, including funded debt to EBITDA and a fixed coverage ratio. Borrowings outstanding as of December 31, 2009 were $3,121,903.

On April 23, 2007, the Company entered into a promissory note in the amount of $1,535,467 with a bank to finance the purchase of machinery and equipment. The note bears interest at one-month LIBOR plus 1.75% (1.98% as of December 31, 2009) and was payable in 60 monthly principal and interest payments. The note contained certain restrictive covenants, which required minimum financial ratios, including funded debt to EBITDA and a fixed coverage ratio. The note was collateralized by the equipment that was purchased. On October 11, 2007, the note was amended to increase borrowings by $313,796, totaling $1,849,263. Borrowings outstanding as of December 31, 2009 were $1,047,916.

On November 13, 2007, the Company entered into a promissory note in the amount of $2,521,797 with a bank to finance the purchase of machinery and equipment. The note bears interest at 1-month LIBOR plus 2.5% (2.73% as of December 31, 2009) and was payable in 60 monthly principal and interest payments. The note was amended on December 19, 2007 to increase the balance to $2,617,509. The note was collateralized by equipment purchased. Borrowings outstanding on the note as of December 31, 2009 were $1,570,506.

As a result of the amount accrued for the settlement discussed in Note 13, the Company was in violation with the funded debt to EBITDA covenant related to its promissory notes as of September 30, 2010 and thereafter. The Company repaid in full the outstanding borrowings under the promissory notes on December 13, 2010.

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 6. Notes Payable  – (continued)

Long term debt consists of the following as of December 31, 2010 and 2009:

		December 31,
		2010				2009
Note payable to a bank, payable in monthly installments of principal and interest at 1-month LIBOR plus 1.4%, collateralized by land and building.		$	—			$	3,121,903
Note payable to a bank, bearing interest at 1-month LIBOR plus 1.75%, payable in monthly installments of principal and interest through March 2012, collateralized by equipment			—				1,047,916
Note payable to a bank, payable in monthly installments of principal and interest at 1-month LIBOR plus 2.5% collateralized by equipment			—				1,570,506
Note payable to a financial institution, payable in monthly installments of principal and interest through July 2011, at a fixed rate of 6.98%, unsecured			58,888				170,686
			58,888				5,911,011
Less current maturities			58,888				1,090,969
		$	—			$	4,820,042

Line of Credit:  On August 3, 2007, the Company entered into a loan and security agreement with a financial institution with maximum borrowings equal to the lesser of $8,000,000 or the borrowing base amount which was based on a percentage of eligible inventories as outlined in the agreement. Borrowings made on the loan were used to repay term loans with a different financial institution. The initial term of the agreement was through August 2010 with the option to renew year to year unless terminated by either party. The agreement also provided for letters of credit up to $1,000,000. Borrowings bore interest at a rate equal to 1-month LIBOR plus 2.75%. The weighted average interest rate on the line of credit was 2.98% as of December 31, 2009. The line of credit was collateralized by all personal property of the Company excluding equipment. The line of credit contained certain restrictive covenants, which required minimum financial ratios, including funded debt to EBITDA and a fixed coverage ratio. Borrowings outstanding as of December 31, 2009 were $3,458,183, which included $753,183 of checks issued which had not cleared the bank. Amounts available on the line of credit as of December 31, 2009 were $4,541,817.

In October 2010, the Company entered into an amendment to modify and restate the loan and security agreement with maximum borrowings not to exceed $12,000,000 or the borrowing base amount as outlined in the agreement. The termination date was July 31, 2011 unless earlier terminated by either party. The line of credit was collateralized by all property of the Company excluding equipment. Borrowings bore interest at a rate equal to one-month LIBOR plus 2.25%. Fees associated with the amendment were not significant.

As a result of the amount accrued for the settlement discussed in Note 13, the Company was in violation with the funded debt to EBITDA covenant related the line of credit as of September 30, 2010 and thereafter. The Company repaid in full the outstanding borrowings under the line of credit on December 13, 2010.

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 7. Stock Option Plan

A summary of the Company’s stock option activity for common stock for the years ended December 31, 2010, 2009 and 2008 is as follows:

		Incentive Options
		Options Awards				Weighted Average Exercise Price				Weighted Average Grant Date Fair Value				Weighted Average Remaining Contractural Life (Years)				Aggregate Intrinsic Value
Outstanding, January 1, 2008			2,060,000			$	5.40			$	0.88				5.47				—
Granted			728,000				7.50				1.11				9.30				—
Exercised			—				—				—				—				—
Cancelled			—				—				—				—				—
Forfeited			(982,000	)			7.11				0.43				2.03				—
Outstanding, December 31, 2008			1,806,000			$	5.14			$	1.21				7.66				—
Granted			16,000				10.31				7.85				9.59				—
Exercised			(171,128	)			2.66				2.66				4.41			$	1,597,596
Cancelled			(154,192	)			3.49				0.66				5.10				—
Forfeited			(102,000	)			4.56				2.91				7.07				—
Outstanding, December 31, 2009			1,394,680			$	5.74			$	1.50				7.06			$	6,428,418
Granted			247,250				9.72				6.52				8.09				—
Exercised			(190,300	)			4.02				1.53				4.83			$	1,526,270
Cancelled			—				—				—				—				—
Forfeited			(183,500	)			7.86				2.85				9.53				—
Outstanding, December 31, 2010			1,268,130			$	6.47			$	2.28				7.89			$	204,970
Exercisable at December 31, 2009			891,488			$	5.60			$	1.22				6.83			$	4,172,083
Exercisable at December 31, 2010			925,121			$	5.63			$	1.26				5.93			$	199,218

		Nonqualified Options
		Options Awards				Weighted Average Exercise Price				Weighted Average Grant Date Fair Value				Weighted Average Remaining Contractural Life (Years)				Aggregate Intrinsic Value
Outstanding, January 1, 2008			925,200			$	2.00			$	0.58				6.08				—
Granted			63,200				7.50				0.83				10.00				—
Exercised			—				—				—				—				—
Cancelled			—				—				—				—				—
Forfeited			(72,000	)			7.50				2.49				8.50				—
Outstanding, December 31, 2008			916,400			$	1.95			$	0.41				5.15				—
Granted			503,200				11.63				6.88				9.84				—
Exercised			(60,400	)			0.25				0.25				2.54			$	709,738
Cancelled			—				—				—				—				—
Forfeited			(8,000	)			7.50				2.40				7.30				—
Outstanding, December 31, 2009			1,351,200			$	5.59			$	2.84				6.27			$	5,561,204
Granted			200,000				8.91				4.47				10.59				—
Exercised			(101,800	)			0.83				0.41				2.36			$	873,806
Cancelled			—				—				—				—				—
Forfeited			—				—				—				—				—
Outstanding, December 31, 2010			1,449,400			$	6.38			$	3.23				6.25			$	1,691,801
Exercisable at December 31, 2009			1,351,200			$	5.59			$	2.84				6.27			$	5,561,204
Exercisable at December 31, 2010			1,416,067			$	6.32			$	3.21				6.14			$	1,691,801

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 7. Stock Option Plan  – (continued)

As of December 31, 2010, 2009, and 2008, there was approximately $2,067,000, $1,026,000, and $1,196,000 of total unrecognized compensation cost, net of estimated forfeitures related to stock options granted under the Company’s stock plan, which is expected to be recognized over a weighted average period of 2.05 years.

On June 30, 2009 the Company amended the employment agreements of certain of its named executive officers including its Chief Executive Officer and Chief Financial Officer. Pursuant to the amendments, upon completion of an effective registration statement, all stock options currently owned by these officers would be fully vested and nonforfeitable and 430,000 additional fully vested nonforfeitable options would be issued to these officers. Based upon the completion of its initial public offering on September 23, 2009, the Company has accounted for the changes in the terms of the existing options as a modification under stock based compensation accounting and has recorded additional compensation expense of $7,976,304 for the year ended December 31, 2009. In connection with the grant of the 430,000 additional options, the Company recorded $2,920,560 of stock compensation expense.

During 2008, the Company canceled certain awards and concurrently issued replacement awards. The awards were accounted for as a modification of the original award. The Company recorded approximately $449,000 of incremental compensation cost in connection with the modification, which represents the excess fair value of the replacement award over the fair value of the canceled award at the date of modification.

Note 8. Stockholders’ Equity

On August 21, 2009, the Board of Directors approved a 4-for-5 reverse stock split of the Company’s common stock which was effected on September 17, 2009. All shares and per share information referenced throughout the consolidated financial statements have been retroactively adjusted to reflect this reverse stock split.

Note 9. Leases

Certain office space is leased under noncancelable operating leases expiring in various years through August 2016. Future minimum lease payments, by year, and in the aggregate, under operating leases are due as follows as of December 31, 2010:

Year Ending December 31,		Operating Leases
2011		$	1,491,172
2012			1,600,406
2013			1,702,372
2014			1,662,796
2015			591,145
Thereafter			1,990,219
Total minimum lease payments		$	9,038,109

The total rental expense included in the statements of operations for the years ended December 31, 2010, 2009, and 2008 were $2,137,137, $1,050,021, and $1,101,560, respectively.

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction and various state and local jurisdictions. Pursuant to applicable statutes of limitation, returns open for adjustment by the Internal Revenue Service (“IRS”) are the consolidated federal income tax returns for tax years ended December 31, 2006, December 31, 2007, December 31, 2008, and December 31, 2009. However, material amounts of net operating loss (“NOL”) carryforwards exist at the consolidated level, originating from the 1997 – 2000 and 2002 – 2005 tax years. Although the tax returns from the years of NOL origination prior to 2004 are not currently within the statute of limitations of the IRS, their future use will open the returns to audit exposure, specifically verification of the returns generating said NOLs. As such, the Company’s open years for consolidated federal returns are the tax years ended December 31, 1997 through December 31, 2009. This same range also represents the vast majority of open years for state returns.

A number of years may elapse before an uncertain tax position is audited and finally resolved. Settlement of any particular position would usually require the use of cash. The resolution of a matter would be recognized as an adjustment to the provision for income taxes and the effective tax rate in the period of resolution. The Company has determined that there are no material uncertain tax positions and accordingly no associated interest and penalties are required to be accrued at December 31, 2010 and 2009, respectively. The Company’s 2008 Federal income tax return is currently under examination by the IRS. At this time, the Company has not been notified of any potential adjustments to its 2008 Federal tax return.

Reconciliation of the federal statutory income tax rate to the Company’s effective tax rate is as follows:

		December 31,
		2010				2009				2008
Taxes computed at federal tax rate		$	(4,658,071	)		$	2,968,219			$	169,672
State income taxes, net of federal income tax benefit			432,630				53,372				14,971
Non-taxable income			(27,200	)			(17,000	)			—
Meals and entertainment			6,470				6,630				7,528
Incentive stock options			83,192				51,682				276,594
Other tax assets			(75,054	)			(226,837	)			12,863
Change in valuation allowance – state			320,959				—				—
Change in valuation allowance – federal			5,408,314				—				—
Income tax expense		$	1,491,240			$	2,836,066			$	481,628

The provision for income taxes charged to operations for the years ended December 31, 2010, 2009 and 2008, consists of the following:

		December 31,
		2010				2009				2008
Current tax expense (benefit)		$	(1,559,690	)		$	1,318,445			$	63,342
Deferred tax expense			3,050,930				1,517,621				418,286
Income tax expense		$	1,491,240			$	2,836,066			$	481,628

VITACOST.COM, INC
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Income Taxes  – (continued)

The tax effects of temporary differences that give rise to significant components of deferred tax assets at December 31, 2010 and 2009 are presented below:

		December 31,
		2010				2009
Deferred tax assets:
Net operating loss carryforward		$	2,643,774			$	31,942
Inventory			364,597				269,467
Accrued compensation			144,040				173,756
Stock-based compensation			4,453,272				4,176,717
Accrued expenses			2,137,237				—
Interest rate swap			—				169,128
Deferred revenue			871,218				692,559
			10,614,138				5,513,569
Deferred tax liability:
Depreciation and amortization			(4,783,215	)			(2,984,028	)
Valuation Allowance			(6,352,312	)			—
Deferred tax asset (liability), net		$	(521,389	)		$	2,529,541