TMCnet News
VITAMIN SHOPPE, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements and notes thereto included as part of this quarterly report on Form 10-Q. The discussion in this section contains forward-looking statements that are based upon current expectations. We sometimes identify forward-looking statements with such words as "may", "expect", "intend", "anticipate", "plan", "believe", "seek", "estimate", "outlook", "trends", "future benefits", "strategies", "goals" and similar words concerning future events. The forward-looking statements contained herein, include, without limitation, statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, general and administrative expenses, capital resources, liquidity, capital expenditures, new stores, integration of acquisitions, retail inflation, additional financings or borrowings and are subject to risks and uncertainties including, but not limited to, those discussed below and elsewhere in this quarterly report on Form 10-Q that could cause actual results to differ materially from the results contemplated by these forward-looking statements. We also urge you to carefully review the risk factors set forth in Item 1A-"Risk Factors" in our Fiscal 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 25, 2014 (the "Fiscal 2013 Form 10-K"). 15-------------------------------------------------------------------------------- Table of Contents Company Overview We are a multi-channel specialty retailer and contract manufacturer of vitamins, minerals, herbs, specialty supplements, sports nutrition and other health and wellness products. As of September 27, 2014, we operated 701 stores in 44 states, the District of Columbia, Puerto Rico and Ontario, Canada and sold our products directly to consumers through the internet, primarily atwww.vitaminshoppe.com and www.supersup.com, and our catalog. We market over 900 nationally recognized brands as well as our own brands, which include Vitamin Shoppe®, BodyTech®, True Athlete®, Mytrition®, plnt™, ProBioCare™ , Next Step™, Nutri-Force® Sport and Betancourt Sports Nutrition. We believe we offer one of the greatest varieties of products among vitamin, mineral and supplement ("VMS") retailers with approximately 8,000 stock keeping units ("SKUs") offered in our typical store and approximately 17,000 additional SKUs available through our e-commerce and other direct sales channels. Our broad product offering enables us to provide our customers with a selection of products that is not readily available at other specialty retailers or mass merchants, such as discount stores, supermarkets, drugstores and wholesale clubs. We believe our extensive product offering, together with our well-known brand name and emphasis on product education and customer service, help us bond with our target customer and serve as a foundation for strong customer loyalty. On June 6, 2014, the Company acquired all of the outstanding equity interests of Nutri-Force, a company which provides custom manufacturing and private labeling of vitamins, dietary supplements, nutraceuticals and nutritional supplements, as well as, develops and markets its own branded products. The total purchase price is expected to be approximately $85.6 million, including approximately $4.0 million of contingent consideration. Refer to Note 2. Acquisition and Note 12. Segment Data in the Notes to Condensed Consolidated Financial Statements (unaudited) for additional information. We expect to incur approximately $1.0 million during Fiscal 2014 for integration costs related to the acquisition of Nutri-Force, of which we have incurred $0.2 million during the nine months ended September 27, 2014. We currently anticipate incurring approximately $1.0 million for such integration costs in Fiscal 2015. On February 14, 2013, the Company acquired substantially all of the assets and assumed certain liabilities of Super Supplements, a specialty retailer of vitamins, minerals, specialty supplements and sports nutrition, including 31 retail locations in the Pacific Northwest, a distribution center in Seattle, Washington and an e-commerce business. The total purchase price was $50.5 million in cash and the assumption of certain liabilities. Highlights for the Third Quarter of Fiscal 2014 • Total net sales increased 13.4% • Total comparable net sales increased 3.8% • E-commerce sales increased 10.5% • Diluted net income per common share of $0.40 • Acquisition-related items per common share of $0.07 • Opened 23 new stores Segment Information We operate through three business segments: retail, which includes Vitamin Shoppe, Super Supplements and Vitapath retail store formats, direct, which consists of our e-commerce and catalog formats, and manufacturing, which consists of the Nutri-Force manufacturing operations. Retail. Through our Vitamin Shoppe, Super Supplements and Vitapath retail stores, we believe we operate a unique retail store concept in the VMS industry, which has been successful in diverse geographic and demographic markets, ranging from urban locations in New York City to suburban locations in Plantation, Florida and Manhattan Beach, California. Our stores carry a broad selection of VMS products and are staffed with experienced and knowledgeable employees ("Health Enthusiasts") who are able to inform our customers about product features and assist in product selection. We continue to pursue new store growth. Since the beginning of 2012 through September 27, 2014, we have opened 150 new stores and acquired 31 stores, expanding our presence in our existing markets as well as entering new markets. We expect our new stores to reach sales more consistent with our mature store base over an 16 -------------------------------------------------------------------------------- Table of Contents approximate four to five year time period. In addition, our new stores since the beginning of Fiscal 2013 average approximately 3,000 square feet compared to the average of our total store portfolio of approximately 3,600 square feet. This strategy has allowed us to increase our sales per square foot without impacting the breadth of our product assortment. Direct. We sell our products directly to consumers through the internet, primarily at www.vitaminshoppe.com and www.supersup.com. Our e-commerce sites and our catalog complement our in-store experience by extending our retail product offerings with approximately 17,000 additional SKUs that are not available in our stores and enable us to access customers outside our retail markets and those who prefer to shop online. Manufacturing. Through Nutri-Force, we provide custom manufacturing and private labeling of VMS products and develop and market our own branded products for both sales to third parties and for the VSI product assortment. Trends and Other Factors Affecting Our Business Our performance is affected by industry trends including demographic, health and lifestyle preferences, as well as other factors, which we may not foresee. For example, our industry is subject to potential regulatory actions and other legal matters that could affect the viability of a given product. Variable consumer trends, such as those described in the following paragraph, as well as the overall impact on consumer spending, which may be affected heavily by current economic conditions, can dramatically affect purchasing patterns. Our business allows us to respond to changing industry trends by introducing new products and adjusting our product mix and sales incentives. We will continue to diversify our product lines in the attempt to offer items less susceptible to the effects of economic conditions. Additionally, our performance is affected by competitive trends such as changes in promotional strategies or expansion of product assortment by various competitors. Our performance is also affected by trends in product mix and channel penetration. While our sports nutrition category continues to be among our fastest growing categories, product margins within the sports nutrition category are historically lower than other product categories. In addition, our e-commerce sales growth rate is expected to be higher than the sales growth rate for our retail stores. As our e-commerce business has historically operated at a lower gross margin than our retail stores, the increased penetration of the e-commerce channel may adversely affect our gross margins. The acquisition of Nutri-Force will also affect our performance as this manufacturing operation historically generates lower margins than our retail and direct operations. In addition, as a result of fair value accounting for the acquisition of Nutri-Force, a preliminary purchase accounting adjustment of $4.5 million was recorded for the step up of inventory to its market value. During the second and third quarter of Fiscal 2014, $1.2 million and $3.3 million, respectively, of the valuation step up related to inventory sold during these periods was charged to cost of goods sold which negatively impacted our results. Sales of weight management products are generally more sensitive to consumer trends, such as increased demand for products recommended by media personalities, resulting in higher volatility than our other products. Our sales of weight management products have been significantly influenced by the rapid increase and subsequent decline of products such as those containing ephedra, DMAA (1.3 dimethylpentylamine/dimethylamylamine/13-dimethylamylamine), low carb products, and certain thermogenic products. Accordingly, we launch new weight management products on an ongoing basis in response to prevailing market conditions and consumer demands. In addition to the weight management product lines, we intend to continue our focus in meeting the demands of an increasingly aging population, the effects of increasing costs of traditional healthcare and a rapidly growing fitness conscious public. Our historical results have also been significantly influenced by our new store openings. Since the beginning of 2012, we have opened 150 stores, acquired 31 stores and as of September 27, 2014 operate 701 stores located in 44 states, the District of Columbia, Puerto Rico and Ontario, Canada. New stores typically require approximately four to five years to mature, generating lower store level sales in the initial years than our mature stores. As a result, new stores generally have a negative impact on our overall operating margin. In addition, we have reduced the average store size since Fiscal 2011, as we have improved our inventory replenishment systems. Our new stores beginning in Fiscal 2013 are approximately 3,000 square feet 17-------------------------------------------------------------------------------- Table of Contents compared to our mature stores which are approximately 3,600 square feet. Additionally, stores opened in new markets have lower brand awareness compared to stores in existing markets, and as a result initially experience a lower sales volume than stores opened in existing markets. As a result of these trends, our recently opened stores have produced lower sales volume than historical sales trends. As these stores mature, we expect them to contribute to our operating results. With the opening of our Ashland, Virginia distribution center in Fiscal 2013, the Company plans to increase volume and productivity of this facility through Fiscal 2014 and as a result expects higher supply chain costs as a percentage of sales during Fiscal 2014. The Company expects supply chain costs as a percentage of sales to decline in Fiscal 2015. Critical Accounting Policies Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included in our financial statements for Fiscal 2013, Fiscal 2012, and Fiscal 2011 in the Fiscal 2013 Form 10-K. A discussion of our critical accounting policies and estimates is included in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Fiscal 2013 Form 10-K. Management has discussed the development and selection of these policies with the Audit Committee of our Board of Directors, and the Audit Committee of our Board of Directors has reviewed the disclosures relating to them. Management believes there have been no material changes to the critical accounting policies or estimates reported in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the Fiscal 2013 Form 10-K. General Definitions for Operating Results Net Sales consist of sales, net of sales returns, deferred sales, customer incentives and a provision for estimated future returns, from comparable and non comparable sales. Total comparable net sales includes sales generated by retail stores after 410 days of operation, e-commerce sales, and sales generated by acquired retail stores from the Super Supplements acquisition after 365 days. Sales to third parties of manufactured products generated by Nutri-Force are considered non comparable sales. Cost of goods sold includes the cost of inventory sold, costs of warehousing, distribution, manufacturing and store occupancy costs and excludes depreciation and amortization related to the retail and direct segments that is included within selling, general and administrative expenses. Warehousing, distribution and manufacturing costs, which are capitalized into inventory and then expensed as merchandise is sold, include freight to transfer merchandise, rent for the distribution centers and costs associated with our buying department and distribution facilities, including payroll. Store occupancy costs include rent, common area maintenance, real estate taxes and utilities. Gross profit is net sales minus cost of goods sold. Selling, general and administrative expenses consist of depreciation and amortization of fixed and intangible assets, operating payroll and related benefits, advertising and promotion expense, and other selling, general and administrative expenses. Income from operations consists of gross profit minus selling, general and administrative expenses. Interest expense, net includes interest on our revolving credit facility, along with letters of credit fees, interest on our capital leases, as well as amortization of financing costs, offset with interest income earned from highly liquid investments (investments purchased with an original maturity of three months or less). 18 -------------------------------------------------------------------------------- Table of Contents Key Performance Indicators and Statistics We use a number of key indicators of financial condition and operating results to evaluate the performance of our business, including the following (in thousands): Three Months Ended Nine Months Ended September 27, September 28, September 27, September 28, 2014 2013 2014 2013 Net sales $ 308,910 $ 272,472 $ 922,964 $ 831,042 Increase in total comparable net sales (1) 3.8 % 3.5 % 4.2 % 4.1 % Increase in comparable store net sales 3.1 % 2.6 % 3.1 % 3.1 % Gross profit as a percent of net sales 31.5 % 34.2 % 33.6 % 35.1 % Income from operations $ 20,549 $ 26,102 $ 82,962 $ 91,367 (1) Total comparable net sales are comprised of comparable retail store sales and e-commerce sales. The following table shows the growth in our network of stores during the three and nine months ended September 27, 2014 and September 28, 2013: Three Months Ended Nine Months Ended September 27, September 28, September 27, September 28, 2014 2013 2014 2013 Store Data: Stores open at beginning of period 678 630 659 579 Stores opened 23 10 44 33 Stores acquired - - - 31 Stores closed - - (2 ) (3 ) Stores open at end of period 701 640 701 640 Total retail square footage at end of period (in thousands) 2,523 2,334 2,523 2,334 Average store square footage at end of period 3,599 3,647 3,599 3,647 Results of Operations The information presented below is for the three and nine months ended September 27, 2014 and September 28, 2013 and was derived from our condensed consolidated financial statements, which, in the opinion of management, include all adjustments necessary for a fair presentation of our financial position and operating results for such periods and as of such dates. The following table summarizes our results of operations for the three and nine months ended September 27, 2014 and September 28, 2013 as a percentage of net sales: Three Months Ended Nine Months Ended September 27, September 28, September 27, September 28, 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 68.5 % 65.8 % 66.4 % 64.9 % Gross profit 31.5 % 34.2 % 33.6 % 35.1 % Selling, general and administrative expenses 24.8 % 24.6 % 24.6 % 24.1 % Income from operations 6.7 % 9.6 % 9.0 % 11.0 % Interest expense, net 0.0 % 0.1 % 0.0 % 0.0 % Income before provision for income taxes 6.6 % 9.5 % 9.0 % 10.9 % Provision for income taxes 2.7 % 3.5 % 3.6 % 4.3 % Net income 3.9 % 6.0 % 5.4 % 6.7 % Figures may not sum due to rounding. 19-------------------------------------------------------------------------------- Table of Contents Three Months Ended September 27, 2014 Compared To Three Months Ended September 28, 2013 Net Sales Net sales increased $36.4 million, or 13.4%, to $308.9 million for the three months ended September 27, 2014 compared to $272.5 million for the three months ended September 28, 2013. The increase was the result of an increase in our total comparable net sales of $10.3 million, or 3.8%, as well as an increase in our non-comparable sales of $26.1 million, which includes $17.2 million from Nutri-Force. Sales increased primarily in the Sports Nutrition category which increased $7.5 million and in the Other category which increased $8.3 million primarily due to new product introductions. Retail Net sales from our retail stores increased $16.4 million, or 6.7%, to $260.3 million for the three months ended September 27, 2014 compared to $243.9 million for the three months ended September 28, 2013. We operated 701 stores as of September 27, 2014 compared to 640 stores as of September 28, 2013. Store sales increased due to an increase in comparable retail store sales of $7.4 million, or 3.1%, and an increase in non-comparable store sales of $9.0 million. The increase in comparable store sales was primarily driven by customer traffic. Direct Net sales to our direct customers increased $2.8 million, or 9.7%, to $31.3 million for the three months ended September 27, 2014 compared to $28.6 million for the three months ended September 28, 2013. The increase in our direct sales was due to an increase in our e-commerce sales of 10.5% which was offset in part by a decrease in our catalog sales. The increase in e-commerce sales was largely due to retention marketing programs. We continue to reduce our catalog circulation and customer prospecting as we believe catalog purchasing in general is declining in popularity as a purchasing medium, especially in light of the growth of on-line shopping. Manufacturing Net sales to third party manufacturing customers was $17.2 million for the three months ended September 27, 2014. Cost of Goods Sold Cost of goods sold increased $32.2 million, or 17.9%, to $211.6 million for the three months ended September 27, 2014 compared to $179.4 million for the three months ended September 28, 2013. The dollar increase was primarily due to an increase in sales. Cost of goods sold as a percentage of net sales increased to 68.5% for the three months ended September 27, 2014, compared to 65.8% for the three months ended September 28, 2013. The increase of cost of goods sold as a percentage of net sales was primarily due to 1.5% resulting from the acquired manufacturing operations, 0.6% due primarily to changes in product mix and higher coupon discounts and 0.4% of supply chain costs related to the recognition of previously capitalized inventory costs. As a result of fair value accounting for the acquisition of the Nutri-Force manufacturing operation, a preliminary purchase accounting adjustment of $4.5 million was recorded for the step up of inventory to its market value. During the three months ended September 27, 2014, $3.3 million, or 1.1% of net sales, of the inventory valuation step up related to inventory sold during this period and negatively impacted cost of goods sold. The remaining $1.2 million was charged to cost of goods sold during the second quarter of Fiscal 2014. Gross Profit As a result of the foregoing, gross profit increased $4.2 million, or 4.6%, to $97.3 million for the three months ended September 27, 2014 compared to $93.1 million for the three months ended September 28, 2013. Gross profit as a percentage of sales decreased to 31.5% for the three months ended September 27, 2014 compared to 34.2% for the three months ended September 28, 2013. 20-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses Selling, general and administrative expenses increased $9.8 million, or 14.6%, to $76.7 million during the three months ended September 27, 2014, compared to $67.0 million during the three months ended September 28, 2013. The components of selling, general and administrative expenses are explained below. Selling, general and administrative expenses as a percentage of net sales for the three months ended September 27, 2014 increased to 24.8% compared to 24.6% for the three months ended September 28, 2013. Operating payroll and related benefits increased $2.8 million, or 10.5%, to $29.8 million for the three months ended September 27, 2014 compared to $27.0 million for the three months ended September 28, 2013. Operating payroll and related benefits expenses as a percentage of net sales for the three months ended September 27, 2014 decreased to 9.6% compared to 9.9% for the three months ended September 28, 2013. The decrease in operating payroll and related benefits as a percentage of net sales is primarily the result of leverage from the addition of Nutri-Force net sales partially offset by higher average wage rates for the three months ended September 27, 2014 compared to the three months ended September 28, 2013. Advertising and promotion expenses increased $1.8 million, or 50.5%, to $5.3 million for the three months ended September 27, 2014 compared to $3.5 million for the three months ended September 28, 2013. Advertising and promotion expenses as a percentage of net sales increased to 1.7% during the three months ended September 27, 2014 compared to 1.3% during the three months ended September 29, 2013. The increase in advertising and promotion expenses as a percentage of net sales is primarily due to increases in direct to consumer and on-line advertising and promotions. Other selling, general and administrative expenses, which include depreciation and amortization expense, increased $5.2 million, or 14.2%, to $41.7 million for the three months ended September 27, 2014 compared to $36.5 million for the three months ended September 28, 2013. The dollar increase in other selling, general and administrative expenses was primarily due to $2.5 million of costs related to the addition of Nutri-Force and an increase in depreciation and amortization expense of $1.7 million in the three months ended September 27, 2014, partially offset by costs related to the acquisition and integration of Super Supplements of $0.9 million in the three months ended September 28, 2013. Other selling, general and administrative expenses as a percentage of net sales increased to 13.5% for the three months ended September 27, 2014 compared to 13.4% for the three months ended September 28, 2013. Income from Operations As a result of the foregoing, income from operations decreased $5.6 million, or 21.3%, to $20.5 million for the three months ended September 27, 2014 compared to $26.1 million for the three months ended September 28, 2013. Income from operations as a percentage of net sales decreased to 6.7% during the three months ended September 27, 2014 as compared to 9.6% during the three months ended September 28, 2013. Retail Income from operations for the retail segment decreased $1.5 million, or 3.1%, to $45.9 million for the three months ended September 27, 2014 compared to $47.4 million for the three months ended September 28, 2013. Income from operations as a percentage of net sales for the retail segment decreased to 17.6% for the three months ended September 27, 2014 compared to 19.4% for the three months ended September 28, 2013. The decrease as a percentage of net sales was primarily the result of 0.5% in supply chain costs, 0.5% primarily resulting from changes in product mix and higher coupon discounts, 0.4% due to advertising and promotion expenses and 0.3% resulting from payroll and benefits costs. Direct Income from operations for the direct segment decreased $0.5 million, or 9.1%, to $4.9 million for the three months ended September 27, 2014 compared to $5.4 million for the three months ended September 28, 2013. Income from operations as a percentage of net sales for the direct segment decreased to 15.7% for the three months ended September 27, 2014 compared to 19.0% for the three months ended September 28, 2013. The decrease as a percentage of net sales was primarily the result of 1.3% in advertising costs, 1.1% resulting primarily from changes in product mix and higher coupon discounts and 0.5% in payroll and benefits costs. 21 -------------------------------------------------------------------------------- Table of Contents Manufacturing Loss from operations for the manufacturing segment was $2.1 million for the three months ended September 27, 2014. Excluding $3.3 million of charges related to the inventory valuation step up for inventory sold during this three month period, income from operations for the manufacturing segment was $1.2 million, or 6.8% as a percentage of net sales for the manufacturing segment. Corporate Costs Corporate costs increased $1.5 million, or 5.4%, to $28.2 million during the three months ended September 27, 2014 compared to $26.7 million for the three months ended September 28, 2013. Corporate costs as a percentage of net sales decreased to 9.1% for the three months ended September 27, 2014 compared to 9.8% for the three months ended September 28, 2013. The dollar increase in corporate costs was primarily due to an increase in depreciation and amortization expense of $1.4 million. Provision for Income Taxes We recognized $8.2 million of income tax expense during the three months ended September 27, 2014 compared to $9.7 million during the three months ended September 28, 2013. The effective tax rate for the three months ended September 27, 2014 was 40.2%, compared to 37.3% for the three months ended September 28, 2013. The effective tax rate increased primarily due to the reversal of charges previously recorded relating to uncertain tax positions due to the expiration of the applicable statutes of limitations during the three months ended September 28, 2013. Net Income As a result of the foregoing, we generated net income of $12.2 million in the three months ended September 27, 2014 compared to net income of $16.3 million in the three months ended September 28, 2013. Nine Months Ended September 27, 2014 Compared To Nine Months Ended September 28, 2013 Net Sales Net sales increased $91.9 million, or 11.1%, to $923.0 million for the nine months ended September 27, 2014 compared to $831.0 million for the nine months ended September 28, 2013. The increase was the result of an increase in our total comparable net sales of $34.3 million, or 4.2%, as well as an increase in our non-comparable sales of $57.6 million, which includes $21.4 million from Nutri-Force. Sales increased primarily in the Sports Nutrition category which increased $31.6 million and in the Other category which increased $25.5 million primarily due to new product introductions. Retail Net sales from our retail stores increased $59.2 million, or 8.0%, to $802.4 million for the nine months ended September 27, 2014 compared to $743.2 million for the nine months ended September 28, 2013. We operated 701 stores as of September 27, 2014 compared to 640 stores as of September 28, 2013. Store sales increased due to an increase in comparable retail store sales of $23.1 million, or 3.1%, and an increase in non-comparable store sales of $36.1 million, which includes $9.4 million from Super Supplements stores. The increase in comparable store sales was primarily driven by customer traffic. 22-------------------------------------------------------------------------------- Table of Contents Direct Net sales to our direct customers increased $11.3 million, or 12.9%, to $99.1 million for the nine months ended September 27, 2014 compared to $87.9 million for the nine months ended September 28, 2013. The increase in our direct sales was due to an increase in our e-commerce sales of 14.2% which was offset in part by a decrease in our catalog sales. The increase in e-commerce sales was largely due to retention marketing programs. We continue to reduce our catalog circulation and customer prospecting as we believe catalog purchasing in general is declining in popularity as a purchasing medium, especially in light of the growth of on-line shopping. Manufacturing Net sales to third party manufacturing customers was $21.4 million for the nine months ended September 27, 2014. Cost of Goods Sold Cost of goods sold increased $74.2 million, or 13.8%, to $613.3 million for the nine months ended September 27, 2014 compared to $539.1 million for the nine months ended September 28, 2013. The dollar increase was primarily due to an increase in sales. Cost of goods sold as a percentage of net sales increased to 66.4% for the nine months ended September 27, 2014, compared to 64.9% for the nine months ended September 28, 2013. The increase of cost of goods sold as a percentage of net sales was primarily due to 0.7% resulting from the acquired manufacturing operations and 0.6 % due to supply chain costs. Gross Profit As a result of the foregoing, gross profit increased $17.7 million, or 6.1%, to $309.7 million for the nine months ended September 27, 2014 compared to $292.0 million for the nine months ended September 28, 2013. Gross profit as a percentage of sales decreased to 33.6% for the nine months ended September 27, 2014 compared to 35.1% for the nine months ended September 28, 2013. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $26.1 million, or 13.0%, to $226.7 million during the nine months ended September 27, 2014, compared to $200.6 million during the nine months ended September 28, 2013. The components of selling, general and administrative expenses are explained below. Selling, general and administrative expenses as a percentage of net sales for the nine months ended September 27, 2014 increased to 24.6% compared to 24.1% for the nine months ended September 28, 2013. Operating payroll and related benefits increased $9.2 million, or 11.5%, to $89.0 million for the nine months ended September 27, 2014 compared to $79.8 million for the nine months ended September 28, 2013. Operating payroll and related benefits expenses as a percentage of net sales was 9.6% for both the nine months ended September 27, 2014 and the nine months ended September 28, 2013. Advertising and promotion expenses increased $2.4 million, or 18.4%, to $15.3 million for the nine months ended September 27, 2014 compared to $12.9 million for the nine months ended September 28, 2013. Advertising and promotion expenses as a percentage of net sales increased to 1.7% during the nine months ended September 27, 2014 compared to 1.6% during the nine months ended September 28, 2013. Other selling, general and administrative expenses, which include depreciation and amortization expense, increased $14.5 million, or 13.5%, to $122.3 million for the nine months ended September 27, 2014 compared to $107.8 million for the nine months ended September 28, 2013. The dollar increase in other selling, general and administrative expenses was primarily due to an increase in depreciation and amortization of $5.0 million, acquisition and integration expenses of $4.3 million and costs related to the addition of Nutri-Force of $3.2 million. The nine months ended September 28, 2013 included proceeds from insurance recoveries of $1.1 million and costs related to the acquisition and integration of Super Supplements of $3.9 million. Other selling, general and administrative expenses as a percentage of net sales increased to 13.3% for the nine months ended September 27, 2014 compared to 13.0% for the nine months ended September 28, 2013. 23 -------------------------------------------------------------------------------- Table of Contents Income from Operations As a result of the foregoing, income from operations decreased $8.4 million, or 9.2%, to $83.0 million for the nine months ended September 27, 2014 compared to $91.4 million for the nine months ended September 28, 2013. Income from operations as a percentage of net sales decreased to 9.0% during the nine months ended September 27, 2014 as compared to 11.0% during the nine months ended September 28, 2013. Retail Income from operations for the retail segment increased $0.7 million, or 0.5%, to $154.4 million for the nine months ended September 27, 2014 compared to $153.6 million for the nine months ended September 28, 2013. Income from operations as a percentage of net sales for the retail segment decreased to 19.2% for the nine months ended September 27, 2014 compared to 20.7% for the nine months ended September 28, 2013. The decrease as a percentage of net sales was primarily due to supply chain costs of 0.7% and payroll related benefits costs of 0.4% during the nine months ended September 27, 2014 as compared to the nine months ended September 28, 2013. Direct Income from operations for the direct segment increased $1.2 million, or 7.1%, to $17.7 million for the nine months ended September 27, 2014 compared to $16.5 million for the nine months ended September 28, 2013. Income from operations as a percentage of net sales for the direct segment decreased to 17.9% for the nine months ended September 27, 2014 compared to 18.8% for the nine months ended September 28, 2013. This decrease was primarily due to general operating expenses of 0.6% and advertising and promotion expenses of 0.2% as a percentage of net sales. Manufacturing Loss from operations for the manufacturing segment was $3.0 million for the nine months ended September 27, 2014. Excluding $4.5 million of charges related to the inventory valuation step up for inventory sold subsequent to the acquisition, income from operations for the manufacturing segment was $1.5 million, or 7.0% as a percentage of net sales for the manufacturing segment. Corporate Costs Corporate costs increased $7.3 million, or 9.3%, to $86.1 million during the nine months ended September 27, 2014 compared to $78.8 million for the nine months ended September 28, 2013. Corporate costs as a percentage of net sales decreased to 9.3% for the nine months ended September 27, 2014 compared to 9.5% for the nine months ended September 28, 2013. The dollar increase in corporate costs was primarily due to an increase in depreciation and amortization of $4.5 million and acquisition and integration expenses of $4.3 million. The nine months ended September 28, 2013 included proceeds from insurance recoveries of $1.1 million and costs related to the acquisition and integration of Super Supplements of $3.9 million. Provision for Income Taxes We recognized $33.0 million of income tax expense during the nine months ended September 27, 2014 compared to $35.7 million during the nine months ended September 28, 2013. The effective tax rate for the nine months ended September 27, 2014 was 39.9%, compared to 39.2% for the nine months ended September 28, 2013. The effective tax rate increased primarily due to the reversal of charges previously recorded relating to uncertain tax positions due to the expiration of the applicable statutes of limitations during the nine months ended September 28, 2013. 24-------------------------------------------------------------------------------- Table of Contents Net Income As a result of the foregoing, we generated net income of $49.6 million in the nine months ended September 27, 2014 compared to net income of $55.3 million in the nine months ended September 28, 2013. Key Indicators of Liquidity and Capital Resources The following table provides key indicators of our liquidity and capital resources (in thousands): As of September 27, December 28, 2014 2013 Balance Sheet Data: Cash and cash equivalents $ 32,161 $ 74,036 Working capital 167,924 172,341 Total assets 754,405 682,064 Nine Months Ended September 27, September 28, 2014 2013 Other Information: Depreciation and amortization of fixed and intangible assets $ 25,060 $ 20,012 Cash Flows Provided By (Used In): Operating activities $ 69,159 $ 53,221 Investing activities (112,912 ) (82,959 ) Financing activities 1,867 2,817 Effect of exchange rate changes on cash and cash equivalents 11 (46 ) Net decrease in cash and cash equivalents $ (41,875 ) $ (26,967 ) Liquidity and Capital Resources Our primary uses of cash are to fund working capital, operating expenses and capital expenditures related primarily to the build-out of new stores, the remodeling of existing stores and information technology investments. Historically, we have financed our requirements predominately through internally generated cash flow. We believe that the cash generated by operations and cash and cash equivalents, together with the borrowing availability under our revolving credit facility, will be sufficient to meet our working capital needs for the next twelve months, our store growth plans, systems development and store improvements, as well as the repurchase of any shares of our common stock from time to time. In addition to the $81.5 million for the acquisition of Nutri-Force in the second quarter of Fiscal 2014, we expect to pay approximately $4.0 million of the contingent consideration related to this acquisition during the first half of Fiscal 2015. We plan to spend approximately $40 million in capital expenditures during Fiscal 2014, most of which pertains to new stores we anticipated opening throughout this year, the remodeling of existing stores and information technology investments. Of the total capital expenditures projected for Fiscal 2014, we have invested $30.8 million during the nine months ended September 27, 2014. We planned on opening approximately 60 new stores during Fiscal 2014, of which we have opened 44 stores as of September 27, 2014. Our working capital requirements for merchandise inventory will continue to increase as we continue to open additional stores. Currently, our practice is to establish an inventory level of approximately $155,000 at cost for each of our stores, the cost of which is partially offset by vendor incentive and allowance programs. Additionally, 30 day payment terms have been extended to us by some of our suppliers allowing us to effectively manage our inventory and working capital. 25 -------------------------------------------------------------------------------- Table of Contents The Company is subject to concentrations of credit risk associated with cash and cash equivalents, and at times holds cash balances in excess of Federal Deposit Insurance Corporation limits. Currently, the Company's cash management practice is to hold cash balances in quality institutions and invest in highly liquid and secure investments. We were in compliance with all debt covenants relating to our Revolving Credit Facility as of September 27, 2014. We expect to be in compliance with these same debt covenants during the remainder of Fiscal 2014 as well. Cash Provided by Operating Activities Net cash provided by operating activities was $69.2 million for the nine months ended September 27, 2014 as compared to $53.2 million for the nine months ended September 28, 2013. The $15.9 million increase in cash flows from operating activities is primarily due to increases in accrued expenses including the contingent consideration related to the acquisition of Nutri-Force as well as accruals for capital expenditures and operating activities. Cash Used in Investing Activities Net cash used in investing activities was $112.9 million during the nine months ended September 27, 2014 as compared to $83.0 million during the nine months ended September 28, 2013. The $30.0 million increase in cash used in investing activities is primarily due to the $81.5 million for the acquisition of Nutri-Force during the nine months ended September 27, 2014 partially offset by the $50.5 million for the acquisition of Super Supplements and costs for the Ashland, Virginia distribution center during the nine months ended September 28, 2013. Capital expenditures during the nine months ended September 27, 2014 and September 28, 2013 were used primarily for the build-out of new stores and improvements to existing stores, as well as computer equipment related to those stores. The Company opened 44 new stores during the nine months ended September 27, 2014 as compared to 33 new stores during the nine months ended September 28, 2013. Cash Provided by Financing Activities Net cash provided by financing activities was $1.9 million for the nine months ended September 27, 2014, as compared to $2.8 million for the nine months ended September 28, 2013. The $1.0 million decrease in cash provided by financing activities is primarily due to purchases of common stock under the Company's share repurchase program of $7.8 million and an increase in purchases of treasury stock of $2.0 million substantially offset by an increase in the proceeds from exercises of stock options of $4.9 million and an increase in the tax benefits on exercises of stock options of $4.0 million for the nine months ended September 27, 2014 as compared to the nine months ended September 28, 2013. Revolving Credit Facility The terms of our Revolving Credit Facility extend through October 11, 2018, and allow the Company to borrow up to $90.0 million, subject to the terms of the facility, with a Company option to increase the facility up to a total of $150.0 million. For information regarding the terms of our Revolving Credit Facility, refer to Note 6. Credit Arrangements in the Notes to Condensed Consolidated Financial Statements (unaudited). During the nine months ended September 27, 2014 there were no borrowings under the Revolving Credit Facility. The unused available line of credit under the Revolving Credit Facility at September 27, 2014 was $89.0 million. Contractual Obligations and Commercial Commitments Except as described in our Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2014, as filed with the Securities and Exchange Commission on August 5, 2014, there have been no other significant developments with respect to our contractual obligations since December 28, 2013. For additional information, see Contractual Obligations and Commercial Commitments under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", in the Fiscal 2013 Form 10-K. Off-Balance Sheet Arrangements We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any off-balance sheet arrangements or relationships with entities that are not consolidated into our financial statements that have or are reasonably likely to 26 -------------------------------------------------------------------------------- Table of Contents have a material current or future effect on our financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. The company has commitments for its operating leases, primarily related to its stores as well as its manufacturing and corporate facilities, which are not reflected on our balance sheet. For additional information, see Contractual Obligations and Commercial Commitments under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", in the Fiscal 2013 Form 10-K. Effects of Inflation We do not believe that our sales or operating results have been materially affected by inflation during the periods presented in our financial statements. During Fiscal 2014, retail price inflation has been at a rate below historical trends. During the remainder of Fiscal 2014, we anticipate retail inflation to occur at a rate more consistent with past trends of approximately 1% to 2%. Additionally, we may experience increased cost pressure from our suppliers which could have an adverse effect on our gross profit results in the future. Recent Accounting Pronouncements Except as discussed in Note 1. Basis of Presentation in the Notes to Condensed Consolidated Financial Statements (unaudited), the Company has considered all new accounting pronouncements and has concluded that there are no new pronouncements that may have a material impact on its results of operations, financial condition, or cash flows, based on current information. |