S-1/A 1 ds1a.htm AMENDMENT NO. 5 TO FORM S-1 Amendment No. 5 to Form S-1
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As filed with the Securities and Exchange Commission on October 21, 2009

Registration No. 333-160756

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT NO. 5 TO

FORM S-1

REGISTRATION STATEMENT

UNDER THE SECURITIES ACT OF 1933

 

 

VS HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   5400   11-3664322

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

2101 91st Street

North Bergen, New Jersey 07047

Telephone: (201) 868-5959

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

James M. Sander, Esq.

VS Holdings, Inc.

Vice President, General Counsel and Secretary

2101 91st Street

North Bergen, New Jersey 07047

Telephone: (201) 868-5959

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies of all communications, including communications sent to agent for service, should be sent to:

 

Christian O. Nagler, Esq.

Kirkland & Ellis LLP

601 Lexington Avenue

New York, NY 10022

Tel: (212) 446-4800

Fax: (212) 446-4900

 

Marc D. Jaffe, Esq.

Ian D. Schuman, Esq.

Latham & Watkins LLP

885 Third Avenue, Suite 1000

New York, NY 10022-4802

Tel: (212) 906-1200

Fax: (212) 751-4864

Approximate date of commencement of proposed sale to the public:    As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box:  ¨

If this Form is filed to registered additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

¨Large accelerated filer   ¨Accelerated filer  

xNon-accelerated filer

(Do not check if smaller

reporting company)

 

¨Smaller reporting company

CALCULATION OF REGISTRATION FEE

 

 

 

Title of Each Class of Securities to be

Registered

  Amount to be
Registered(1)
  Proposed Maximum
Offering Price Per
Share
  Proposed Maximum
Aggregate Offering
Price(2)
  Amount of
Registration Fee

Common stock, par value $0.01 per share

 

10,460,488

  $16.00   $167,367,808   $9,339.13(3)
 
 
(1) Includes 1,364,411 shares of common stock issuable upon exercise of an option to purchase additional shares granted to the underwriters.
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) under the Securities Act of 1933, as amended, based on an estimate of the proposed maximum aggregate offering price.
(3) Previously paid.

The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and neither we nor the selling stockholders are soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to Completion, Dated October 21, 2009

PROSPECTUS

9,096,077 Shares

LOGO

Vitamin Shoppe, Inc.

Common Stock

 

 

This is an initial public offering of common stock of Vitamin Shoppe, Inc.

We are offering 7,666,667 shares of our common stock, and the selling stockholders identified in this prospectus are offering an additional 1,429,410 shares. It is currently estimated that the initial public offering price per share will be between $14.00 and $16.00. We will not receive any proceeds from the sale of shares being sold by the selling stockholders.

Prior to this offering, no public market existed for our common stock. Our common stock has been approved for listing on The New York Stock Exchange under the symbol “VSI,” subject to official notice of issuance.

 

     Per Share    Total

Initial public offering price

   $                         $                     

Underwriting discounts and commissions

   $                         $                     

Proceeds to the Selling Stockholders, before expenses

   $                         $                     

Proceeds to Vitamin Shoppe, before expenses

   $                         $                     

The selling stockholders have granted the underwriters a 30-day option to purchase up to an additional 1,364,411 shares from them at the initial public offering price less the underwriting discounts and commissions.

Investing in our common stock involves a high degree of risk. See “Risk factors” beginning on page 10.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed on the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares on or about                     , 2009.

 

 

Joint Book-Running Managers

 

J.P.Morgan   BofA Merrill Lynch   Barclays Capital

Co-Managers

 

Piper Jaffray  

Robert W. Baird & Co.

 

Stifel Nicolaus

The date of this prospectus is                     , 2009


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LOGO


Table of Contents

TABLE OF CONTENTS

 

Prospectus Summary

   1

Summary Historical and Pro Forma Consolidated Financial Data

   8

Risk Factors

   10

Special Note Regarding Forward-Looking Statements

   17

Use of Proceeds

   18

Dividend Policy

   18

Holders of Common Equity

   18

Capitalization

   19

Dilution

   20

Unaudited Pro Forma Condensed Consolidated Financial Statements

   22

Selected Historical Consolidated Financial Data

   26

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   28

Business

   50

Management

   65

Compensation Discussion and Analysis

   69

Principal and Selling Stockholders

   84

Certain Relationships and Related Party Transactions

   86

Description of Capital Stock

   89

Shares Eligible for Future Sale

   94

Material U.S. Federal Income Tax Considerations

   96

Underwriting (Conflict of Interest)

   98

Legal Matters

   106

Experts

   106

Where You Can Find Additional Information

   106

Index to Consolidated Financial Statements

   F-1

You should rely only on the information contained in this prospectus, any free writing prospectus prepared by us or information to which we have referred you. We have not, the selling stockholders have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, the selling stockholders are not, and the underwriters are not, making an offer to sell, or soliciting an offer to buy, these securities in any jurisdiction where such offer, sale or solicitation is not permitted. You should assume that the information appearing in this prospectus and any free writing prospectus prepared by us is accurate only as of its respective date. Our business, financial condition, results of operations and prospects may have changed since such date.


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PROSPECTUS SUMMARY

This summary highlights material information regarding the offering contained elsewhere in this prospectus, but may not contain all of the information that may be important to you. As used herein, the “Company,” “we,” “us” and “our” refer to VS Holdings, Inc., which will be renamed “Vitamin Shoppe, Inc.” after the merger of our parent, VS Parent, Inc., into VS Holdings, Inc. prior to the consummation of this offering. References to “VMS” mean vitamins, minerals, herbs, supplements, sports nutrition and other health and wellness products. You should read this entire prospectus, including the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes thereto, before deciding whether to invest in our common stock.

Overview

We are a leading specialty retailer and direct marketer of vitamins, minerals, herbs, supplements, sports nutrition and other health and wellness products. For each of the past five years, we have been the second largest in retail sales and the fastest growing national VMS specialty retailer. We market over 700 different nationally recognized brands as well as our proprietary Vitamin Shoppe, BodyTech and MD Select brands. We believe we offer the greatest variety of products among VMS retailers with approximately 8,000 stock keeping units (“SKUs”) offered in our typical store and an additional 12,000 SKUs available through our Internet and other direct sales channels. We target the dedicated, well-informed VMS consumer and differentiate ourselves by providing high quality products at competitive prices in an educational and high-touch customer service environment. We believe our extensive product offerings, 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.

We sell our products through two business segments: retail and direct. In our retail segment, we have leveraged our successful store economic model by opening a total of 171 new stores from the beginning of fiscal year 2005 through fiscal year 2008. As of September 25, 2009, we operated 434 stores in 37 states and the District of Columbia, located in high-traffic regional retail centers. In our direct segment, we sell our products directly to consumers through our websites, primarily www.vitaminshoppe.com, and our catalog. Our websites and our catalog complement our in-store experience by extending our retail product offerings and by enabling us to access customers outside our retail markets and those who prefer to shop online.

We have grown our net sales from $436.5 million in fiscal year 2005 to $601.5 million in fiscal year 2008, representing a compound annual growth rate (“CAGR”) of 11.3%. We have achieved positive comparable store sales for 15 consecutive years (prior to which we did not track comparable store sales) and have grown our retail sales from $362.2 million in 2005 to $522.5 million in 2008, representing a CAGR of 13.0%. We believe our industry performs well through economic cycles, including the current economic recession, and we have generated comparable store sales increases of 6.2% in each of 2007 and 2008, and 4.7% and 7.2% for the six months ended June 27, 2009 and June 28, 2008, respectively.

Industry

According to the Nutrition Business Journal (“NBJ”), sales of nutritional supplements in the United States in 2008 were approximately $25.2 billion, representing a 4.9% CAGR between 2001 and 2008. The NBJ forecasts 4.5% average annual growth for U.S. nutritional supplement sales through 2014. We believe that one of the primary trends driving the industry is consumption by the over-50 demographic, including Baby Boomers

 

 

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(those born between 1946 and 1964), who seek to improve their health and wellness and treat and prevent disease and illness. According to the U.S. Census, the total U.S. population of people 50 and older is expected to increase to 115 million people in 2018 from 94 million people in 2008, representing a CAGR of 2.1%, which is more than twice the overall population growth rate.

According to the NBJ, growth in the U.S. nutritional supplement industry is expected to be led by the specialty supplements and sports nutrition product categories. Based on NBJ forecasts, from 2009 to 2014, the U.S. specialty supplements product category is expected to grow approximately 38% faster than the overall industry, and the sports nutrition product category is expected to grow approximately 29% faster than the overall industry. Our sales are concentrated in these fastest-growing categories; the specialty supplements and sports nutrition product categories represented 27.4% and 29.0%, respectively, of our fiscal 2008 net sales.

Competitive Strengths

We believe we are well positioned to capitalize on the favorable VMS industry dynamics as a result of the following competitive strengths:

Most Extensive Product Selection, Including a Strong Assortment of Proprietary Brands.    We believe we have the most complete and authoritative merchandise assortment and market the broadest product selection in the VMS industry, with over 20,000 competitively priced SKUs from a combination of over 700 different nationally recognized brands and our proprietary brands. Our proprietary brand merchandise accounted for approximately 25% of our net sales in fiscal 2008, and provides our customers the opportunity to purchase VMS products at a great value while affording us higher gross margins.

Value-Added Customer Service.    We believe we offer the highest degree of customer service in the VMS retail industry, aided by the deep product knowledge of our experienced store associates. We place a strong emphasis on employee training and customer service and view our sales associates as health and wellness information stewards who educate our customers while assisting them with their product selections.

Highly Refined Real Estate Strategy.    We apply demanding criteria to our retail site selection. We locate our stores exclusively in attractive stand-alone locations or endcap (corner) positions in retail centers. We believe that the location and visibility of our real estate is our single most effective and efficient customer acquisition strategy.

Attractive, Loyal Customer Base.    We have a large and growing base of loyal customers who proactively manage their long-term health and wellness through the use of supplements. Our no-fee Healthy Awards Program promotes brand loyalty among our customers and allows our customers to earn points redeemable for future purchases, approximately 70% of which are redeemed annually.

Multi-Channel Retailer.    We are a multi-channel retailer, distributing products through our retail stores, our websites and our catalog, enabling us to access customers outside our retail markets and those who prefer to shop online. This business model affords us multiple touch points with our customers, which allows us to gather data and communicate with them in person, through our call center and via the web.

Experienced Management Team with Proven Track Record.    We have assembled a management team across a broad range of disciplines with extensive experience in building leading national specialty retailers.

For additional information, see the section of this prospectus entitled “Business—Competitive Strengths.”

 

 

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Growth Strategies

We plan to execute several strategies in the future to promote our revenue growth, capture market share and drive operating income growth, including:

Expand Our Store Base.    We believe we have a highly attractive economic model for our new stores. We plan to continue to expand our store base over the next five years, which we believe will complement the maturation of the 171 stores we have opened since January 1, 2005. Based upon our operating experience and research conducted by The Buxton Company, we are confident that the U.S. VMS market can support over 900 Vitamin Shoppe stores operating under our current format.

Grow Our Loyal Customer Base.    We plan to continue to grow our loyal customer base by enhancing our marketing initiatives and leveraging our direct business.

Continue to Improve Store Productivity.    We plan to generate higher sales productivity through refined merchandising and pricing initiatives.

Continue to Invest in Education and Knowledge of Our Employees.     We believe we provide the most comprehensive training program in the VMS industry and that our sales associates’ ability to provide greater, value-added assistance to our customers helps us deliver a differentiated retail experience.

For additional information, see the section of this prospectus entitled “Business—Growth Strategies.”

Risk Factors

An investment in our common stock is subject to a number of risks and uncertainties. Before investing in our common stock, you should carefully consider the following, as well as the more detailed discussion of risk factors and other information included in this prospectus:

 

   

unfavorable publicity or consumer perception of our products and any similar products distributed by other companies could cause fluctuations in our operating results and could have a material adverse effect on our reputation, resulting in decreased sales;

 

   

our substantial indebtedness could adversely affect our financial health;

 

   

we may incur material product liability claims, which could increase our costs and adversely affect our reputation, sales and operating income;

 

   

we may not be able to obtain insurance coverage in the future at current rates or at all; and

 

   

compliance with new and existing governmental regulations could increase our costs significantly and adversely affect our operating income.

Recent Development

On September 9, 2009, Richard L. Markee was appointed as our Chief Executive Officer. Mr. Markee has served as a member of our board of directors since September 2006, and has been non-executive Chairman since April 2007. Mr. Markee previously served as the President of Babies “R” Us from August 2004 to November 2006, and Vice Chairman of Toys “R” Us from May 2003 to November 2007. Mr. Markee also served as interim Chief Executive Officer of Toys “R” Us and its subsidiaries from July 2005 to February 2006. Mr. Markee served as President of Toys “R” Us U.S. from May 2003 to August 2004.

 

 

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The appointment of Mr. Markee was made in connection with the resignation of Thomas A. Tolworthy as our Chief Executive Officer and as a member of our board of directors, which was effective as of September 8, 2009. Mr. Tolworthy’s resignation resulted from discussions with the Company with respect to misrepresentations made by Mr. Tolworthy in connection with his educational history.

Mr. Tolworthy will continue as a Vice President of Corporate Strategy and Business Development and his responsibilities will include assisting us in the areas of real estate, store operations, new product development, new business ventures and other matters as determined by our Chief Executive Officer.

Investment by Irving Place Capital Partners II, L.P.

We were acquired in November 2002 by Irving Place Capital Partners II, L.P. (formerly Bear Stearns Merchant Banking Partners II, L.P.) and its affiliates and other investors. Following this offering and the transactions described below under “Prospectus Summary—Our Corporate Structure,” Irving Place Capital Partners II, L.P. and certain of its affiliates, which we refer to collectively as “IPC,” will own approximately 54.5% of our common stock.

Our Corporate Structure

Our current corporate structure is made up as follows: VS Holdings, Inc., the issuer of the common stock offered hereby, owns all of the common stock of Vitamin Shoppe Industries Inc. VS Holdings, Inc. has no operations of its own. All of our operating assets are held by Vitamin Shoppe Industries Inc. and its direct wholly owned subsidiary, VS Direct Inc. VS Holdings, Inc. is a direct wholly owned subsidiary of VS Parent, Inc. Prior to the completion of this offering, VS Parent, Inc. will be merged into VS Holdings, Inc. with VS Holdings, Inc. being the surviving corporation. The merger will result in approximately an 1.8611-for-one split of our common stock. Upon the merger, the warrants and common stock issued by VS Parent, Inc. will become warrants and common stock of VS Holdings, Inc. and the preferred stock of VS Parent, Inc. will be converted into preferred stock of VS Holdings, Inc. VS Holdings, Inc. will then be renamed “Vitamin Shoppe, Inc.” We refer to these transactions as our “corporate reorganization.” Based on an assumed initial public offering price of $15.00 per share, the mid-point of the price range set forth on the cover of this prospectus, approximately 36,762 shares of the Series A Preferred Stock will be redeemed from the proceeds of this offering for approximately $63.6 million, shortly after our receipt of such proceeds, and the remaining 42,106 shares of Series A Preferred Stock will then be converted into 4,859,572 shares of our common stock. Any increase (decrease) in the assumed initial public offering price would increase (decrease) the number of shares of our Series A Preferred Stock redeemed, which would in turn decrease (increase) the number of shares of our Series A Preferred Stock converted into shares of our common stock to be outstanding after the offering. Each share of Series A Preferred Stock converts into shares of our common stock at a rate equal to the liquidation value of the preferred stock divided by the initial public offering price. Upon consummation of this offering, the warrants will be automatically exercised for 1,055,540 shares of our common stock.

The net assets of VS Parent, Inc. currently consist of all of the equity interests in VS Holdings, Inc. VS Parent, Inc. has approximately $30,000 of liabilities in the form of accrued expenses as of September 26, 2009.

Corporate and Other Information

Our executive offices are located at 2101 91st Street, North Bergen, New Jersey 07047, and our telephone number is (201) 868-5959. Our principal website address is www.vitaminshoppe.com. Information contained on any of our websites does not constitute part of this prospectus.

 

 

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The Vitamin Shoppe and BodyTech are some of our registered trademarks. Other brand names or trademarks appearing in this prospectus are the property of their respective owners. Solely for convenience, our trademarks and tradenames referred to in this prospectus are without the ® symbol, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the right of the applicable licensors to these trademarks and tradenames.

Some of the market and industry data and other statistical information used throughout this prospectus are based on independent industry publications including the 2009 Supplement Business Report issue of the NBJ, government publications, reports by market research firms or other published independent sources. Some data are also based on our good faith estimates, which are derived from our review of internal surveys, as well as the independent sources referred to above. The industry forecasts and projections are based on industry surveys and management’s experience in the industry, and we cannot give you any assurance that any of the projected results will be achieved.

 

 

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The Offering

 

Common stock offered by us

7,666,667 shares.

 

Common stock offered by the selling stockholders

1,429,410 shares, which includes shares the selling stockholders will receive upon the conversion of a portion of our Series A Preferred Stock for shares of our common stock. See “Prospectus Summary—Our Corporate Structure.”

 

Common stock to be outstanding after this offering

27,667,128 shares.

 

Use of proceeds

We estimate that our net proceeds from the sale of 7,666,667 shares of our common stock in this offering will be approximately $107.0 million, based on an assumed initial public offering price of $15.00 per share, the mid-point of the price range set forth on the cover of this prospectus, after deducting underwriting discounts and commissions. We intend to use the net proceeds from this offering to (i) redeem 36,762 shares of our Series A Preferred Stock for $63.6 million; (ii) repurchase approximately $39.9 million in aggregate principal amount of our Second Priority Senior Secured Floating Rate Notes (the “Notes”) and pay approximately $0.4 million of related premiums; and (iii) pay offering related expenses of approximately $3.1 million identified in “Use of Proceeds.” We will not receive any proceeds from the sale of shares by the selling stockholders.

 

Dividends

We do not anticipate paying any cash dividends in the foreseeable future.

 

Risk Factors

See the section entitled “Risk Factors” beginning on page 10 for a discussion of some of the factors you should carefully consider before deciding to invest in shares of our common stock.

 

Conflict of Interest

Under Rule 2720 of the NASD Conduct Rules, we are considered an affiliate of J.P. Morgan Securities Inc. because J.P. Morgan Securities Inc. has an economic interest in approximately 25% of our common stock outstanding as of October 9, 2009. As such, the public offering price per share of our common stock can be no higher than that recommended by a “qualified independent underwriter” meeting certain standards. Barclays Capital Inc. is assuming the responsibilities of acting as the qualified independent underwriter in pricing the offering and conducting due diligence. See the section of this prospectus entitled “Underwriting—Conflict of Interest.”

 

Proposed New York Stock Exchange symbol

“VSI.”

 

 

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The number of shares of common stock outstanding after this offering is based on 14,085,349 shares outstanding as of October 9, 2009, the conversion of 42,106 shares of Series A Preferred Stock into 4,859,572 shares of common stock at an assumed initial public offering price of $15.00 per share and the conversion of 567,163 warrants for 1,055,540 shares of our common stock upon consummation of the offering, in each case, giving effect to completion of the merger, including the approximately 1.8611-for-one stock split to be effected pursuant thereto. The number of shares of our Series A Preferred Stock to be converted into our common stock will vary depending on the initial public offering price of our common stock. For example, 34,194 shares of Series A Preferred Stock would be redeemed for cash and the remaining 44,674 shares of Series A Preferred Stock would then convert upon the closing of this offering into 5,524,104 shares of common stock if the initial public offering price is $14.00 per share, and 39,335 shares of Series A Preferred Stock would be redeemed for cash and the remaining 39,533 shares of Series A Preferred Stock would then convert upon the closing of this offering into 4,276,893 shares of common stock if the initial public offering price is $16.00 per share.

Unless the context otherwise requires (such as the presentation of historical financial information), the share information in this prospectus assumes that the merger of VS Parent, Inc. into VS Holdings, Inc., including the 1.8611-for-one stock split to be effected pursuant thereto, has occurred and assumes an offering price of $15.00 per share, the mid-point of the range set forth on the cover of this prospectus and does not give effect to 55,484 shares of our common stock issuable under the Amended and Restated 2006 Stock Option Plan of VS Parent, Inc. (the “2006 Plan”) or 1,397,250 shares of our common stock issuable under the Vitamin Shoppe 2009 Equity Incentive Plan (the “2009 Plan”). See “Prospectus Summary—Our Corporate Structure.”

 

 

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Summary Historical and Pro Forma Consolidated Financial Data

The following table sets forth summary historical and pro forma consolidated financial data for VS Holdings, Inc. as of the dates and for the periods indicated. Our fiscal years end on the last Saturday in December. The statement of operations data for the fifty-two weeks ended December 27, 2008, fifty-two weeks ended December 29, 2007, and the fifty-two weeks ended December 30, 2006, have been derived from our audited consolidated financial statements and notes thereto included in this prospectus. The statement of operations data for the six months ended June 27, 2009, and for the six months ended June 28, 2008, and the balance sheet data as of June 27, 2009, have been derived from our unaudited condensed consolidated financial statements included in this prospectus, which, in our opinion, contain adjustments which are of a normal recurring nature and which we consider necessary to present fairly our financial position and results of operations at such dates and for such periods. Results for the six months ended June 27, 2009, are not necessarily indicative of the results that may be expected for the entire fiscal year.

The pro forma as adjusted data set forth below gives effect to both our corporate reorganization and this offering as if they had been consummated on December 30, 2007 with respect to the pro forma data for the year ended December 27, 2008 and the six months ended June 27, 2009, and to the pro forma balance sheet data as if consummated on June 27, 2009. The adjustments include (i) a reduction of interest expense due to the redemption of a portion of our Notes; (ii) a proportionate decrease in deferred financing fee amortization; and (iii) related tax effects. For further information regarding these adjustments, see “Unaudited Pro Forma Condensed Consolidated Financial Statements.”

The summary historical and pro forma consolidated financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Unaudited Pro Forma Condensed Consolidated Financial Statements,” “Use of Proceeds” and our financial statements and notes thereto included in this prospectus.

 

 

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     Pro Forma as adjusted     Historical  
     Six Months
Ended

June 27,
2009
    Year Ended
December 27,
2008
    Six Months Ended     Year Ended  
         June 27,
2009
    June 28,
2008
    December 27,
2008
    December 29,
2007
    December 30,
2006
 
    

(data presented in thousands, except for shares and per share data)

 

Statement of Operations Data:

             

Net sales

  $ 343,698      $ 601,540      $ 343,698      $ 307,091      $ 601,540      $ 537,872      $ 486,026   

Cost of goods sold

    230,924        405,659        230,924        206,791        405,659        360,346        326,523   
                                                       

Gross profit

    112,774        195,881        112,774        100,300        195,881        177,526        159,503   

Selling, general and administrative expenses

    87,941        160,235        87,929        80,328        160,140        144,833        130,002   
                                                       

Income from operations

    24,833        35,646        24,845        19,972        35,741        32,693        29,501   

Extinguishment of debt and other (1)

    —          —          —          —          —          —          (366

Interest income

    (29     (115     (2     (22     (62     (234     (350

Interest expense

    7,956        16,858        9,841        10,789        21,253        22,340        22,161   
                                                       

Interest expense, net

    7,927        16,743        9,839        10,767        21,191        22,106        21,811   
                                                       

Income before provision for income taxes

    16,906        18,903        15,006        9,205        14,550        10,587        8,056   

Provision for income taxes

    7,003        8,055        6,238        3,589        6,341        3,792        3,242   
                                                       

Net income

    9,903        10,848        8,768        5,616        8,209        6,795        4,814   

Preferred stock dividends

                                              4,123   
                                                       

Net income applicable to common stockholders

  $ 9,903      $ 10,848      $ 8,768      $ 5,616      $ 8,209      $ 6,795      $ 691   
                                                       

Pro forma as adjusted weighted average shares outstanding (2)

             

Basic

    26,485,762        26,485,762             

Diluted

    26,923,669        27,095,761             

Pro forma as adjusted net income per share (2)

             

Basic

  $ 0.37      $ 0.41             

Diluted

  $ 0.37      $ 0.40             

Other Operating Data:

             

Average net sales for comparable store

      $ 773      $ 783      $ 1,458      $ 1,437      $ 1,387   

Comparable store sales growth (3)

        4.7     7.2     6.2     6.2     6.6

Average square footage per store

        3.7        3.7        3.7        3.7        3.7   

 

(1)    Extinguishment of debt and other for the fiscal year ended December 30, 2006 of $0.4 million relates to gains recognized on our interest rate swap that we entered into in fiscal 2005, prior to qualification for hedge accounting.

(2)    For a discussion of how this pro forma data was calculated, see “Unaudited Pro Forma Condensed Consolidated Financial Statements.”

(3)    A store is included in comparable store sales after 410 days of operation.

 

        

       

       

Balance Sheet Data:

             
    As of June 27, 2009                                
    Actual     Pro Forma
as adjusted(a)
                               

Working capital

  $ 59,861      $ 60,470             

Total assets

    459,099        457,998             

Total debt

    177,753        137,902             

Stockholders’ equity

    179,147        218,179             

 

(a) Reflects the corporate reorganization, including the stock split of approximately 1.8611-for-one, and this offering and the use of proceeds therefrom. See “Use of Proceeds.”

 

 

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RISK FACTORS

Any investment in our common stock involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information contained in this prospectus, before buying shares of our common stock.

Risks Relating to Our Business and Industry

Unfavorable publicity or consumer perception of our products and any similar products distributed by other companies could cause fluctuations in our operating results and could have a material adverse effect on our reputation, resulting in decreased sales.

We are highly dependent upon consumer perception regarding the safety and quality of our products, as well as similar products distributed by other companies. Consumer perception of products can be significantly influenced by adverse publicity in the form of published scientific research, national media attention or other publicity, whether or not accurate, that associates consumption of our products or any other similar products with illness or other adverse effects, or questions the benefits of our or similar products or that claims that any such products are ineffective. A product may be received favorably, resulting in high sales associated with that product that may not be sustainable as consumer preferences change. 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. Such research or publicity could have a material adverse effect on our ability to generate sales. For example, sales of some of our products, such as those containing ephedra, were initially strong, but decreased as a result of negative publicity and an ultimate ban by the Food and Drug Administration (“FDA”). As a result of the above factors, the results of our operations may fluctuate significantly from quarter-to-quarter and year-to-year.

Our substantial indebtedness could adversely affect our financial health.

As of June 27, 2009, after giving effect to our corporate reorganization, this offering and the use of proceeds therefrom, we would have had $133.6 million of outstanding indebtedness. Our substantial indebtedness could have important consequences to you. For example, it could:

 

   

make it more difficult for us to satisfy our obligations with respect to our indebtedness;

 

   

increase our vulnerability to general adverse economic, industry and competitive conditions;

 

   

require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes;

 

   

limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

   

place us at a competitive disadvantage compared to our competitors that have less debt; and

 

   

limit our ability to borrow additional funds.

Additionally, despite our current indebtedness levels, the agreements governing our outstanding debt upon consummation of the offering would allow us to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage.

We may incur material product liability claims, which could increase our costs and adversely affect our reputation, sales and operating income.

As a retailer and direct marketer of products designed for human consumption, we are subject to product liability claims if the use of our products is alleged to have resulted in injury or include inadequate instructions for use or inadequate warnings concerning possible side effects and interactions with other substances. Most of our

 

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products are vitamins, minerals, herbs and other ingredients that are classified as foods or dietary supplements and are not subject to pre-market regulatory approval in the United States. Our products could contain 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. While we attempt to manage these risks by obtaining indemnification agreements and insurance, our insurance policies may not be sufficient or available and/or third parties may not satisfy their commitments to us. A product liability claim against us could result in increased costs and could adversely affect our reputation with our customers, which in turn could adversely affect our financial performance. See “Business—Legal Proceedings.”

We may not be able to obtain insurance coverage in the future at current rates or at all.

Our current insurance program is consistent with both our past level of coverage and our risk management policies. While we believe we will be able to obtain product liability insurance in the future, there is no assurance that we will be able to do so and because of increased selectivity by insurance providers we may only be able to obtain such insurance at increased rates and/or with reduced coverage levels which could reduce our income from operations and increase our financial exposure to material litigation.

Compliance with new and existing governmental regulations could increase our costs significantly and adversely affect our operating income.

The processing, formulation, manufacturing, packaging, labeling, advertising and distribution of our products are subject to federal laws and regulation by one or more federal agencies, including the FDA, Federal Trade Commission (“FTC”), the Department of Agriculture (“DOA”) and the Environmental Protection Agency (“EPA”). These activities are also regulated by various state, local and international laws and agencies of the states and localities in which our products are sold. Regulations may prevent or delay the introduction, or require the reformulation, of our products, which could result in lost sales and increased costs to us. The FDA may not accept the evidence of safety for any new ingredients that we may want to market, may determine that a particular product or product ingredient presents an unacceptable health risk, may determine that a particular statement of nutritional support on our products, or that we want to use on our products, is an unacceptable drug claim or an unauthorized version of a food “health claim,” or the FDA or the FTC may determine that particular claims are not adequately supported by available scientific evidence. Any such regulatory determination would prevent us from marketing particular products or using certain statements on our products which could adversely affect our sales of those products. The FDA also could require us to remove a particular product from the market. For example, in April 2004, the FDA banned the sale of products containing ephedra. We stopped selling ephedra-based products in June 2003. Sales of products containing ephedra amounted to approximately $10.9 million, or 4% of our net sales, in 2002. Any recall or removal of products we sell could result in additional costs to us and the loss of future sales from any products that we are required to remove from the market. Any such product recalls or removals could also lead to liability and substantial costs and may subject us to substantial monetary penalties. Delayed product introduction, product recalls or similar issues as a result of governmental regulation may arise from time to time, which may have a material adverse effect on our sales and operating results.

In addition, from time to time, Congress, the FDA, the FTC or other federal, state, local or foreign legislative and regulatory authorities may impose additional laws or regulations that apply to us, repeal laws or regulations that we consider favorable to us or impose more stringent interpretations of current laws or regulations. Such developments could 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, adverse event reporting or other new requirements. Any such developments could increase our costs significantly and could have a material adverse effect on our business, financial condition and results of operations. For example, in 2006 Congress enacted the Dietary Supplement and Nonprescription Drug Consumer Protection Act, which creates requirements related to the reporting of serious adverse events. Other legislation

 

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has been introduced in Congress to, among other things, impose substantial new regulatory requirements for dietary supplements, including post-market surveillance requirements, FDA market reviews of dietary supplement ingredients, safety testing and records inspection. If enacted, new legislation could raise our costs and negatively impact our business. In addition, in June 2007 the FDA adopted final regulations setting forth the Good Manufacturing Practices (“GMP”) in manufacturing, packing or holding dietary ingredients or dietary supplements which apply to the products we distribute and which are enforced by the FDA through its facilities inspection program. These regulations require dietary supplements to be prepared, packaged, and held in compliance with strict rules, and require quality control provisions similar to the GMP regulations for drugs. We or our third-party manufacturers have incurred and continue to incur additional expenses in complying with the new rules. A failure to comply with these regulations by us or our third party manufacturers may result in fines and civil penalties, suspension of operations and/or increased costs or delays in obtaining raw materials and third-party products.

We rely on contract manufacturers to produce all of the proprietary branded products we sell. Disruptions in our contract manufacturers’ systems, losses of manufacturing certifications or actions by these manufacturers could adversely affect our sales, reputation and customer relationships and/or lead to an increase in our proprietary product cost.

Our contract manufacturers produce 100% of our proprietary branded products. Any significant disruption in those operations for any reason, such as regulatory requirements and loss of certifications, power interruptions, fires, hurricanes, war or threats of terrorism could adversely affect our sales and customer relationships and/or lead to an increase in our proprietary product cost. Additionally, we do not have complete oversight over our third-party contract manufacturers and they may take actions or fail to comply with applicable laws and regulations that may ultimately impact our sales, reputation and/or results of operations.

Increase in the price and shortage of supply of key raw materials could adversely affect our business.

Our products are composed of certain key raw materials. If the prices of these raw materials were to increase significantly, it could result in a significant increase to us in the prices our contract manufacturers and third-party manufacturers charge us for our Vitamin Shoppe and BodyTech branded products and third-party products. Raw material prices may increase in the future and we may not be able to pass on such increases to our customers. A significant increase in the price of raw materials that cannot be passed on to customers could have a material adverse effect on our results of operations and financial condition. In addition, if we no longer are able to obtain products from one or more of our suppliers on terms reasonable to us or at all, our revenues could suffer. We purchased approximately 7% of our total merchandise from Nature’s Value during the fiscal year ended December 27, 2008 (“Fiscal 2008”), one of the suppliers of our Vitamin Shoppe and BodyTech branded products. Events such as terrorist attacks or war, or the perceived threat thereof, may also have a significant impact on raw material prices and transportation costs for our products. In addition, the interruption in supply of certain key raw materials essential to the manufacturing of our products, may have an adverse impact on our suppliers ability to provide us with the necessary products needed to maintain our customer relationships and an adequate level of sales.

We rely on a single warehouse and distribution facility to distribute all of the products we sell. Disruptions to our warehouse and distribution facility or an increase in fuel costs could adversely affect our business.

Our warehouse and distribution operations are concentrated in a single location adjacent to our corporate headquarters in New Jersey. Any significant disruption in our distribution center operations for any reason, such as a flood, fire or hurricane, could adversely affect our product distribution and sales. Additionally, increasing fuel costs may adversely affect our results of operations, as the costs of our sales may increase in connection with the transportation of goods from our warehouse and distribution facility to our stores.

 

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Our new store base, or any stores opened in the future, may not achieve sales and operating levels consistent with our mature store base on a timely basis or at all. In addition, our growth strategy includes the addition of a significant number of new stores each year. We may not be able to successfully implement this strategy on a timely basis or at all, and our business could be adversely affected if we are unable to successfully negotiate favorable lease terms.

Since the beginning of 2005, we have aggressively pursued new store growth by opening 171 new stores through Fiscal 2008 in existing and new markets. Historically, our new stores have reached sales that are consistent with our mature stores over the course of a four year period. New stores opened since the beginning of 2005, or any new stores to be opened in the future, may not achieve sales and operating levels consistent with our mature store base in this time frame or at all. The failure of our new store base to achieve sales and operating levels consistent with our mature store base on a timely basis will have an adverse effect on our financial condition and operating results. As of September 25, 2009, we leased 434 stores along with our corporate headquarters and distribution facility. The store leases are generally for a term of ten years and we have options to extend most leases for a minimum of five years. Our business, financial condition, and operating results could be adversely affected if we are unable to continue to negotiate profitable lease and renewal terms.

In addition, our growth continues to depend, in part, on our ability to open and operate new stores successfully. The success of this strategy depends upon, among other things, the identification of suitable sites for store locations, the negotiation of acceptable lease terms, the hiring, training and retention of competent sales personnel, and the effective management of inventory to meet the needs of new and existing stores on a timely basis. Our proposed expansion will also place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which in turn could cause deterioration in the financial performance of our existing stores. Further, our new store openings may result in reduced net sales volumes in the direct channel, as well as in our existing stores in those markets. We expect to fund our expansion through cash flow from operations and, if necessary, by borrowings under the new revolving credit facility, which we entered into on September 25, 2009 (the “2009 revolving credit facility”). If we experience a decline in performance, we may slow or discontinue store openings. If we fail to successfully implement these strategies, our financial condition and operating results may be adversely affected.

If we fail to protect our brand name, competitors may adopt tradenames that dilute the value of our brand name.

We may be unable or unwilling to strictly enforce our trademark in each jurisdiction in which we do business. In addition, because of the differences in foreign trademark laws concerning proprietary rights, our trademarks may not receive the same degree of protection in foreign countries as they do in the United States. Also, we may not always be able to successfully enforce our trademarks against competitors, or against challenges by others. Our failure to successfully protect our trademarks could diminish the value and efficacy of our past and future marketing efforts, and could cause customer confusion and potentially adversely affect our sales and profitability. Moreover, we may be subject to intellectual property litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling or using some aspect of our products.

Our ability to continue to access credit on the terms previously obtained for the funding of our operations and capital projects may be limited due to the deterioration of the credit markets.

The credit markets and the financial services industry continue to experience a period of significant disruption characterized by the bankruptcy, failure, collapse or sale of various financial institutions, increased volatility in securities prices, severely diminished liquidity and credit availability and a significant level of intervention from the United States and other governments. Continued concerns about the systemic impact of potential long-term or widespread recession, energy costs, geopolitical issues, the availability and cost of credit, the global commercial and residential real estate markets and related mortgage markets and reduced consumer

 

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confidence have contributed to increased market volatility and diminished expectations for most developed and emerging economies. As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads.

Due to current economic conditions, we cannot be certain that funding for our capital and operating needs on a long term basis will be available from our existing financial institutions and the credit markets if needed, and if available, to the extent required, and on acceptable terms. Our 2009 revolving credit facility matures in September 2013, which we feel should cover our foreseeable liquidity needs. However, if we cannot obtain sufficient funding when needed, or on acceptable terms, we may be unable to continue our current rate of growth and store expansion, which may have an adverse effect on our revenues and results of operations.

Risks Relating to the Shares and this Offering

Shares eligible for future sale may cause the market price of our common stock to decline, even if our business is doing well.

Sales of substantial amounts of our common stock in the public market after this offering, or the perception that these sales may occur, could adversely affect the price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. Upon completion of this offering, our amended and restated certificate of incorporation will authorize us to issue 400,000,000 shares of common stock and we will have 27,667,128 shares of common stock outstanding. Of these outstanding shares, the 9,096,077 shares of common stock sold in this offering will be freely tradeable, without restriction, in the public market. The remaining 18,571,051 shares of common stock will be “restricted securities,” as that term is defined in Rule 144 under the Securities Act of 1933, as amended (the “Securities Act”) which will be freely tradeable subject to applicable holding period, volume and other limitations under Rule 144 or Rule 701 of the Securities Act. As of October 12, 2009, there were a total of 2,017,621 options outstanding, of which 1,340,781 were vested and 28,420 were available for grant under the 2006 Plan and 48,658 shares of restricted stock and no options outstanding and 701,342 shares were available for grant under the 2009 Plan. We also had warrants outstanding to purchase 567,163 shares of VS Parent, Inc. common stock. Upon completion of this offering, approximately 18.5 million shares of these restricted securities (after giving effect to the 1.8611-for-one stock split) will be subject to lock-up agreements with the underwriters, restricting the sale of such shares for 180 days after the date of this prospectus (subject to extension). These lock-up agreements are subject to a number of exceptions and holders may be released from these agreements without prior notice at the discretion of underwriters. See “Shares Eligible for Future Sale.” Some of our stockholders are entitled, subject to limited exceptions, to demand registration rights with respect to the registration of shares under the Securities Act. By exercising their registration rights, and selling a large number of shares, these holders could cause the price of our common stock to decline. An estimated 17.1 million shares of common stock will be entitled to demand registration rights 180 days after completion of this offering (subject to extension).

The shares you purchase in this offering will experience immediate and substantial dilution.

The initial public offering price of our common stock will be substantially higher than the tangible book value per share of our outstanding common stock. Assuming an initial public offering price of $15.00 per share, the midpoint of the range on the cover of this prospectus, purchasers of our common stock will incur dilution of $16.07 per share in the net tangible book value of their purchased shares. The shares of our common stock owned by existing stockholders will receive a material increase in the net tangible book value per share. You may experience additional dilution if we issue common stock in the future. As a result of this dilution, you may receive significantly less than the full purchase price you paid for the shares in the event of a liquidation.

A trading market may not develop for our common stock, and you may not be able to sell your stock.

There has not been a public market for our common stock. A liquid trading market for our common stock may not develop. The initial public offering price will be determined in negotiations among representatives of the

 

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underwriters and us and may not be indicative of prices that will prevail in the trading market. In the absence of an active trading market for our common stock, investors may not be able to sell their common stock at or above the initial public offering price or at the time they would like to sell.

Approximately 54.5% of our voting power will be controlled by one principal stockholder whose interests may conflict with those of our other stockholders.

Upon completion of this offering, affiliates of IPC will hold approximately 54.5% of our voting power. As a result of this ownership, IPC will have significant influence in the consideration of all matters requiring the approval of our stockholders and/or our board of directors. This influence may also have the effect of delaying or preventing a change in control of our company or discouraging others from making tender offers for our shares, which could prevent stockholders from receiving a premium for their shares.

Our amended and restated certificate of incorporation will provide that IPC and its affiliates are not required to offer corporate opportunities of which they become aware to us and could therefore offer such opportunities instead to other companies including portfolio companies of IPC. In addition, until IPC ceases to beneficially own at least 33 1/3% of our common stock, the prior consent of IPC will be required for certain actions, including, but not limited to, (i) mergers, (ii) certain sales or acquisitions not in the ordinary course of business, (iii) changes in our authorized, or issuance of, capital stock, (iv) adoptions of incentive plans, (v) amendments of our certificate of incorporation and bylaws, (vi) the declaration of dividends, and (vii) changes in the number of directors on our board or changes to board committees. These restrictions could prevent us from pursuing transactions or relationships that would otherwise be in the best interests of our stockholders. These restrictions could also limit stockholder value by preventing a change of control that you might consider favorable.

Because IPC will own more than 50% of our common stock after this offering, we are considered a “controlled company” for the purposes of the New York Stock Exchange (“NYSE”) listing requirements. As such, we are permitted to, and have opted out of, the NYSE corporate governance requirements that our board of directors, our compensation committee and our nominating and corporate governance committee meet the standard of independence established by those corporate governance requirements. As a result, our board of directors and those committees may have more directors who do not meet the NYSE independence standards than they would if those standards were to apply. The independence standards are intended to ensure that directors who meet the independence standard are free of any conflicting interest that could influence their actions as directors.

We do not currently intend to pay dividends on our common stock, and as a result, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

Since our acquisition by IPC in 2002, other than the dividend paid to VS Parent, Inc. of approximately $561,000 in 2008, we have not declared or paid any cash dividends on our common stock and we do not expect to declare or pay any cash dividends on our common stock in the foreseeable future. In addition, our senior credit facilities may limit our ability to declare and pay cash dividends on our common stock. For more information, see “Dividend Policy.” As a result, your only opportunity to achieve a return on your investment in us will be if the market price of our common stock appreciates and you sell your shares at a profit. The market price for our common stock after this offering might never exceed the price that you pay for our common stock in this offering.

Requirements associated with being a public company will increase our costs significantly, as well as divert significant company resources and management attention.

As an independent public company, the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, as well as the rules of the NYSE, will require us to implement additional corporate governance

 

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practices and adhere to a variety of reporting requirements and complex accounting rules. Compliance with these public company obligations will increase our legal and financial compliance costs and place significant additional demands on our finance and accounting staff and on our financial, accounting and information systems.

In particular, as a public company, our management will be required to continue to conduct an annual evaluation of our internal control over financial reporting and include a report of management on our internal control over financial reporting in our Annual Report on Form 10-K for our fiscal year ending December 26, 2009 (“Fiscal 2009”). In addition, we will be required to have our independent registered public accounting firm report on the effectiveness of our internal control over financial reporting. Under current rules, we will be subject to this requirement beginning with our Annual Report on Form 10-K for fiscal year 2010. If we are unable to conclude that we have effective internal control over financial reporting or, if our independent registered public accounting firm is unable to provide us with an unqualified report as to the effectiveness of our internal control over financial reporting, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.

Certain provisions of our corporate governing documents and Delaware law could discourage, delay, or prevent a merger or acquisition at a premium price.

Certain provisions of our organizational documents and Delaware law could discourage potential acquisition proposals, delay or prevent a change in control of our company, or limit the price that investors may be willing to pay in the future for shares of our common stock. For example, our certificate of incorporation and by-laws will, upon completion of this offering, permit us to issue, without any further vote or action by the stockholders, up to 250,000,000 shares of preferred stock in one or more series and, with respect to each series, to fix the number of shares constituting the series and the designation of the series, the voting powers (if any) of the shares of the series, and the preferences and relative, participating, optional, and other special rights, if any, and any qualifications, limitations, or restrictions of the shares of the series. See “Description of Capital Stock—Antitakeover Effects of Provisions of the Certificate of Incorporation and Bylaws” and “—Antitakeover Legislation.”

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains statements that do not directly or exclusively relate to historical facts. As a general matter, forward-looking statements are those focused upon anticipated events or trends and expectations and beliefs relating to matters that are not historical in nature. The words “believe,” “expect,” “plan,” “intend,” “estimate” or “anticipate” and similar expressions, as well as future or conditional verbs such as “will,” “should,” “would,” and “could,” often identify forward-looking statements. Such forward-looking statements are subject to uncertainties and factors relating to our operations and business environment, any of which are difficult to predict and many of which are beyond our control. These uncertainties and factors could cause actual results to differ materially from those matters expressed in or implied by such forward-looking statements.

The following uncertainties and factors, among others (including those set forth under “Risk Factors”), could affect future performance and cause actual results to differ materially from those expressed in or implied by forward-looking statements:

 

   

unfavorable publicity or consumer perception of our products;

 

   

the impact of our substantial indebtedness on our financial health;

 

   

our continued ability to effectively manage and defend litigation matters pending, or asserted in the future, against us, including product liability claims;

 

   

our ability to obtain insurance coverage at current rates or at all;

 

   

compliance with government regulations;

 

   

our ability to maintain and to enter into key purchasing, supply and outsourcing relationships;

 

   

changes in our raw material costs;

 

   

increases in fuel prices;

 

   

disruptions to our warehouse and distribution facility;

 

   

the ability of our new store base to achieve sales and operating levels consistent with our mature store base;

 

   

pricing of our products;

 

   

the maturation of our stores opened since 2005;

 

   

our ability to protect our brand name;

 

   

our ability to renew our current leases and enter into new leases on terms acceptable to us;

 

   

the successful implementation of other strategic initiatives, including, without limitation, opening new stores and improving the functionality of our websites; and

 

   

our ability to continue to access credit on terms previously obtained for the funding of our operations and capital projects.

 

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USE OF PROCEEDS

We expect to receive net proceeds of approximately $107.0 million from the sale by us of 7,666,667 shares of common stock in this offering, assuming an initial public offering price of $15.00 per share (the midpoint of the range on the cover of this prospectus) and after deducting estimated underwriting discounts of approximately $8.0 million. A $1.00 increase (decrease) in the assumed initial offering price of $15.00 per share would increase (decrease) the net proceeds of this offering by $7.1 million, assuming the sale by us of 7,666,667 shares of our common stock and after deducting estimated underwriting discounts and commissions. We will not receive any proceeds from the sale of shares by the selling stockholders.

We intend to use the net proceeds to us of approximately $107 million from this offering for:

 

   

the pro rata redemption of 36,762 shares of Series A Preferred Stock for approximately $63.6 million, which we will have outstanding immediately after the corporate reorganization, including accumulated and undeclared dividends, 77.2% of which is held by IPC, 9.5% of which is held by the Horowitz Family and 6.3% of which is held, collectively, by Blackstone Mezzanine Partners L.P. and Blackstone Mezzanine Holdings L.P.;

 

   

the repurchase of approximately $39.9 million in aggregate principal amount of our Notes and the payment of approximately $0.4 million of related premiums; and

 

   

the payment of offering related expenses of approximately $3.1 million, which includes a management services agreement fee of approximately $750,000 to be paid to IPC.

Pursuant to the terms of the indenture governing our outstanding Notes, we are obligated to apply 35% of the gross proceeds received by us from this offering to offer to repurchase a portion of our outstanding notes at a price of 101%, an aggregate principal amount of $39.9 million based on an assumed initial public offering price of $15.00 per share (the midpoint of the range on the cover of this prospectus). Any increase (decrease) in the assumed initial public offering price would increase (decrease) the aggregate principal amount of our Notes repurchased and the number of shares of our Series A Preferred Stock redeemed.

As of September 25, 2009, the interest rate on our Notes, which mature in 2012, was 7.94%, and the interest rate on our 2009 revolving credit facility, which matures in 2013, was 2.78%.

Affiliates of certain of the underwriters are holders of the Series A Preferred Stock and therefore may receive a portion of the net proceeds of this offering. See the section entitled “Underwriting.”

DIVIDEND POLICY

Except for a one-time cash dividend in 2008 of approximately $561,000, we have not declared or paid any cash dividends on our common stock since the acquisition of our company by IPC in November 2002. We currently expect to retain future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Our ability to pay cash dividends on our common stock is limited by the covenants of our credit facilities and may be further restricted by the terms of any of our future debt or preferred securities.

HOLDERS OF COMMON EQUITY

We have only one authorized class of common equity, which is our common stock. As of October 9, 2009, VS Parent, Inc. was our sole stockholder.

 

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CAPITALIZATION

The table below sets forth our cash and cash equivalents and capitalization on a historical basis, pro forma basis reflecting the merger of VS Parent, Inc. into VS Holdings, Inc. as of June 27, 2009 as well as the redemption of shares in connection with the extinguishment of a note receivable due from an officer, and on a pro forma as adjusted basis to give effect to our corporate reorganization, this offering and use of proceeds therefrom (assuming an initial public offering price of $15.00, the midpoint of the price range set forth on the cover of this prospectus).

See “Unaudited Pro Forma Condensed Consolidated Financial Statements,” “Selected Historical Consolidated Financial Data” and “Use of Proceeds.” For further discussion regarding the capital structure of VS Parent, Inc. and for a discussion of the formation of VS Parent, Inc., see Note 2 to our consolidated financial statements contained elsewhere in this prospectus.

The table below should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this prospectus.

 

     As of June 27, 2009  
     Actual     Pro forma
after giving
effect to the
Merger
    Pro forma
as adjusted(1)(2)
 
    

(dollars in thousands, except par value)

 

Cash and cash equivalents

   $ 2,107      $ 2,107      $ 2,107   
                        

Obligations under capital lease, net of current portion of $1,353

   $ 2,900      $ 2,900        2,900   

Second Priority Senior Secured Floating Rate Notes

     165,000        165,000        125,149   
                        

Total long-term debt (3)

     167,900        167,900        128,049   
                        

Preferred stock: $0.01 par value; 78,868 shares of preferred stock issued and outstanding on June 27, 2009 (250,000,000 shares authorized and no shares of preferred stock issued and outstanding upon completion of this offering)

     —          1        —     

Common stock: $0.01 par value; 20,472,100 shares authorized and 14,035,491 shares of common stock issued and outstanding on June 27, 2009 (post-split) (400,000,000 shares authorized and 27,667,128 shares of common stock issued and outstanding upon completion of this offering)

     —          141        277   

Additional paid-in-capital

     160,825        154,852        201,266   

Warrants (4)

     —          5,666        —     

Accumulated other comprehensive income

     (2,034     (2,034     (1,542

Retained earnings

     20,356        20,161        18,178   
                        

Total stockholders’ equity

     179,147        178,787        218,179   
                        

Total capitalization

   $ 347,047      $ 346,687      $ 346,228   
                        

 

(1) Any increase (decrease) in the assumed initial public offering price would increase (decrease) the aggregate principal amount of our Notes repurchased and the number of shares of our Series A Preferred Stock redeemed and would have no effect on pro forma cash and cash equivalents, assuming the sale by us of 7,666,667 shares of our common stock.
(2) Adjustments reflect the repurchase of approximately $39.9 million in aggregate principal amount of our outstanding Notes, the impact of the payment of a premium on the Notes repurchased, a one-time payment for a management services agreement fee, a write-off of the unamortized portion of the deferred financing fees related to the portion of the Notes repurchased, the redemption of 36,762 shares of our Series A Preferred Stock for $63.6 million, estimated fees associated with the offering, the conversion to common stock of the remaining balance of Series A Preferred Stock and the conversion of our outstanding warrants into common stock.
(3) Total long-term debt excludes debt outstanding under our Revolving Credit Facility of $8.5 million, which is classified as a current liability on our consolidated balance sheet.
(4) Represents 567,163 warrants (pre-split), valued at $10 per warrant, which will convert into 1,055,540 shares of our common stock upon consummation of the offering on a post-split basis.

 

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DILUTION

Our net tangible book deficit as of June 27, 2009, was approximately $201.8 million or $14.23 per share of common stock. Net tangible book value per share represents total tangible assets less total liabilities, divided by the number of outstanding shares of common stock. After giving effect to our corporate reorganization and the sale of the 7,666,667 shares of common stock offered by us at an assumed initial public offering price of $15.00 per share, and after deducting underwriting discounts and estimated offering expenses, the as adjusted net tangible book deficit at June 27, 2009, would have been approximately $29.8 million or approximately $1.07 per share of common stock. This represents an immediate decrease in net tangible book deficit of $13.16 per share to existing stockholders and an immediate dilution of $16.07 per share to new investors in this offering. The following table illustrates this dilution on a per share basis:

 

Initial public offering price per share

   $ 15.00   
        

Net tangible book value (deficit) per share at June 27, 2009

     (14.23

Increase per share attributable to this offering

     13.16   
        

As adjusted net tangible book value (deficit) per share after this offering

     (1.07
        

Dilution per share to new investors

   $ 16.07   
        

The table above excludes, as of June 27, 2009, 1,947,094 shares of common stock issuable upon (i) exercise of outstanding stock options under the 2006 Plan and (ii) our outstanding warrants. To the extent options and warrants are exercised, there will be further dilution to new investors.

A $1.00 increase (decrease) in the assumed initial offering price of $15.00 per share would affect our as adjusted net tangible book deficit by $7.1 million, the net tangible book deficit per share after this offering by $0.26 per share, and the dilution per common share to new investors is adjusted by $0.25 per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the commissions and discounts and estimated offering expenses payable by us.

If all stock options with exercise prices less than the assumed initial public offering price are exercised, the as adjusted net tangible book deficit per share would be $19.58 per common share and the dilution to new investors purchasing our common stock in this offering would be $18.96 per common share.

The following table sets forth on an as adjusted basis as of June 27, 2009, the differences between the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing stockholders and by new investors, before deducting underwriting discounts and commissions and estimated offering expenses, at an assumed initial public offering price of $15.00 per share.

 

     Shares Purchased     Total
Consideration
    Average
Price
Per Share
(in millions, except per share data)    Number    Percent     Amount    Percent    

Existing stockholders

   20.1    72   $ 132.0    53   $ 6.57

New investors

   7.7    28     115.0    47     15.00
                      

Total

   27.8    100   $ 247.0    100   $ 8.90
                      

A $1.00 increase (decrease) in the assumed initial public offering price of $15.00 per share would increase (decrease) total consideration paid by new investors, total consideration paid by all stockholders and average price per share paid by all stockholders by $7.7 million, $7.7 million and $0.28 per share, respectively, assuming the number of shares offered by us, as set forth on the cover page of this prospectus remains the same, and after deducting the commissions and discounts and estimated offering expenses payable by us.

 

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If the underwriters exercise their option to purchase 1,364,411 additional shares of our common stock from the selling stockholders in this offering, the number of shares held by new investors will increase to approximately 10.5 million shares of our common stock, or approximately 37.8% of the total number of shares of our common stock outstanding after this offering.

If all vested stock options with exercise prices less than the initial public offering price are exercised, the number of shares held by existing stockholders will increase to approximately 21.2 million shares of our common stock, or approximately 73.0% of the total number of shares of our common stock outstanding after this offering.

 

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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

You should read the pro forma condensed consolidated financial statements presented below in conjunction with the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and our historical consolidated financial statements and the related notes thereto included elsewhere in this prospectus.

The pro forma condensed consolidated statements of operations for the year ended December 27, 2008 and for the six months ended June 27, 2009, and the pro forma condensed consolidated balance sheet as of June 27, 2009, are unaudited and have been derived from our historical consolidated financial statements, as well as those of VS Parent, Inc., as adjusted to give effect to:

 

   

the merger of VS Parent, Inc. with and into VS Holdings, Inc. (including the redemption of the officer’s note and the approximately 1.8611-for-one stock split to be effected pursuant thereto), as described in the accompanying notes to the unaudited pro forma condensed consolidated financial statements; and

 

   

this offering, including the use of proceeds therefrom, assuming an initial public offering price of $15.00 per share (the mid-point of the range set forth on the cover of this prospectus);

as if they had occurred on December 30, 2007, with respect to the pro forma condensed consolidated statements of operations, and as of June 27, 2009, with respect to the pro forma condensed consolidated balance sheet.

The unaudited pro forma condensed consolidated financial statements are presented for informational purposes only, do not purport to represent what our results of operations or financial condition actually would have been had the relevant transactions been consummated on the dates indicated and are not necessarily indicative of our results of operations for any future period or our financial condition as of any future date. The assumptions underlying the pro forma adjustments are described in the accompanying notes, which you should read in conjunction with these unaudited pro forma condensed consolidated financial statements. In our opinion, all adjustments have been made that are necessary to present fairly the pro forma impact of the above-mentioned transactions in the unaudited pro forma condensed consolidated financial statements. The pro forma statements of operations do not adjust for the following:

 

   

the compensation expense associated with equity awards that will vest upon the completion of this offering. We estimate that this compensation expense will be approximately $0.6 million;

 

   

the write-off of a portion of the unamortized deferred financing fees, of approximately $0.8 million, related to the redemption of $39.9 million in aggregate principal amount of our Notes;

 

   

the premium on extinguishment of debt related to the redemption of $39.9 million in aggregate principal amount of our Notes of approximately $0.4 million;

 

   

a fee in connection with the termination of the management fee agreement, which we expect to be approximately $0.8 million; and

 

   

the write-off of approximately $0.5 million of the unrealized loss on our interest rate swap in connection with the redemption of $39.9 million in aggregate principal amount of our Notes.

The unaudited pro forma adjustments and the offering adjustments are based on available information and certain assumptions that we believe are reasonable and are described below in the accompanying notes. The unaudited information was prepared on a basis consistent with that used in preparing our consolidated financial statements and includes all adjustments, consisting of normal and recurring items, that we consider necessary for a fair presentation of the financial position and results of operations for such periods.

The unaudited pro forma consolidated condensed statement of operations should not be considered indicative of actual results that would have been achieved had the transactions been consummated on the dates indicated. Also, the unaudited pro forma condensed consolidated financial statements should not be viewed as indicative of our financial condition or results of operations as of any future dates or for any future period.

 

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VS HOLDINGS, INC. AND SUBSIDIARY

PRO FORMA

CONDENSED CONSOLIDATED BALANCE SHEETS

JUNE 27, 2009

(in thousands, except share and per share data)

(Unaudited)

    VS Holdings,
Inc.
    VS Parent,
Inc.
    Adjustments/
Elimination
          Pro Forma
After giving
effect to the
Merger
        Adjustments
for the
Offering
        Pro Forma
As Adjusted
 
ASSETS                  

Current assets:

                 

Cash and cash equivalents

  $ 2,107      $ —        $ —          $ 2,107        $                 $ 2,107   

Inventories

    103,443        —          —            103,443              103,443   

Prepaid expenses and other current assets

    11,658        —          —            11,658              11,658   

Deferred income taxes

    2,998        —          —            2,998              2,998   
                                                     

Total current assets

    120,206        —          —            120,206              120,206   

Property and equipment, net

    85,331        —          —            85,331              85,331   

Goodwill

    177,248        —          —            177,248              177,248   

Other intangibles, net

    70,721        —          —            70,721              70,721   

Other assets:

                 

Deferred financing fees, net of accumulated amortization

    3,512        —          —            3,512          (771   g)     2,741   

Investment in Subsidiary

      180,096        (180,096   a     —                —     

Other long-term assets

    2,081        —          (330   a     1,751              1,751   
                                                     

Total other assets

    5,593        180,096        (180,426       5,263          (771       4,492   
                                                     

Total assets

  $ 459,099      $ 180,096      $ (180,426     $ 458,769        $ (771     $ 457,998   
                                                     
LIABILITIES AND STOCKHOLDERS’ EQUITY                  

Current liabilities:

                 

Current portion of capital lease obligation

  $ 1,353      $ —        $ —          $ 1,353        $          $ 1,353   

Revolving credit facility m)

    8,500        —          —            8,500              8,500   

Accounts payable

    23,577        —          —            23,577          75   l)     24,327   

Deferred sales

    7,807        —          —            7,807              7,807   

Accrued salaries and related expenses

    5,213        —          —            5,213              5,213   

Accrued interest

    2,045        —          —            2,045              2,045   

Other accrued expenses

    11,850        30        —            11,880          (1,389 )   h) l)     10,491   
                                                     

Total current liabilities

    60,345        30        —            60,375          (639       59,736   

Long-term debt

    165,000        —          —            165,000          (39,851   i)     125,149   

Capital lease obligation, net of current portion

    2,900        —          —            2,900              2,900   

Deferred income taxes

    20,657        —          —            20,657          327      h)     20,984   

Other long-term liabilities

    7,972        330        (330   a     7,972              7,972   

Deferred rent

    23,078        —          —            23,078              23,078   

Commitments and contingencies

                 

Stockholders’ equity:

                 

Preferred stock $0.01 par value; 500,000 shares authorized; 79,502 Series A shares issued and outstanding at June 27, 2009 (aggregate liquidation preference $132,964)

    —          1        —            1      f)     (1   j)     —     

Common stock, $0.01 par value; 20,472,100 shares authorized, 14,035,491 shares issued and outstanding at June 27, 2009

    —          76        6 5   b     141          136      j)     277   

Warrants

    —          5,666        —            5,666          (5,666   j)     —     

Note receivable due from officer including accrued interest of $329

    —          (1,829     1,829      c     —            —            —     

Additional paid-in capital

    160,825        151,224        (157,197   d     154,852          46,414      k) l)     201,266   

Accumulated other comprehensive loss

    (2,034     —          —            (2,034       492      h)     (1,542

Retained earnings

    20,356        24,598        (24,793   e     20,161          (1,983   l)     18,178   
                                                     

Total stockholders’ equity

    179,147        179,736        (180,096       178,787          39,392          218,179   
                                                     

Total liabilities and stockholders’ equity

  $ 459,099      $ 180,096      $ (180,426     $ 458,769        $ (771     $ 457,998   
                                                     

 

 

a) Represents elimination of intercompany payables and receivables and investment in subsidiary.
b) Represents the retroactive split of common shares based on an approximately 1.8611-for-one split ratio.
c) Represents extinguishment of the officer’s note along with accrued interest.
d) Represents the elimination of VS Parent’s additional paid-in capital along with the elimination of the impact of the transfer of common stock, warrants, and preferred shares from VS Holdings to VS Parent which arose during the formation of VS Parent as well as the effect of the retroactive stock split based on the 1.8611-for-one stock split ratio.
e) Represents the elimination of VS Parent retained earnings derived from equity in earnings of VS Holdings.
f) Represents 78,868 total preferred stock shares outstanding subsequent to the merger at June 27, 2009. Subsequent to the completion of the offering, there are no shares of preferred stock outstanding.
g) Represents the write-off of a portion of deferred financing fees in connection with the redemption of a portion of the Notes.
h) Represents the write-off of a portion of the unrealized loss on the interest rate swap in connection with the redemption of a portion of the Notes, along with related deferred income tax effects.
i) Represents the redemption of a portion of the Notes, exclusive of a redemption premium of $399,000 charged to retained earnings.
j) Represents the conversion of preferred stock and warrants to common shares (or cash) upon consummation of the offering.
k) Represents the impact of the consummation of the offering, which includes the conversion of our outstanding warrants to common stock and the conversion of a portion of our preferred shares into common stock.
l) Represents the impact of the write-off of deferred financing fees, the premium to be paid upon redemption of the Notes, the write-off of a portion of unrealized losses on the interest rate swap, accelerated options expense for certain officers and the termination fee for the management agreement, net of related tax effects.
m) On September 25, 2009, we entered into a new revolving credit facility and simultaneously terminated our equity credit facility. See “Summary Management’s Discussion and Analysis of Financial Construction and Results of Operations—Liquidity and Capital Resources—2009 Revolving Credit Facility.”

 

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VS HOLDINGS, INC. AND SUBSIDIARY

PRO FORMA

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE SIX MONTHS ENDED JUNE 27, 2009

(in thousands except share and per share data)

(Unaudited)

 

     VS Holdings, Inc.     VS Parent, Inc.     Eliminations     Pro Forma
After giving effect
to the Merger
    Adjustments
for the
Offering
    Pro Forma
As
adjusted
 

Net sales

   $ 343,698      $        $        $ 343,698      $        $ 343,698   

Cost of goods sold

     230,924            230,924          230,924   
                                                

Gross profit

     112,774            112,774          112,774   

Selling, general and administrative expenses (a)

     87,113        12   a)        87,125          87,125   

Related party expenses

     816            816          816   
                                                

Income from operations

     24,845        (12       24,833          24,833   

Interest income

     (2     (27 )  b)        (29       (29

Interest expense

     9,841            9,841        (1,885 )  d)      7,956   
                                                

Income before provision for income taxes

     15,006        15          15,021        1,885        16,906   

Provision for income taxes

     6,238        —            6,238        765    e)      7,003   
                                                

Income before equity in net earnings of subsidiary

     8,768        15          8,783        1,120        9,903   

Equity in net earnings of subsidiary

     —          8,768        (8,768     —          —          —     
                                                

Net income

     8,768        8,783        (8,768     8,783        1,120        9,903   

Preferred stock dividends in arrears

     —          5,205   c)        5,205        (5,205 )  f)      —     
                                                

Net income applicable to common stockholders

   $ 8,768      $ 3,578      $ (8,768   $ 3,578      $ 6,325      $ 9,903   
                                                

Pro Forma weighted average shares outstanding

            

Basic

       14,035,399   g)        17,692,666   h)        26,485,762   i) 

Diluted

       15,528,846   g)        19,186,113   h)        26,923,669   i) 

Pro Forma net income per share

            

Basic

         $ 0.20        $ 0.37   

Diluted

         $ 0.19        $ 0.37   

 

a) Represents general operating expenses of VS Parent, Inc.
b) Represents interest income accrued on the note from an officer, which was extinguished.
c) Represents dividends accrued on VS Parent, Inc. preferred shares for the period.
d) Represents a reduction in interest due to the portion of the Notes repurchased and a related reduction in amortization of deferred financing fees.
e) Represents the income tax impact of the decrease in interest expense.
f) Represents the elimination of preferred stock dividends due to the redemption and conversion of all preferred shares upon consummation of this offering.
g) Represents 7,617,000 basic weighted average common shares and 8,419,459 diluted common shares and common share equivalents outstanding of VS Parent, Inc., for the period ended June 27, 2009, less 75,497 common shares retired in connection with the extinguishment of the note receivable due from an officer, adjusted retroactively using a stock split ratio of approximately 1.8611-for-one.
h) Represents basic and diluted shares subsequent to the merger giving effect to the number of shares (3,657,267) whose proceeds would be necessary to pay the accumulated dividends in arrears.
i) Represents the post-offering outstanding shares taking into effect converted warrants, converted preferred shares, and additional shares issued at the time of this offering.

 

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VS HOLDINGS, INC. AND SUBSIDIARY

PRO FORMA

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEAR ENDED DECEMBER 27, 2008

(in thousands except shares and per share data)

(Unaudited)

 

    VS Holdings,
Inc.
    VS Parent,
Inc.
    Eliminations     Pro Forma
After giving
effect to the
Merger
    Adjustments
for the
Offering
    Pro Forma
As Adjusted
 

Net sales

  $ 601,540      $        $        $ 601,540      $        $ 601,540   

Cost of goods sold

    405,659            405,659          405,659   
                                               

Gross profit

    195,881            195,881          195,881   

Selling, general and administrative expenses

    158,617        95   a)        158,712          158,712   

Related party expenses

    1,523            1,523          1,523   
                                               

Income from operations

    35,741        (95       35,646          35,646   

Interest income

    (62     (53 ) b)        (115       (115

Interest expense

    21,253            21,253        (4,395 ) d)      16,858   
                                               

Income before provision for income taxes

    14,550        (42       14,508        4,395        18,903   

Provision for income taxes

    6,341        —            6,341        1,714  e)      8,055   
                                               

Income before equity in net earnings of subsidiary

    8,209        (42       8,167        2,681        10,848   

Equity in net earnings of subsidiary

    —          8,209        (8,209     —          —          —     
                                               

Net income

    8,209        8,167        (8,209     8,167        2,681        10,848   

Preferred stock dividends in arrears

    —          9,279   c)        9,279        (9,279 ) f)      —     
                                               

Net (loss) income applicable to common stockholders

  $ 8,209      $ (1,112   $ (8,209   $ (1,112   $ 11,960      $ 10,848   
                                               

Pro Forma weighted average shares outstanding

           

Basic

      14,035,399   g)        17,733,732  h)        26,485,762  i) 

Diluted

      14,035,399   g)        17,733,732  h)        27,095,761  i) 

Pro Forma net income per share

           

Basic

        $ (0.06     $ 0.41   

Diluted

        $ (0.06     $ 0.40   

 

a) Represents general operating expenses of VS Parent, Inc.
b) Represents interest income accrued on the note from an officer, which was extinguished.
c) Represents dividends accrued on VS Parent, Inc. preferred shares for the period.
d) Represents a reduction in interest due to the portion of the Notes repurchased and a related reduction in amortization of deferred financing fees.
e) Represents the income tax impact of the decrease in interest expense.
f) Represents the elimination of preferred stock dividends due to the redemption and conversion of all preferred shares upon consummation of this offering.
g) Represents 7,617,000 basic and diluted weighted average common shares outstanding of VS Parent, Inc., for the fiscal year ended December 27, 2008, less 75,497 common shares retired in connection with the extinguishment of the note receivable due from an officer, adjusted retroactively using a stock split ratio of approximately 1.8611-for-one.
h) Represents basic and diluted shares subsequent to the merger giving effect to the number of shares (3,698,333) whose proceeds would be necessary to pay the accumulated dividends in arrears.
i) Represents the post-offering outstanding shares taking into effect converted warrants, converted preferred shares, and additional shares issued at the time of this offering.

 

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

Our fiscal years end on the last Saturday in December and are designated by the calendar year in which the fiscal year ends. As used herein, the term “Fiscal” with respect to any year refers to the 52-week period ending in the last Saturday in December of such year, except for “Fiscal 2005,” which refers to the 53-week period ended December 31, 2005. Results for the periods presented represent the results of VS Holdings, Inc. and its subsidiary.

The following table sets forth selected historical consolidated financial information for the Company for the periods presented. The statement of operations data for Fiscal 2008, 2007 and 2006 and the balance sheet data as of Fiscal 2008 and 2007 have been derived from the audited financial statements included in this prospectus. The balance sheet data as of Fiscal 2006, 2005 and 2004, and the statements of operations data for Fiscal 2005 and 2004, have been derived from our audited consolidated financial statements which are not included in this prospectus. The statements of operations data for the six months ended June 27, 2009 and for the six months ended June 28, 2008, and the balance sheet data as of June 27, 2009 have been derived from our unaudited condensed consolidated financial statements included in this prospectus, which, in our opinion, contain adjustments which are of a normal recurring nature, which we consider necessary to present fairly our financial position and results of operations at such dates and for such periods. The balance sheet data as of June 28, 2008 has been derived from our unaudited condensed consolidated financial statements which are not included in this prospectus. Results for the six months ended June 27, 2009 are not necessarily indicative of the results that may be expected for the entire fiscal year.

The selected historical consolidated financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto included in this prospectus.

 

    Six Months Ended     Year Ended  
    June 27,
2009
    June 28,
2008
    December 27,
2008
    December 29,
2007
    December 30,
2006
    December 31,
2005
    December 25,
2004
 
    (data presented in thousands, except for shares and per share data)  

Statement of Operations Data:

             

Net sales

  $ 343,698      $ 307,091      $ 601,540      $ 537,872      $ 486,026      $ 436,463      $ 387,357   

Cost of goods sold

    230,924        206,791        405,659        360,346        326,523        290,243        258,223   
                                                       

Gross profit

    112,774        100,300        195,881        177,526        159,503        146,220        129,134   

Selling, general and administrative expenses

    87,929        80,328        160,140        144,833        130,002        128,313        113,758   
                                                       

Income from operations

    24,845        19,972        35,741        32,693        29,501        17,907        15,376   

Extinguishment of debt and other (1)

                                (366     11,573          

Interest income

    (2     (22     (62     (234     (350     (209     (190

Interest expense

    9,841        10,789        21,253        22,340        22,161        19,595        16,538   
                                                       

Interest expense, net

    9,839        10,767        21,191        22,106        21,811        19,386        16,348   
                                                       

Income (loss) before provision (benefit) for income taxes

    15,006        9,205        14,550        10,587        8,056        (13,052     (972

Provision (benefit) for income taxes

    6,238        3,589        6,341        3,792        3,242        (5,063     (361
                                                       

Income (loss) before cumulative effect of accounting change

    8,768        5,616        8,209        6,795        4,814        (7,989     (611

Cumulative effect of accounting change (2)

                                       2,280          
                                                       

Net income (loss)

  $ 8,768      $ 5,616      $ 8,209      $ 6,795      $ 4,814      $ (5,709   $ (611
                                                       

 

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    Six Months Ended     Year Ended  
    June 27,
2009
    June 28,
2008
    December 27,
2008
    December 29,
2007
    December 30,
2006
    December 31,
2005
    December 25,
2004
 
    (data presented in thousands, except for shares and per share data)  

Preferred stock dividends in arrears

  $      $      $      $      $ 4,123      $ 7,771      $ 7,180   
                                                       

Net income (loss) applicable to common stockholders

  $ 8,768      $ 5,616      $ 8,209      $ 6,795      $ 691      $ (13,480   $ (7,791
                                                       

Weighted average shares outstanding (3)

             

Basic

    100        100        100        100        100        100        100   

Diluted

    100        100        100        100        104        100        100   

Net income (loss) per share

             

Basic

  $ 87,680      $ 56,160      $ 82,090      $ 67,950      $ 6,910      $ (134,800   $ (77,910

Diluted

  $ 87,680      $ 56,160      $ 82,090      $ 67,950      $ 6,644      $ (134,800   $ (77,910

Cash dividends paid per share

  $      $      $ 5,610      $      $      $      $   

Pro forma weighted average shares outstanding

             

Basic

    17,692,666 (5)        17,733,732  (4)         

Diluted

    19,186,113 (5)        17,733,732  (4)         

Pro forma net income (loss) per share 

             

Basic

  $ 0.20 (5)      $ (0.06 )(4)         

Diluted

  $ 0.19 (5)      $ (0.06 )(4)        

Operating Data:

             

Average net sales per comparable
store

  $ 773      $ 783      $ 1,458      $ 1,437      $ 1,387      $ 1,333      $ 1,437   

Comparable store sales
growth (6)

    4.7     7.2     6.2     6.2     6.6     0.1     1.8

Average square footage per store

    3.7        3.7        3.7        3.7        3.7        3.7        3.7   

Balance Sheet Data (as of the end of period dated above):

             

Working capital

  $ 59,861      $ 54,820      $ 52,347      $ 51,227      $ 38,286      $ 28,268      $ 27,281   

Total assets

    459,099        436,239        463,690        428,283        411,620        408,601        390,460   

Total debt

    177,753        177,494        186,382        165,000        171,500        177,127        159,336   

Stockholders’ equity

    179,147        166,260        168,530        159,794        153,506        147,855        153,349   

 

(1) Extinguishment of debt and other for Fiscal 2006 of $0.4 million relates to gains recognized on our interest rate swap that we entered into in Fiscal 2005, prior to qualification for hedge accounting. The Fiscal 2005 amount includes $11.1 million of expenses related to the repayment of our previous debt upon our issuance of the Notes and $0.4 million in expense relating to our interest rate swap that we entered into in Fiscal 2005, prior to qualification for hedge accounting. The $11.1 million consists of the writeoff of $7.7 million of original issue discount related to the allocation of value to the warrants and Series A Preferred Stock and the writeoff of $3.4 million of unamortized deferred financing costs from the previous debt.
(2) Reflects cumulative effect of accounting changes relating to costs included in inventory for Fiscal 2005.
(3) For the purpose of presenting basic and diluted net income (loss) per share on a comparative basis, as a result of the reverse merger on June 12, 2006, weighted average shares outstanding were retroactively restated for all periods presented based on the exchange ratio in the reverse merger.
(4) Represents basic and diluted shares subsequent to the merger giving effect to the number of shares (3,698,333) whose proceeds would be necessary to pay the accumulated dividends in arrears.
(5) Represents basic and diluted shares subsequent to the merger giving effect to the number of shares (3,657,267) whose proceeds would be necessary to pay the accumulated dividends in arrears.
(6) A store is included in comparable store sales after 410 days of operation.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of our Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and notes thereto included in this prospectus. The discussion in this section contains forward-looking statements that are based upon current expectations. The forward-looking statements contained herein include, without limitation, statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, research and development expenses, general and administrative expenses, capital resources, additional financings or borrowings and additional losses and are subject to risks and uncertainties including, but not limited to, those discussed below and elsewhere in this prospectus 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 information set forth in “Special Note Regarding Forward-Looking Statements” and “Risk Factors.”

Overview

We are a leading specialty retailer and direct marketer of vitamins, minerals, herbs, supplements, sports nutrition and other health and wellness products. For each of the past three years, we have been the second largest in retail sales and the fastest growing national VMS specialty retailer. We market over 700 different nationally recognized brands as well as our proprietary Vitamin Shoppe, BodyTech and MD Select brands. We believe we offer the greatest variety of products among VMS retailers with approximately 8,000 SKUs offered in our typical store and an additional 12,000 SKUs available through our Internet and catalog direct sales channels. Our broad product offering enables us to provide our target customers with a selection of products not readily available at other specialty VMS retailers or mass merchants, such as supermarkets and drugstore chains. We target the dedicated, well-informed VMS consumer and differentiate ourselves by providing high quality products at competitive prices in an educational and high-touch customer service environment. 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.

Our company was founded as a single store in New York, New York in 1977. Our Vitamin Shoppe branded products were introduced in 1989. We were acquired in November 2002 by IPC and other investors.

Segment Information

We sell our products through two business segments: retail and direct.

Retail

Since the beginning of Fiscal 2005 through Fiscal 2008, we have leveraged our successful store economic model by opening a total of 171 new stores. Over the past five years, we have expanded our presence in our existing markets as well as entered many new markets such as California, Texas, Michigan and Hawaii. As of September 25, 2009, we operated 434 stores in 37 states and the District of Columbia located in high-traffic regional centers. In the first six months of Fiscal 2009, our retail segment generated net sales of $303.4 million, representing a 13.8% increase over the first six months of Fiscal 2008 retail net sales of $266.6 million. We have achieved positive comparable store sales for 15 consecutive years (prior to which we did not track comparable store sales), including comparable store sales growth of 6.2% in each of 2007 and 2008 and 4.7% and 7.2% for the six months ended June 27, 2009 and June 28, 2008, respectively. In Fiscal 2008, our retail segment generated net sales of $522.5 million, representing a 13.1% increase over Fiscal 2007 retail net sales of $462.0 million. From Fiscal 2005 to Fiscal 2008, we have grown our net sales in our retail segment at approximately a 13.0% CAGR. From Fiscal 2005 to Fiscal 2008, we have grown our store base at a 13.4% CAGR.

 

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Direct

We sell our products directly to consumers through our websites, primarily www.vitaminshoppe.com. Our websites and our catalog complement our in-store experience by extending our retail product offerings with an additional 12,000 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. Catalog sales were not material in 2008, and are expected to remain immaterial in the future, as customers migrate to our website and stores. In 2008 we increased the number of active online customers, defined by shopping frequency and annual dollars spent, by approximately 60,000 to more than 460,000. In the first six months of Fiscal 2009, our direct segment generated net sales of $40.3 million representing a 0.5% decrease over the first six months of Fiscal 2008 direct net sales of $40.5 million. In Fiscal 2008, the direct segment generated net sales of $79.0 million representing a 4.1% increase over Fiscal 2007 direct net sales of $75.9 million.

Trends and Other Factors Affecting Our Business

The VMS industry in the U.S. is highly fragmented, and based on information from the NBJ and public filings with the SEC, no single industry participant accounted for more than 5% of total industry sales in 2008. Retailers of VMS products primarily include specialty retailers and mass merchants, such as drugstores and supermarkets. The specialty retailers typically cater to the more sophisticated VMS customer by focusing on selection and customer service, while the mass merchants generally offer a limited assortment comprised of more mainstream products with less customer care. Specialty retailers comprised the largest segment of the market in 2008, with 37% market share, sales in which are forecasted to grow by 4.7% annually through 2014, according to the NBJ.

According to the NBJ, growth in the U.S. nutritional supplement industry from 2006 through 2008 has been led by specialty supplements, which have grown due to increasing popularity of condition-specific products, including glucosamine / chondroitin (for joint health), homeopathics (for miscellaneous conditions), fish oils (for cardiovascular health), Coenzyme Q10 (CoQ10) (for energy and cardiac health), vitamin D (for bone support through better calcium absorption) and probiotics (for digestive health). Consumers use nutritional supplements to improve their lifestyles, support specific health conditions, and keep themselves feeling younger and more active. According to the NBJ from 2009 to 2014, the U.S. specialty supplement product category is expected to grow at a 5.9% CAGR, or approximately 38% faster than the overall industry. The specialty supplements product category represented 17.9% of the total U.S. nutritional supplement industry in 2008. By way of comparison, specialty supplements, the fastest growing product category in the VMS industry, generated 27.4% of our Fiscal 2008 net sales. We over-index our concentration in specialty supplements to focus on target customers who emphasize health and wellness as part of their lifestyle.

Sports nutrition products represented approximately 10.8% of the total U.S. nutritional supplement industry in 2008. By way of comparison, sports nutrition products generated 29.0% of our Fiscal 2008 net sales. We believe our sports nutrition offering emphasizes products such as protein powders which appeal to our customers’ emphasis on health and wellness rather than products taken in conjunction with a body building regimen. From 2009 to 2014, the sports nutrition product category is expected to grow at a 5.5% CAGR, representing the second fastest growing product category in the VMS industry.

We believe that one of the primary trends driving the growth in the industry is the aging U.S. population. The total U.S. population of people 50 and older is expected to increase to 115 million people in 2018 from 94 million people in 2008, a CAGR of 2.1%, which is more than twice the overall population growth rate. The aging Baby Boomer generation comprises a significant and increasing part of the 50 and older population.

For the three months ended September 26, 2009, we expect to report that total sales increased 11.3% to $168.4 million from $151.3 million in the comparable prior year period and comparable store sales for the quarter increased 4.4%. Gross margin for the three months ended September 26, 2009 is expected to decline due to increased promotional activity in August.

The foregoing figures are preliminary estimates only, are based upon management estimates as of the date of this prospectus, have not been reviewed by our independent registered public accounting firm and are subject

 

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to adjustments including those as a result of subsequent events which occur after the date of this prospectus. The final financial results for the three months ended September 26, 2009 may vary from our expectations and may be materially different from the preliminary estimates we are providing above due to completion of quarterly close and review procedures, final adjustments and other developments that may arise between now and the time the financial results for this period are finalized.

Critical Accounting Policies

The preparation of 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 revenue and expenses during the reporting period. 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 financial statements, our most critical accounting policies, discussed below, pertain to revenue recognition, inventories, impairment of long-lived assets, goodwill and other intangible assets, deferred sales for our Healthy Awards Program, stock-based compensation and income taxes. In applying such policies, we must use some amounts that are based upon our informed judgments and best estimates. Estimates, by their nature, are based on judgments and available information. The estimates that we make are based upon historical factors, current circumstances and the experience and judgment of management. We evaluate our assumptions and estimates on an ongoing basis.

Revenue Recognition

We recognize revenue upon sale of our products to our retail customers at the “point of sale,” which occurs when merchandise is sold “over-the-counter” in retail stores or upon delivery to a direct customer, net of sales returns. In accordance with Emerging Issues Task Force (“EITF”) Issue 00-10, “Accounting for Shipping and Handling Fees and Costs,” we classify all amounts billed to customers that represent shipping fees as sales in all periods presented. To arrive at net sales, gross sales are reduced by actual customer returns and a provision for estimated future customer returns, which is based on management’s review of historical and current customer returns. The amounts reserved for sales returns, net of cost of goods sold, were $0.1 million and $0.1 million at December 27, 2008 and December 29, 2007, respectively.

Inventories

Inventories are stated at the lower of cost or market value. Cost is determined using the moving weighted average method. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing the product to its existing condition and location. Finished goods inventory includes the cost of labor and overhead required to package products. In addition, the cost of inventory is reduced by purchase discounts and allowances received from certain of our vendors. We adjust our inventory to reflect situations in which the cost of inventory is not expected to be recovered. We regularly review our inventory, including when a product is close to expiration and not expected to be sold, when a product has reached its expiration date, or when a product is not expected to be saleable. In determining the reserves for these products, we consider factors such as the amount of inventory on hand and its remaining shelf life, and current and expected market conditions, including management forecasts and levels of competition. We have evaluated the current level of inventory considering historical trends and other factors, and based on our evaluation, have recorded adjustments to reflect inventory at net realizable value. These adjustments are estimates, which could vary significantly from actual results if future economic conditions, customer demand or competition differ from expectations. These estimates require us to make assessments about the future demand for our products in order to categorize the status of such inventory items as slow moving, obsolete or in excess of need. These future estimates are subject to the ongoing accuracy of management’s forecasts of market conditions, industry trends and competition. We are also subject to volatile changes in specific product demand as a result of unfavorable publicity, government regulation and rapid changes in demand for new and improved products or services. At December 27, 2008, and December 29, 2007, obsolescence reserves were $1.4 million and $1.3 million, respectively.

 

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Long-Lived Assets

We evaluate long-lived assets, including fixed assets and intangible assets with finite useful lives, periodically for impairment whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. If the sum of our estimated undiscounted future cash flows is less than the carrying value, we recognize an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset. These estimates of cash flow require significant management judgment and certain assumptions about future volume, sales and expense growth rates, devaluation and inflation. As such, these estimates may differ from actual cash flows. For the periods presented we had no impairments of our long-lived assets.

Goodwill and Other Intangible Assets

On an annual basis, or whenever impairment indicators exist, we perform a valuation of goodwill and indefinite lived intangible assets. In the absence of any impairment indicators, goodwill and other indefinite lived intangible assets are tested in the fourth quarter of each fiscal year. With regards to goodwill, our tests are based on our two reporting units, and utilize the discounted cash flow method, based on our current operating projections, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). For those intangible assets which have definite lives, we amortize their cost on a straight-line basis over their estimated useful lives which are various periods based on their contractual terms. Judgments regarding the existence of impairment indicators are based on market conditions and operational performance of the business. Future events could cause us to conclude that impairment indicators exist, and therefore that goodwill and other intangible assets are impaired. To the extent that the fair value associated with the goodwill and indefinite-lived intangible assets is less than the recorded value, we would write down the value of the asset to its fair value.

Our impairment test involves calculating the fair value of both our reporting units (our segments) using the discounted cash flow method along with the market multiples method which is used for additional validation of the value calculated. Both of these valuation methods require us to make certain assumptions and estimates regarding certain industry trends and future profitability of our reporting units. It is our policy to conduct goodwill impairment testing from information based on our most current business projections, which include projected future revenues and cash flows. The cash flows utilized in the discounted cash flow analysis are based on five-year financial forecasts developed internally by our management. Cash flows for each unit are discounted using an internally derived weighted average cost of capital which reflects the costs of borrowing for the funding of each unit as well as the risk associated with the units themselves and the industry they perform in. If the carrying amount of a reporting unit exceeds its fair value, we would compare the implied fair value of the reporting unit goodwill with its carrying value. To compute the implied fair value, we would assign the fair value of the reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. If the carrying value of the reporting unit goodwill exceeded the implied fair value of the reporting unit goodwill, we would record an impairment loss to write down such goodwill to its implied fair value. The valuation of goodwill and indefinite-lived intangible assets is affected by, among other things, our business plan for the future and estimated results of future operations. Changes in the business plan or operating results that are different than the estimates used to develop the valuation of the assets may impact their valuation.

We have tested our goodwill and indefinite-lived intangibles for impairment in the fourth quarter of each fiscal year presented and concluded there was no impairment relative to such assets. Accordingly, there is no impairment expense recorded in any of the periods presented.

Deferred Sales

Our Healthy Awards Program allows customers to earn points toward free merchandise based on the volume of purchases. Points are earned each year under our Healthy Awards Program and are redeemable within the first

 

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three months of the following year or they expire. We defer sales on transactions based on estimated redemptions, which are based on historical redemption data as well as marketing efforts within the current period, and record a liability for points being earned within the current period. Net changes to deferred sales were $1.8 million, $0.3 million, and $0.4 million for the years ended December 27, 2008, December 29, 2007 and December 30, 2006, respectively. The balance of the deferred sales liability was $13.0 million and $11.2 million at December 27, 2008 and December 29, 2007, respectively.

Stock-Based Compensation

Effective January 1, 2006, the Company adopted the fair value method of recording stock-based compensation in accordance with SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), an amendment of FASB Statements No. 123, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors. Under the fair value recognition provisions of SFAS No. 123(R), stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards at the grant date requires considerable judgment, including estimating expected volatility, expected term and risk-free rate. Our expected volatility is based on the volatility levels over the past 6.25 years from the average volatility of similar actively traded companies. The expected holding period of the option is calculated using the simplified method using the vesting term of four years and the contractual term of 10 years. The simplified method was chosen as a means to determine our holding period as we currently have no historical option exercise experience due to being a privately held company. The risk-free interest rate is derived from the average yield for the five and seven year zero-coupon U.S. Treasury Strips. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. As a result of our application of the adoption of SFAS No. 123(R), we expect stock-based compensation expense to increase significantly over the next several years. In addition, upon consummation of this offering, we expect to incur a compensation charge due to the acceleration of options pursuant to employment agreements, as disclosed in “Compensation Discussion and Analysis.” Based upon an estimated offering price of $15.00 per share, the midpoint of the price range set forth on the cover of this prospectus, the outstanding vested and unvested options would have an intrinsic value of $13.7 million.

Amounts charged to expense were $2.4 million, $1.6 million and $0.5 million for stock-based compensation for Fiscal 2008, Fiscal 2007, and Fiscal 2006, respectively. The weighted average fair value for grants for Fiscal 2008, Fiscal 2007, and Fiscal 2006 was $14.74, $13.10, and $6.09, respectively.

Income Taxes

We record our income taxes based on the requirements of SFAS No. 109, “Accounting for Income Taxes.” Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We periodically assess the realizability of deferred tax assets and the adequacy of deferred tax liabilities, including the results of local state, and federal statutory tax audits or estimates and judgments used.

Realization of deferred tax assets associated with net operating loss and credit carryforwards is dependent upon generating sufficient taxable income prior to their expiration in the applicable tax jurisdiction. We periodically review the recoverability of tax assets recorded on our balance sheet and provide valuation allowances as we deem necessary. Deferred tax assets could be reduced in the near term if our estimates of taxable income during the carryforward period are significantly reduced or alternative tax strategies are no longer viable.

Our income tax returns are periodically audited by the Internal Revenue Service and state and local jurisdictions. We reserve for tax contingencies when it is probable that a liability has been incurred and the contingent amount is reasonably estimable. These reserves are based upon our best estimation of the potential exposures associated with the timing and amount of deductions, as well as various tax filing positions.

 

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Effective December 31, 2006 (the first day of Fiscal 2007), we adopted FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. FIN 48 provides guidance for the recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In accordance with FIN 48, we recognized a liability for uncertain tax positions for $3.2 million, increasing our previously recorded liability for uncertain tax positions, interest, and penalties, and reducing the December 31, 2006 balance of retained earnings by $0.2 million as well increasing the balance of goodwill. See Note 7 to our consolidated financial statements for the year ended December 27, 2008, for more information on income taxes.

Prior to 2007 and the adoption of FIN 48, reserves were recorded when management determined that it was probable that a loss would be incurred related to these matters and the amount of the loss was reasonably determinable. Subsequent to the adoption of FIN 48, we are required to recognize, at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority, the impact of an uncertain income tax position on our income tax return. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The tax positions are analyzed periodically (at least quarterly) and adjustments are made as events occur that warrant adjustments to those positions. We record interest expense and penalties payable to relevant tax authorities as income tax expense.

General Definitions for Operating Results

Net Sales consist of sales from comparable stores and non comparable stores, as well as sales made directly to our Internet and catalog customers net of deferred sales. A store is included in comparable store sales after 410 days of operation.

Cost of goods sold excludes depreciation and amortization shown separately within selling, general and administrative expenses below, and includes the cost of inventory sold, markdowns, costs of warehousing and distribution and store occupancy costs. Warehousing and distribution costs include freight on internally transferred merchandise, rent for the distribution center and costs associated with our buying department and distribution facility, including payroll, which are capitalized into inventory and then expensed as merchandise is sold. 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 assets, operating payroll and related benefits, advertising and promotion expense, and other selling, general and administrative expenses.

Related party expenses consist of management fees incurred and paid to IPC Manager II, LLC, and consulting fees incurred and paid to Renaissance Brands Ltd.

Income from operations consists of gross profit minus selling, general and administrative expenses, and related party expenses.

Other includes $0.4 million of income in Fiscal 2006 related to our interest rate swap.

Interest income represents income earned from highly liquid investments purchased with an original maturity of three months or less.

Interest expense includes interest on the Notes, amortization of debt discount and amortization of financing costs, and interest on the revolving credit line.

 

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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):

 

     Six Months Ended     Year Ended  
     June 27,
2009
    June 28,
2008
    December 27,
2008
    December 29,
2007
    December 30,
2006
 

Net sales

   $ 343,698      $ 307,091      $ 601,540      $ 537,872      $ 486,026   

Increase in comparable store net sales

     4.7     7.2     6.2     6.2     6.6

Gross profit as a percent of net sales

     32.8     32.7     32.6     33.0     32.8

Income from operations

   $ 24,845      $ 19,972      $ 35,741      $ 32,693      $ 29,501   

The following table shows the growth in our network of stores for the six months ended June 27, 2009 and June 28, 2008 and Fiscal 2008, 2007 and 2006:

 

     Six Months Ended    Fiscal Year  
     June 27,
2009
    June 28,
2008
   2008     2007     2006  

Stores open at beginning of year

   401      341    341      306      275   

Stores opened

   25      20    62      36      32   

Stores closed

   (1      (2   (1   (1
                             

Stores open at end of period

   425      361    401      341      306   
                             

Results of Operations

The information presented below is for the six months ended June 27, 2009 and June 28, 2008, which was derived from our unaudited consolidated financial statements and, in the opinion of management, includes all adjustments necessary for a fair presentation of our financial position and operating results for such periods and as of such dates and the fiscal years ended December 27, 2008, December 29, 2007 and December 30, 2006, which was derived from our audited consolidated financial statements. The following table summarizes our results of operations for periods presented as a percentage of net sales:

 

     Six Months Ended     Fiscal Year Ended  
     June 27,
2009
    June 28,
2008
    December 27,
2008
    December 29,
2007
    December 30,
2006
 

Net sales

   100.0   100.0   100.0   100.0   100.0

Cost of goods sold

   67.2   67.3   67.4   67.0   67.2
                              

Gross profit

   32.8   32.7   32.6   33.0   32.8

Selling, general and administrative expenses

   25.3   25.9   26.4   26.7   26.5

Related party expenses

   0.3   0.3   0.3   0.2   0.3
                              

Income from operations

   7.2   6.5   5.9   6.1   6.1

Other

       0.0   0.0   -0.1

Interest income

   (0.0 )%    (0.0 )%    -0.1   -0.1   -0.1

Interest expense

   2.8   3.5   3.5   4.2   4.6
                              

Interest expense, net

   2.8   3.5   3.4   4.1   4.5
                              

Income before provision for income taxes

   4.4   3.0   2.5   2.0   1.7

Provision for income taxes

   1.8   1.2   1.1   0.7   0.7
                              

Net income

   2.6   1.8   1.4   1.3   1.0
                              

The net sales results presented for Fiscal 2008, 2007 and 2006 are each based on a 52-week period. The net sales results presented for the six months ended June 27, 2009 and June 28, 2008, are each based on a 26-week period.

 

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Six Months Ended June 27, 2009 Compared To Six Months Ended June 28, 2008

Net Sales

Net sales increased $36.6 million, or 11.9%, to $343.7 million for the six months ended June 27, 2009 compared to $307.1 million for the six months ended June 28, 2008. The increase was the result of an increase in our comparable store sales, new sales from our non-comparable stores, offset in part, by a decrease in our direct sales.

Retail

Net sales from our retail stores increased $36.8 million, or 13.8%, to $303.4 million for the six months ended June 27, 2009 compared to $266.6 million for the six months ended June 28, 2008. We operated 425 stores as of June 27, 2009 compared to 361 stores as of June 28, 2008. Our overall store sales for the six months ended June 27, 2009 increased due to non-comparable store sales increases of $8.1 million and an increase in comparable store sales of $28.7 million, or 4.7%. Our overall sales increased primarily in the categories of supplements, which increased $10.6 million, or 16.5%; vitamins and multivitamins, which increased $5.1 million, or 15.0%; sports nutrition, which increased by $13.3 million, or 20.4%; minerals, which increased $1.2 million, or 14.1%; and herbs, which increased $8.5 million, or 18.1%; offset in part by weight management, sales of which decreased $1.1 million, or 6.3%.

The supplements category, which is among the largest selling product categories in our mix, continues to experience significant growth in sales of essential fatty acids, or EFAs, which have been responsible for most of the growth in the supplement category for several quarters. Given the current trend in EFA consumption, and the growing number of publications and recommendations regarding the heart-health benefits of fish oils (such as by The American Heart Association and US National Institutes of Health), we expect continued strength in sales of EFAs for the remainder of this Fiscal year. Product sales in the sports nutrition category increased at a greater rate than the overall increase in net sales during the six months ended June 27, 2009, and has done so since the middle of Fiscal 2006. We believe this is due largely to the growth in the fitness-conscious market as well as the diversity of new product introductions and innovations in functionally specific supplementation. In addition, net sales in our Herbs category increased at a greater rate than the overall increase in net sales primarily as a result of an increase in sales in our cleansing and superfoods products. Sales in the weight management category decreased during the six months ended June 27, 2009, due primarily to a recall of a popular thermogenic product which was not replaced with a reformulated product until after the close of the second Fiscal quarter of 2009.

Direct

Net sales to our direct customers decreased $0.2 million, or 0.5%, to $40.3 million for the six months ended June 27, 2009 compared to $40.5 million for the six months ended June 28, 2008. The overall decrease in our direct sales was due to an increase in our Internet sales of approximately $2.3 million which was offset by a decrease in our catalog sales. The increase in web-based sales was largely due to a greater influx of customers during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008, as a result of our prior web-based marketing initiatives. We have reduced our catalog circulation and customer prospecting as we believe catalog purchasing in general is declining in popularity as a purchasing medium, especially in the wake of the introduction of online shopping. In addition, as we continue to open more stores in new markets, some catalog customers choose to shop at our retail locations.

Cost of Goods Sold

Cost of goods sold, which includes product, warehouse and distribution and occupancy costs, increased $24.1 million, or 11.7%, to $230.9 million for the six months ended June 27, 2009 compared to $206.8 million for the six months ended June 28, 2008. The dollar increase was primarily due to an increase in product costs and occupancy costs for the six months ended June 27, 2009, as compared to the six months ended June 28, 2008.

 

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Cost of goods sold as a percentage of net sales decreased to 67.2% for the six months ended June 27, 2009, compared to 67.3% for the six months ended June 28, 2008. The decrease of cost of goods sold as a percentage of net sales was due primarily to decreases in product costs and distribution costs as a percentage of sales of 0.6% and 0.4%, respectively, which were offset by an increase in occupancy costs of 0.8% as a percentage of sales. The increase of occupancy costs as a percentage of sales is largely attributable to the larger body of new (non-comparable) stores in operations during the first six months of Fiscal 2009, as compared to the same period last year.

Gross Profit

As a result of the foregoing, gross profit increased $12.5 million, or 12.4%, to $112.8 million for the six months ended June 27, 2009 compared to $100.3 million for the six months ended June 28, 2008.

Selling, General and Administrative Expenses

Selling, general and administrative expenses, including operating payroll and related benefits, advertising and promotion expense, depreciation and amortization, and other selling, general and administrative expenses, increased $7.5 million, or 9.4%, to $87.1 million for the six months ended June 27, 2009, compared to $79.6 million for the six months ended June 28, 2008. The components of selling, general and administrative expenses are explained below. Selling, general and administrative expenses as a percentage of net sales for the six months ended June 27, 2009 decreased to 25.3% compared to 25.9% for the six months ended June 28, 2008.

Operating payroll and related benefits increased $4.3 million, or 14.8%, to $33.4 million for the six months ended June 27, 2009 compared to $29.1 million for the six months ended June 28, 2008. Operating payroll and related benefits expenses as a percentage of net sales increased to 9.7% for the six months ended June 27, 2009 compared to 9.5% for the six months ended June 28, 2008. The increase as a percentage of net sales was primarily due to the greater volume of newer stores thus resulting in lower sales per hour relative to net sales during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008.

Advertising and promotion expenses increased $0.3 million, or 4.6%, to $7.4 million for the six months ended June 27, 2009 compared to $7.1 million for the six months ended June 28, 2008. Advertising and promotion expenses as a percentage of net sales decreased to 2.1% for the six months ended June 27, 2009 from 2.3% for the six months ended June 28, 2008. The decrease is primarily due to a decline in our catalog circulation for the six months ended June 27, 2009, as compared to the six months ended June 28, 2008, as we are reducing our catalog advertising and prospecting efforts.

Other selling, general and administrative expenses, which includes depreciation and amortization expense, increased $2.9 million, or 6.7%, to $46.3 million for the six months ended June 27, 2009 compared to $43.4 million for the six months ended June 28, 2008. The increase was due to increases in depreciation and amortization expense of approximately $2.1 million, and an increase in corporate payroll expenses of $0.8 million. The increase in payroll was attributable to increases to our corporate staff to meet the needs of our growth during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008. Other selling, general and administrative expenses as a percentage of net sales decreased to 13.5% during the six months ended June 27, 2009 compared to 14.1% for the six months ended June 28, 2008, due to achieving greater overall efficiencies from our operations and corporate infrastructure relative to net sales during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008.

Related Party Expenses

Related party expenses increases $0.1 million, or 10.9%, to $0.8 million for the six months ended June 27, 2009, as compared to $0.7 million for the six months ended June 28, 2008, due to the increase in net sales.

 

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Income from Operations

As a result of the foregoing, income from operations increased $4.9 million, or 24.4%, to $24.8 million for the six months ended June 27, 2009 compared to $20.0 million for the six months ended June 28, 2008. Income from operations as a percentage of net sales increased to 7.2% for the six months ended June 27, 2009, compared to 6.5% for the six months ended June 28, 2008.

Retail

Income from operations for the retail segment increased $7.7 million, or 18.2%, to $49.7 million for the six months ended June 27, 2009 compared to $42.0 million for the six months ended June 28, 2008. Income from operations as a percentage of net sales for the retail segment increased to 16.4% for the six months ended June 27, 2009 compared to 15.8% for the six months ended June 28, 2008. The increase as a percentage of net sales was primarily due to the decrease in cost of goods sold of 0.4% as a percent of sales and a decrease and in operating expenses of 0.6% as a percent of sales. The decrease in operating expenses were as a result of the economies of scale described in “Other, selling, general and administrative expenses.” These decreases were offset in part by an increase in advertising expense of 0.2% as a percentage of net sales, which is attributable to the increases in greater national media exposure and media for grand openings during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008.

Direct

Income from operations for the direct segment increased $0.4 million, or 4.7%, to $8.1 million for the six months ended June 27, 2009 compared to $7.7 million for the six months ended June 28, 2008. Income from operations as a percentage of net sales for the direct segment increased to 20.1% for the six months ended June 27, 2009 compared to 19.1% for the six months ended June 28, 2008. This increase in income from operations as a percentage of net sales was due mainly to a 1.9% decrease in advertising costs as percentage of net sales, as we are reducing our catalog advertising and prospecting efforts, offset by an increase in cost of goods sold of 0.9% as a percentage of net sales which was primarily due to greater distribution costs. The increase in distribution costs was primarily as a result of a lower ratio of units per shipment experienced for the six months ended June 27, 2009, as compared the six months ended June 28, 2008.

Corporate Costs

Corporate costs increased by $3.2 million, or 10.6%, to $32.9 million for the six months ended June 27, 2009 compared to $29.8 million for the six months ended June 28, 2008. Corporate costs as a percentage of net sales decreased to 9.6% for the six months ended June 27, 2009 compared to 9.7% for the six months ended June 28, 2008. The dollar increase was primarily due to increases in depreciation and amortization expense of approximately $2.1 million, and an increase in payroll of $0.8 million, attributable to our growing corporate infrastructure. The 0.1% decrease as a percentage of net sales for the six months ended June 27, 2009, as compared to the six months ended June 28, 2008, was primarily due to achieving greater overall efficiencies from our corporate infrastructure relative to net sales during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008.

Interest Income

Interest income decreased $20,000 to $2,000 for the six months ended June 27, 2009 compared to $22,000 for the six months ended June 28, 2008. The decrease was due largely to lower interest rates, and lower cash balances during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008.

Interest Expense

Interest expense decreased $0.9 million, or 8.8%, to $9.8 million for the six months ended June 27, 2009 compared to $10.8 million for the six months ended June 28, 2008. The decrease was due to lower interest rates as well as lower outstanding short-term borrowings experienced during the six months ended June 27, 2009, as compared to the six months ended June 28, 2008.

 

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Provision for Income Taxes

We recognized $6.2 million of income tax expense during the six months ended June 27, 2009 compared with $3.6 million for the six months ended June 28, 2008. The effective tax rate for the six months ended June 27, 2009 was 41.6%, compared to 39.0% for the six months ended June 28, 2008. The effective rate for the current period, as compared to the same period last year, increased primarily due to increases in our blended state tax rates.

Net Income

As a result of the foregoing, we generated net income of $8.8 million for the six months ended June 27, 2009 compared to $5.6 million for the six months ended June 28, 2008.

Comparison of Fiscal 2008 with Fiscal 2007

Net Sales

Net sales increased $63.7 million, or 11.8%, to $601.5 million for Fiscal 2008 compared to $537.9 million for Fiscal 2007. The increase was the result of an increase in our comparable store sales, as well as sales from our new non-comparable stores, and an increase in our direct sales.

Retail

Net sales from our retail stores increased $60.6 million, or 13.1%, to $522.5 million for Fiscal 2008 compared to $462.0 million for Fiscal 2007. We operated 401 stores as of December 27, 2008 compared to 341 stores as of December 29, 2007. Our overall store sales increased due to non-comparable store sales of $32.5 million, as well as an increase in comparable store sales growth of $28.1 million, or 6.2% (Comparable store sales include only those stores open more than 410 days and align with Fiscal 2007). Our overall sales increased primarily in the categories of sports nutrition, which increased $27.2 million, or 22.0%; supplements, which increased $13.0 million, or 11.2%; herbs and homeopathic, which increased $7.9 million, or 9.3%; weight management, which increased $2.7 million, or 9.4%; vitamins category, which increased $7.7 million, or 12.7%, and minerals, which increased $1.8 million, or 12.1%.

The supplements category, which is among the largest selling product categories in our mix, continues to experience significant growth in sales of essential fatty acids, or EFAs, which have been responsible for most of the growth in the supplement category since Fiscal 2006. Given the current trend in EFA consumption, and the growing number of publications and recommendations regarding the heart-health benefits of fish oils (such as by The American Heart Association and US National Institutes of Health), we expect continued strength in sales of EFAs for the next fiscal year. The vitamins category was one of our fastest growing categories in Fiscal 2008, as we experienced significant growth in sales of multi-vitamins, as we released new special formulations in Fiscal 2008, and in Vitamin D, which we believe was due in part to recent favorable press. Product sales in the sports nutrition category increased at a greater rate than the overall increase in net sales during Fiscal 2008, and have done so since mid Fiscal 2006. We believe this is due largely to the continued growth in the fitness-conscious market as well as the diversity of new product introductions.

Direct

Net sales to our direct customers increased $3.1 million, or 4.1%, to $79.0 million for Fiscal 2008 compared to $75.9 million for Fiscal 2007. The overall increase in our direct sales was due to an increase in Internet sales of $9.8 million in Fiscal 2008, offset by a decrease in our catalog sales. The increase in our web-based sales was primarily due to a greater influx of customers in Fiscal 2008 as compared to Fiscal 2007, as a result of our prior web-based marketing initiatives. We have reduced our catalog circulation and catalog customer prospecting as we believe catalog purchasing in general is declining in popularity as a purchasing medium, especially in the wake of the growth of online shopping. In addition, as we continue to open more stores in new markets, some catalog customers choose to shop at our retail locations.

 

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Cost of Goods Sold

Cost of goods sold, which includes product, warehouse and distribution and store occupancy costs, increased $45.3 million, or 12.6%, to $405.7 million for Fiscal 2008 compared to $360.3 million for Fiscal 2007. The components of cost of goods sold are explained below. Cost of goods sold as a percentage of net sales increased to 67.4% for Fiscal 2008 compared to 67.0% for Fiscal 2007.

Product costs increased $31.6 million, or 11.3%, to $311.4 million during Fiscal 2008 compared to $279.8 million for Fiscal 2007. Product costs as a percentage of net sales decreased to 51.8% during Fiscal 2008 compared to 52.0% for Fiscal 2007. The percentage decrease was primarily the result of a decrease in price promotions for our products of approximately 0.5%; a decrease in inventory markdowns of 0.3%, as well as an increase in inventory efficiency of 0.3%, offset in part by an increase in product costs of approximately 1.0% as a percentage of sales in Fiscal 2008 versus Fiscal 2007.

Warehouse and distribution costs increased $3.2 million, or 17.3%, to $21.8 million for Fiscal 2008 compared to $18.6 million for Fiscal 2007. Warehouse and distribution costs as a percentage of net sales increased to 3.6% for Fiscal 2008 compared to 3.5% in Fiscal 2007. The increase was mainly attributable to increases in shipping costs as a result of a having significant number of new stores, with many of them being at greater distances, during Fiscal 2008 as compared to Fiscal 2007.

Occupancy costs increased $10.5 million, or 16.9%, to $72.4 million for Fiscal 2008 compared to $61.9 million for Fiscal 2007. Occupancy costs as a percentage of net sales increased to 12.0% during Fiscal 2008 compared to 11.5% for Fiscal 2007. This increase as a percentage of sales is mainly attributable to the increases in utilities and real estate tax expenses as well as increased rent for our newer store leases.

Gross Profit

As a result of the foregoing, gross profit increased $18.4 million, or 10.3%, to $195.9 million for Fiscal 2008 compared to $177.5 million for Fiscal 2007.

Selling, General and Administrative Expenses

Selling, general and administrative expenses, including operating payroll and related benefits, advertising and promotion expense, and other selling, general and administrative expenses, increased $15.1 million, or 10.6%, to $158.6 million during Fiscal 2008, compared to $143.5 million for Fiscal 2007. The components of selling, general and administrative expenses are explained below. Selling, general and administrative expenses as a percentage of net sales for Fiscal 2008 decreased to 26.4% compared to 26.7% for Fiscal 2007.

Operating payroll and related benefits increased $5.6 million, or 10.4%, to $59.0 million for Fiscal 2008 compared to $53.5 million for Fiscal 2007. The increase is due mainly to our increase in retail locations throughout Fiscal 2008. Operating payroll and related benefits expenses as a percentage of net sales decreased to 9.8% during Fiscal 2008 compared to 9.9% for Fiscal 2007. This was largely due to experiencing greater sales per hour during Fiscal 2008.

Advertising and promotion expenses decreased $0.5 million, or 3.9%, to $13.2 million for Fiscal 2008 compared to $13.7 million for Fiscal 2007. Advertising and promotion expenses as a percentage of net sales decreased to 2.2% during Fiscal 2008 compared to 2.6% for Fiscal 2007, as we are reducing our catalog advertising and prospecting efforts.

Other selling, general and administrative expenses, which include depreciation and amortization expense, increased $10.1 million, or 13.3%, to $86.4 million in Fiscal 2008 compared to $76.3 million for Fiscal 2007. The increase was due primarily to an increase in depreciation and amortization of approximately $2.6 million, reflecting

 

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our expanding operation and the amortization of the purchased intangible assets in Fiscal 2008; $3.2 million for corporate payroll expense which was primarily due to an increase in corporate staff during Fiscal 2008 to accommodate our growth; various employee related administrative fees of $1.5 million; and stock-based compensation expense of approximately $0.8 million, due to additional grants issued in Fiscal 2008. In addition to the above, credit card fees increased by approximately $0.8 million due to our increased sales during Fiscal 2008, and store pre-opening costs increased $1.2 million due to the increase in the number of new stores we opened during Fiscal 2008, as well as the lead time needed in opening some of these new stores. Other selling, general and administrative expenses as a percentage of net sales increased to 14.4% during Fiscal 2008 compared to 14.3% for Fiscal 2007, due primarily to increases in our corporate infrastructure to accommodate our growing operations.

Related Party Expenses

Related party expenses increased $0.2 million, or 11.6%, to $1.5 million during Fiscal 2008, as compared to $1.4 million for Fiscal 2007 (for a detailed presentation of related party expenses, see Note 11 to our consolidated financial statements).

Income from Operations

As a result of the foregoing, income from operations increased $3.0 million, or 9.3%, to $35.7 million for Fiscal 2008 compared to $32.7 million for Fiscal 2007. Income from operations as a percentage of net sales decreased to 5.9% during Fiscal 2008 as compared to 6.1% for Fiscal 2007.

Retail

Income from operations for the retail segment increased $9.2 million, or 13.0%, to $80.4 million for Fiscal 2008 compared to $71.2 million for Fiscal 2007. Income from operations as a percentage of net sales for the retail segment remained level at 15.4% for Fiscal 2008 compared to 15.4% for Fiscal 2007.

Direct

Income from operations for the direct segment increased $0.9 million, or 6.7%, to $14.9 million for Fiscal 2008 compared to $14.0 million for Fiscal 2007. Income from operations as a percentage of net sales for the direct segment increased to 18.8% for Fiscal 2008 compared to 18.4% for Fiscal 2007. This increase as a percentage of net sales was primarily due to a decrease in advertising expense of 1.1% as a percentage of sales, due to the decrease in catalog mailings, offset by an increase in product costs as a percentage of sales, due to greater price promotions for our direct products, during Fiscal 2008 as compared to Fiscal 2007.

Corporate Costs

Corporate costs increased $7.1 million, or 13.5%, to $59.6 million during Fiscal 2008 compared to $52.5 million for Fiscal 2007. Corporate costs as a percentage of net sales increased to 9.9% for Fiscal 2008 compared to 9.8% for Fiscal 2007. This increase was due primarily to the increase in depreciation and amortization expense of $2.6 million, reflecting our growing operations and asset acquisitions, an increase in corporate payroll costs of approximately $3.2 million, and various employee related administrative fees of approximately $1.5 million which occurred in Fiscal 2008 as compared to Fiscal 2007. This was offset by approximately $0.5 million of deferred offering fees written-off during Fiscal 2007, which did not occur in Fiscal 2008.

Interest Income

Interest income decreased $172,000 to $62,000 in Fiscal 2008 compared to $234,000 for Fiscal 2007. The decrease was due to maintaining a lower balance in our interest bearing investment account, as well as experiencing lower interest rates throughout Fiscal 2008 as compared to Fiscal 2007.

 

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Interest Expense

Interest expense decreased $1.1 million, or 4.9%, to $21.3 million in Fiscal 2008 compared to $22.3 million for Fiscal 2007. The decrease was primarily attributable to a decrease in interest rates in Fiscal 2008 compared to Fiscal 2007.

Provision for Income Taxes

We recognized $6.3 million of income tax expense during Fiscal 2008 compared to $3.8 million in Fiscal 2007. The effective tax rate, which includes items relating to adjustments to our FIN 48 liability as well as certain adjustments related to our state income tax for Fiscal 2008, was 43.6%, compared to 35.8% for Fiscal 2007. The 7.8% increase in the effective tax rate is primarily due to changes in our blended state income tax rate, increases to our FIN 48 liability of 1.3%, as well as a benefit of 2.8% for a discrete item which occurred in Fiscal 2007.

Net Income

As a result of the foregoing, we generated net income of $8.2 million in Fiscal 2008 compared to net income of $6.8 million in Fiscal 2007.

Comparison of Fiscal 2007 with Fiscal 2006

Net Sales

Net sales increased $51.8 million, or 10.7%, to $537.9 million for Fiscal 2007 compared to $486.0 million for Fiscal 2006. The increase was the result of an increase in our comparable store sales, as well as sales from our new non-comparable stores, which were offset by a decrease in our direct sales.

Retail

Net sales from our retail stores increased $54.5 million, or 13.4%, to $462.0 million for Fiscal 2007 compared to $407.5 million for Fiscal 2006. We operated 341 stores as of December 29, 2007 compared to 306 stores as of December 30, 2006. Our overall store sales increased due to non-comparable store sales of $29.2 million, as well as an increase in comparable store sales growth of $25.3 million, or 6.2% (Comparable store sales include only those stores open more than 410 days and align with Fiscal 2006). Our overall sales increased primarily in the categories of sports nutrition, which increased by $32.1 million, or 35.3%; supplements, which increased $10.0 million, or 9.5%; herbs and homeopathic, which increased $5.3 million, or 6.7%; weight management, which increased $2.8 million, or 10.5%; and multi-vitamins, which increased $2.3 million, or 7.7%. These increases were partially offset by a decrease in the category of our books-accessories, sales of which decreased by $0.7 million to $2.0 million in Fiscal 2007 as compared to $2.7 million in 2006, comprising only 0.4% and 0.7% of our total net retail sales in Fiscal 2007 and Fiscal 2006, respectively.

The supplements category, which is among the largest selling product categories in our mix, experienced significant growth in sales of essential fatty acids, or EFAs, which were responsible for most of the increase in the supplement category in Fiscal 2007. Given the current trend in EFA consumption, and the growing number of publications and recommendations regarding the heart-health benefits of fish oils (such as by The American Heart Association and US National Institutes of Health), we expect continued strength in sales of EFAs for the next fiscal year. Product sales in the sports nutrition category increased at a greater rate than the overall increase in net sales during the Fiscal 2007, and have done so since early Fiscal 2006. We believe this is due largely to the growth in the fitness-conscious market as well as the diversity of new product introductions.

Direct

Net sales to our direct customers decreased $2.6 million, or 3.3%, to $75.9 million for Fiscal 2007 compared to $78.5 million for Fiscal 2006. This decrease was due to a decrease in our catalog sales, which we believe is the result of our continued expansion of our retail store locations and online stores, as well as the general decline in

 

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effectiveness of catalogs as a merchandising medium. This overall decrease was largely offset by an increase in our Internet based sales of $4.7 million during Fiscal 2007, which was primarily due to improvements to our e-commerce platform and customer experience, as well as continued improvements in our online customer prospecting efforts.

Cost of Goods Sold

Cost of goods sold, which includes product, warehouse and distribution and store occupancy costs, increased $33.8 million, or 10.4%, to $360.3 million for Fiscal 2007 compared to $326.5 million for Fiscal 2006. The components of cost of goods sold are explained below. Cost of goods sold as a percentage of net sales was 67.0% for Fiscal 2007 compared to 67.2% for Fiscal 2006.

Product costs increased $23.7 million, or 9.3%, to $279.8 million during Fiscal 2007 compared to $256.1 million for Fiscal 2006. Product costs as a percentage of net sales decreased to 52.0% in Fiscal 2007 compared to 52.7% for Fiscal 2006. The percentage decrease was largely a result of a decrease in price promotions for our products of approximately 1.2%, offset in part, by an increase in product costs of approximately 0.6% as a percentage of sales in Fiscal 2007 versus Fiscal 2006.

Warehouse and distribution costs increased $2.1 million, or 12.4%, to $18.6 million for Fiscal 2007 compared to $16.6 million for Fiscal 2006. Warehouse and distribution costs as a percentage of net sales increased to 3.5% for Fiscal 2007 compared to 3.4% in Fiscal 2006. The increase was mainly attributable to increases in shipping costs in Fiscal 2007 as compared to Fiscal 2006, as a result of rising fuel costs and shipments to greater distances as we continue to expand our geographic store base.

Occupancy costs increased $8.1 million, or 15.0%, to $61.9 million for Fiscal 2007 compared to $53.9 million for Fiscal 2006. Occupancy costs as a percentage of net sales increased to 11.5% during Fiscal 2007 compared to 11.1% for Fiscal 2006. This increase as a percentage of sales is mainly attributable to the increases in utilities and real estate tax expenses as well as a lower ratio of direct net sales, as a component of total net sales, to occupancy expenses.

Gross Profit

As a result of the foregoing, gross profit increased $18.0 million, or 11.3%, to $177.5 million for Fiscal 2007 compared to $159.5 million for Fiscal 2006.

Selling, General and Administrative Expenses

Selling, general and administrative expenses, including operating payroll and related benefits, advertising and promotion expense, and other selling, general and administrative expenses, increased $14.8 million, or 11.5%, to $143.5 million during Fiscal 2007, compared to $128.6 million for Fiscal 2006. The components of selling, general and administrative expenses are explained below. Selling, general and administrative expenses as a percentage of net sales for Fiscal 2007 was 26.7% compared to 26.5% for Fiscal 2006.

Operating payroll and related benefits increased $5.2 million, or 10.9%, to $53.5 million for Fiscal 2007 compared to $48.2 million for Fiscal 2006. The increase is due mainly to our increase in retail locations throughout Fiscal 2007. Operating payroll and related benefits expenses as a percentage of net sales remained level at 9.9% during Fiscal 2007 compared to 9.9% for Fiscal 2006.

Advertising and promotion expenses increased $0.6 million, or 4.9%, to $13.7 million for Fiscal 2007 compared to $13.1 million for Fiscal 2006. Advertising and promotion expenses as a percentage of net sales decreased to 2.6% during Fiscal 2007 compared to 2.7% for Fiscal 2006, primarily as a result of web-based advertising initiatives, such as broadening our web platform, which began in early Fiscal 2006 and generated expenses throughout that year, but were completed well before Fiscal 2007 year-end.

 

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Other selling, general and administrative expenses, which include depreciation and amortization expense, increased $9.0 million, or 13.4%, to $76.3 million in Fiscal 2007 compared to $67.3 million for Fiscal 2006. The increase was due to an increase in depreciation and amortization of approximately $1.2 million, reflecting our expanding operation, and an increase in professional fees of $1.5 million in Fiscal 2007 as a result of legal and consulting fees which occurred in Fiscal 2007 and not in Fiscal 2006. In addition, there was an increase of $2.7 million for corporate payroll expense which was primarily due to an increase in corporate staff during 2007 to accommodate our growth; stock-based compensation expense of approximately $1.1 million, due to additional grants issued in Fiscal 2007; credit card fees, which increased by approximately $0.5 million due to our increased sales; and various employee related administrative fees of approximately $1.3 million due to our increased operations in Fiscal 2007. In addition, there was approximately $0.5 million of deferred offering fees written-off during Fiscal 2007, due to our decision not to pursue an initial public offering at this time. Other selling, general and administrative expenses as a percentage of net sales increased to 14.3% during Fiscal 2007 compared to 13.9% for Fiscal 2006, due primarily to increases in our corporate infrastructure to accommodate our growing operations.

Related Party Expenses

Related party expenses remained level at $1.4 million for both Fiscal 2007 and for Fiscal 2006 (for a detailed presentation of related party expenses, see Note 11 to our consolidated financial statements).

Income from Operations

As a result of the foregoing, income from operations increased $3.2 million, or 10.8%, to $32.7 million for Fiscal 2007 compared to $29.5 million for Fiscal 2006. Income from operations as a percentage of net sales remained level at 6.1% during Fiscal 2007 compared to 6.1% for Fiscal 2006.

Retail

Income from operations for the retail segment increased $11.3 million, or 18.9%, to $71.2 million for Fiscal 2007 compared to $59.9 million for Fiscal 2006. Income from operations as a percentage of net sales for the retail segment increased to 15.4% for Fiscal 2007 compared to 14.7% for Fiscal 2006. The increase as a percentage of net sales was primarily due to an increase in gross profit resulting from the decrease in price promotion activity in Fiscal 2007, described above in the cost of goods sold discussion. In addition, we believe as certain of our new retail markets and new stores mature, we expect to experience more efficiencies in future periods that will continue to contribute to increased profitably in our retail segment.

Direct

Income from operations for the direct segment decreased $1.0 million, or 6.5%, to $14.0 million for Fiscal 2007 compared to $14.9 million in Fiscal 2006. Income from operations as a percentage of net sales for the direct segment decreased to 18.4% for Fiscal 2007 compared to 19.0% for Fiscal 2006. This decrease as a percentage of net sales was primarily due to the 1.2% decrease in gross profit as a percentage of sales in Fiscal 2007 as compared to Fiscal 2006, as we continue to offer discounted selling prices to maintain competitiveness in the current VMS online environment. These decreases were partially offset by a 0.7% decrease in general operating expenses and payroll as a percentage of sales.

Corporate Costs

Corporate costs increased $7.2 million, or 16.0%, to $52.5 million during Fiscal 2007 compared to $45.3 million for Fiscal 2006. Corporate costs as a percentage of net sales increased to 9.8% for Fiscal 2007 compared to 9.3% for Fiscal 2006. This increase was due primarily to the increase in depreciation and amortization expense of $1.2 million, reflecting our growing operations, an increase in professional fees of $1.5 million in Fiscal 2007, an increase in corporate payroll costs of approximately $2.7 million, and various employee related administrative fees of approximately $1.3 million, which occurred in Fiscal 2007 as compared to Fiscal 2006. In addition, there was approximately $0.5 million of deferred offering costs written off during Fiscal 2007 due to our decision not to pursue an initial public offering at that time.

 

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Other

Other for Fiscal 2006 represents $0.4 million in income related to our interest rate swap for the period prior to our qualification for hedge accounting. We did not incur these expenses in Fiscal 2007.

Interest Income

Interest income decreased $116,000 to $234,000 in Fiscal 2007 compared to $350,000 for Fiscal 2006. The decrease was due to maintaining a lower balance in our interest bearing investment account throughout Fiscal 2007 as compared to Fiscal 2006.

Interest Expense

Interest expense increased $0.2 million, or 0.8%, to $22.3 million in Fiscal 2007 compared to $22.2 million for Fiscal 2006. The nominal increase was primarily attributable to an increase in interest rates in Fiscal 2007 compared to Fiscal 2006.

Provision for Income Taxes

We recognized $3.8 million of income tax expense during Fiscal 2007 compared to $3.2 million in Fiscal 2006. The effective tax rate for Fiscal 2007 was 35.8% compared to 40.2% for Fiscal 2006, primarily as a result changes in our blended state rate, which were offset in part, by current year adjustments to our for FIN 48 liability (see Note 7 in Notes to Consolidated Financial Statements for further discussion).

Net Income

As a result of the foregoing, we generated net income of $6.6 million in Fiscal 2007 compared to net income of $4.8 million in Fiscal 2006.

Key Indicators of Liquidity and Capital Resources

The following table sets forth key indicators of our liquidity and capital resources (in thousands):

 

     As of
     June 27,
2009
   December 27,
2008
   December 29,
2007

Balance Sheet Data:

        

Cash and cash equivalents

   $ 2,107    $ 1,623    $ 1,453

Working capital

     59,861      52,347      51,227

Total assets

     459,099      463,690      428,283

Total debt

     177,753      186,382      165,000

 

     Six Months Ended     Fiscal Year Ended  
     June 27,
2009
    June 28,
2008
    December 27,
2008
    December 29,
2007
    December 30,
2006
 

Other Information:

          

Depreciation and amortization, including deferred rent (1)

   $ 12,442      $ 10,281      $ 22,098      $ 18,251      $ 16,865   

Cash Flows Provided By (Used In):

          

Operating activities

   $ 23,391      $ 4,933      $ 19,588      $ 20,618      $ 16,755   

Investing activities

     (13,771     (16,560     (35,389     (14,092     (13,580

Financing activities

     (9,136     11,933        15,971        (6,545     (6,487
                                        

Net increase (decrease) in cash and cash equivalents

   $ 484      $ 306      $ 170      $ (19   $ (3,312
                                        

 

(1) Also includes amortization of deferred financing fees.

 

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Liquidity and Capital Resources

Our primary uses of cash are to fund working capital, operating expenses, debt service and capital expenditures related primarily to the construction of new stores. Historically, we have financed these requirements from internally generated cash flow, supplemented with short-term financing. We believe that the cash generated by operations, together with the borrowing availability under our 2009 revolving credit facility (described below), will be sufficient to meet our working capital needs for the next twelve months, including investments made and expenses incurred in connection with our store growth plans, systems development and store improvements.

We plan to spend up to $18 million in capital expenditures during Fiscal 2009, of which up to $14 million will be in connection with our store growth and improvement plans with the remainder of $4 million being used for all other capital expenditures. Of the total capital expenditures projected for Fiscal 2009, we have already invested $13.8 million during the six months ended June 27, 2009. We plan to open between 35 and 40 new stores during Fiscal 2009, of which we have already opened 25 stores as of June 27, 2009. We plan to open 35 to 45 stores in Fiscal 2010, which will require approximately $15.0 million in capital expenditures. Our working capital requirements for merchandise inventory will continue to increase as we continue to open additional stores. Despite the recent challenges obtaining credit from the tightened global credit markets, we feel our new revolving credit facility (entered into on September 25, 2009, as discussed elsewhere in this document) will provide us with sufficient liquidity through the next fiscal year. Furthermore, we have an additional two years of liquidity as compared to our previous facility which we terminated on September 24, 2009. 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.

We were in compliance with all debt covenants as of June 27, 2009. At June 27, 2009, we had $2.1 million in cash and cash equivalents and $59.9 million in working capital. At December 27, 2008, we had $1.6 million in cash and cash equivalents and $52.3 million in working capital.

During Fiscal 2008 we spent approximately $27.9 million, out of the $31.9 million of total capital expenditures, in connection with our store growth and improvement plans. We opened 62 new stores during Fiscal 2008, and closed two stores. 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 $165,000 to $185,000 at cost for each of our stores, a portion of which is vendor-financed based upon agreed credit terms.

Cash Provided by (Used in) Operating Activities

Cash provided by operating activities was $23.4 million for the six months ended June 27, 2009, as compared to $4.9 million of cash provided by operating activities for the six months ended June 28, 2008. The $18.5 million increase in cash flows from operating activities is primarily due to an increase in our net income, as well as decreases in expenditures on inventory and on our accounts payable for the six months ended June 27, 2009, as compared to the six months ended June 28, 2008. The decrease in changes to our inventory is attributable to an increase in our inventory efficiency, as we require less lead time to fulfill a retail store’s needs, as well as due to the planned decrease in new store openings in the coming months relative to the same period last year, as we increased our inventory in anticipation of the numerous store openings which occurred during Fiscal 2008. The decrease in changes to our accounts payable in Fiscal 2009 was primarily due to increasing the frequency of payments to our trade vendors beginning in Fiscal 2008 to align with accelerated payment terms.

Cash provided by operating activities was $19.6 million and $20.6 million during Fiscal 2008 and Fiscal 2007, respectively. This decrease was primarily a result of a decrease in changes to our accounts payables of $19.6 million, to take advantage of favorable payment terms by our suppliers, offset in part by an increase in our net income and a decrease in inventory expenditures in Fiscal 2008 compared to Fiscal 2007.

 

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Cash provided by operating activities was $20.6 million and $16.8 million for the fiscal years ended December 29, 2007 and December 30, 2006, respectively. This increase was primarily a result of an increase in our net income and increases in changes to our accounts payables of $9.8 million which were offset in part by an increase in changes to inventory of $7.6 million in Fiscal 2007 compared to Fiscal 2006.

Cash (Used in) Investing Activities

Net cash used in investing activities during the six months ended June 27, 2009, was $13.8 million, compared to $16.6 million during the six months ended June 28, 2008. Capital expenditures during the six months ended June 27, 2009, were used for the construction of 25 new stores, and improvements to exiting stores. During the six months ended June 28, 2008, capital expenditures were used for the construction of 20 new stores, as well as the construction in progress for approximately 30 new stores which were opened in the following two quarters in Fiscal 2008. In addition, investing activities during the first two quarters of Fiscal 2008 included the $3.0 million asset purchase related to our Florida stores.

Net cash used in investing activities during Fiscal 2008 and Fiscal 2007 was $35.4 million and $14.1 million, respectively. The increase in cash used in investing activities of $21.3 million was primarily due to opening 26 more stores in Fiscal 2008 as compared to Fiscal 2007, as well as the acquisition of $3.5 million of intangible assets (as discussed in Note 4 to our Financial Statements) in the same period.

Net cash used in investing activities during Fiscal 2007 and Fiscal 2006 was $14.1 million and $13.6 million, respectively. The increase in cash used in investing activities of $0.5 million was primarily due to opening four more stores in Fiscal 2007 as compared to Fiscal 2006.

Cash (Used in) Provided by Financing Activities

Net cash used in financing activities was $9.1 million for the six months ended June 27, 2009, as compared to net cash provided by financing activities of $11.9 million for the six months ended June 28, 2008. The $21.1 million change in cash flows from financing activities was due primarily to net repayments to our revolving credit agreement during the six months ended June 27, 2009, compared to net borrowing during the first six months of Fiscal 2008.

Net cash provided by financing activities was $16.0 million in Fiscal 2008, compared to $6.5 million of net cash used in financing activities during Fiscal 2007. The increase in net cash provided by financing activities was primarily due to net borrowings of $17.0 million from our revolving credit facility during Fiscal 2008, compared to our paying down a net of $6.5 million on our revolving credit facility during Fiscal 2007.

Net cash used in financing activities was $6.5 million in both Fiscal 2007 and Fiscal 2006. During Fiscal 2007, we paid down $10.5 million on our revolving credit facility, after borrowing an additional $4.0 million, as we had sufficient working capital to fund our operations.

2005 Senior Notes

On November 7, 2005, we completed our Notes offering for $165 million. The indenture governing the Notes restricts the ability of Vitamin Shoppe Industries Inc. and VS Direct Inc. to incur additional debt, pay dividends and make distributions, make certain investments, repurchase stock, incur liens, enter into transactions with affiliates, enter into sale and lease back transactions, merge, or consolidate or transfer or sell assets.

Revolving Credit Facility

On November 15, 2005, Vitamin Shoppe Industries Inc. entered into its $50.0 million Revolving Credit Facility, and Vitamin Shoppe Industries Inc. has the option to increase or decrease the facility size by $25.0 million, subject to certain conditions. The availability under the credit facility is subject to a borrowing base

 

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calculated on the basis of certain eligible accounts receivable from credit card companies and inventory of Vitamin Shoppe Industries Inc. and VS Direct Inc. The obligations thereunder are secured by a security interest in substantially all of the assets of Holdings, Vitamin Shoppe Industries Inc. and VS Direct Inc. In addition, if the foregoing cannot make payments to the Revolving Credit Facility when they become due, VS Parent, Inc. has guaranteed the Revolving Credit Facility and must make payments on their behalf. The credit facility provides for affirmative and negative covenants affecting Vitamin Shoppe Industries Inc., VS Holdings, Inc. and VS Direct Inc. The credit facility restricts, among other things, our ability to incur indebtedness, create or permit liens on our assets, declare or pay dividends and certain other restricted payments, consolidate, merge or recapitalize, acquire or sell assets, make certain investments, loans or other advances, enter into transactions with affiliates, change our line of business, and restricts the types of hedging activities we can enter into. The credit facility has a maturity date of November 15, 2010. The unused available line of credit under the Revolving Credit Facility at June 27, 2009 was $39.6 million.

The borrowings under our Revolving Credit Facility accrue interest, at our option at the rate per annum announced from time to time by the agent as its “prime rate,” or at a per annum rate equal to between 1.25% and 1.75% (depending on excess availability) above the adjusted Eurodollar rate. The combined weighted average interest rate from December 27, 2008 through June 27, 2009 was 2.44%. The combined weighted average annual interest rate in Fiscal 2008 was 4.06%.

VS Direct Inc. and VS Holdings, Inc. provided guarantees in respect of our obligations under our Revolving Credit Facility, and Vitamin Shoppe Industries Inc. and VS Holdings, Inc. have provided guarantees in respect of VS Direct Inc.’s obligations under our Revolving Credit Facility.

We entered into an interest rate swap during December 2005 on a portion of our Notes, which qualifies for hedge accounting under Statement of Financial Accounting Standards (“SFAS”) No. 133. The swap’s fair market value of $(4.4) million at December 27, 2008 and $(3.5) million at June 27, 2009, is recorded in other long-term liabilities on the condensed consolidated balance sheets. Of the increase in market value of $0.9 million in Fiscal 2009, $0.6 million is recorded in other comprehensive income, and $0.3 million is recorded in deferred tax liabilities. Under the terms of the swap, concurrent with the termination of our Revolving Credit Facility, as described below, our interest rate swap was cancelled on September 25, 2009, at cost of $3.1 million.

2009 Revolving Credit Facility

On September 25, 2009, we entered into a new revolving credit facility, and simultaneously terminated our existing credit facility that was entered into on November 15, 2005. We entered into the 2009 revolving credit facility to obtain an additional two years of liquidity beyond the termination date of our previous facility. In doing so, we incurred an incremental borrowing rate of 1% as compared to the Revolving Credit Facility. The terms of the credit facility extend through September 2013, and allow us to borrow up to $50.0 million subject to the terms of the facility. Similar to our previous credit facility, the availability under the 2009 revolving credit facility is subject to a borrowing base calculated on the value of certain accounts receivable from credit card companies as well as the inventory of Vitamin Shoppe Industries Inc. and VS Direct Inc. The obligations thereunder are secured by a security interest in substantially all of the assets of VS Holdings, Inc., Vitamin Shoppe Industries Inc. and VS Direct Inc. The 2009 revolving credit facility provides for affirmative and negative covenants affecting Vitamin Shoppe Industries Inc., VS Holdings, Inc. and VS Direct Inc. The 2009 revolving credit facility restricts, among other things, our ability to incur indebtedness, create or permit liens on our assets, declare or pay dividends and make certain other restricted payments, consolidate, merge or recapitalize, acquire or sell assets, make certain investments, loans or other advances, enter into transactions with affiliates, change our line of business, and restricts the types of hedging activities we can enter into.

The 2009 revolving credit facility has a maturity date of September, 2013. The 2009 revolving credit facility will terminate if at any time on or after August 15, 2012 the sum of all amounts owed under our Notes is greater than the sum of our cash and cash equivalents plus excess availability (as defined under the 2009 revolving credit

 

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facility), subject to certain limitations. The unused available line of credit under the 2009 revolving credit facility at September 29, 2009 was $40.5 million. The borrowings under our 2009 revolving credit facility accrue interest, at our option at the rate per annum announced from time to time by the agent as its “prime rate,” or at a per annum rate equal to 2.50% above the adjusted Eurodollar rate.

VS Direct Inc. and VS Holdings, Inc. provided guarantees in respect of our obligations under the 2009 revolving credit facility, and Vitamin Shoppe Industries Inc. and VS Holdings, Inc. have provided guarantees in respect of VS Direct Inc.’s obligations under the 2009 revolving credit facility.

Contractual Obligations and Commercial Commitments

As of June 27, 2009, our lease commitments and contractual obligations are as follows (in thousands):

 

Fiscal year ending

   Total    Operating
Leases (1)
   Capital Lease
Obligation,
Including Interest
   Long-Term
Debt
   Interest
Payments (2)
   Revolving
Credit
Facility

Remainder of Fiscal 2009

   $ 43,935    $ 33,994    $ 803    $    $ 9,138    $

2010

     97,465      69,081      1,607           18,277      8,500

2011

     85,514      65,732      1,505           18,277     

2012

     244,113      63,058      824      165,000      15,231     

2013

     56,641      56,641                    

Thereafter

     146,937      146,937                    
                                         
   $ 674,605    $ 435,443    $ 4,739    $ 165,000    $ 60,923    $ 8,500
                                         

 

(1) The operating leases included in the above table do not include contingent rent based upon sales volume, which represented less than 1% of our minimum lease obligations during the first six months of Fiscal 2009. In addition, the operating leases do not include common area maintenance costs or real estate taxes that are paid to the landlord during the year, which combined represented approximately 17.3% of our minimum lease obligations for the six months ended June 27, 2009.
(2) Interest payments are based upon the prevailing interest rates at June 27, 2009, net of projected activity arising from our hedging activities which cease in 2011. Interest payments do not include interest expense related to our Revolving Credit Facility due to its revolving nature.

We have an aggregate contingent liability of up to $2.1 million related to potential severance payments for five executives as of June 27, 2009 pursuant to their respective employment agreements. We have an aggregate contingent liability of up to $1.9 million related to potential severance payments for eight employees as of June 27, 2009 following a change in control pursuant to their respective employment agreements. These potential severance payments are not reflected in the table above.

Excluded from the above commitments is $4.4 million of long-term liabilities related to uncertain tax positions pursuant to FIN 48, due to the uncertainty of the time and nature of resolution.

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 or disclosed on our financial statements that have or are reasonably likely to 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.

Effects of Inflation

We do not believe that our sales or operating results have been materially impacted by inflation during the periods presented in our financial statements. There can be no assurance, however, that our sales or operating results will not be impacted by inflation in the future.

 

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Recent Accounting Pronouncements

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133,” (“SFAS No. 161”). SFAS No. 161 requires entities to provide enhanced disclosures for derivative activities and hedging activities with regards to the reasons for employing derivative instruments, how they are accounted for, and how these instruments affect an entity’s financial position, financial performance, and cash flows. We adopted the provisions of SFAS No. 161 in the first quarter of Fiscal 2009. The adoption of SFAS No. 161 did not have a material impact on our financial condition, results of operations or cash flows.

Effective December 30, 2007, we adopted certain provisions of SFAS No. 157, “Fair Value Measurements,” that apply to certain financial assets and liabilities. This statement defines and establishes a framework for measuring fair value, and expands fair value disclosures. It does not require any new fair value measurements. The intent of this statement is to increase consistency of definitions and comparability of methods of fair value measurements, as well as to enhance fair value disclosure. SFAS No. 157, as amended by FASB Staff Position 157-2 (“FSP 157-2”), requires that the remaining provisions, which apply to nonfinancial assets and nonfinancial liabilities, were effective in the first quarter of Fiscal 2009. The adoption of the remaining provisions of SFAS No. 157 and FSP 157-2 did not have a material impact on our financial condition, results of operations or cash flows.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)),” SFAS No. 141(R) attempts to improve the relevance and comparability of the information included in companies’ financial reports regarding business combinations and their effects. The provisions of SFAS 141(R) were effective in the first quarter of Fiscal 2009. The adoption of SFAS 141(R) did not have an impact on our current financial condition, results of operations or cash flows. However, we cannot determine the future impact, if any, the adoption will have on our financial condition, results of operations or cash flows.

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 and commodity prices. Changes in these factors could cause fluctuations in the results of our operations and cash flows. In the ordinary course of business, we are primarily exposed to interest rate risks. Other than on our Notes, which carry a floating interest rate, we do not use derivative financial instruments in connection with these market risks. Our risk management activities are described below.

Our market risks relate primarily to changes in interest rates. Our Revolving Credit Facility and Notes carry floating interest rates that are tied to the London Interbank Offered Rate (“LIBOR”) and the prime rate and, therefore, our statements of operations and our cash flows will be exposed to changes in interest rates. A one percentage point increase in LIBOR would cause an increase to the interest expense on our Notes of approximately $0.8 million, as the total potential increase of $1.7 million would be offset by our hedging activities described in the paragraph below. Additionally, a one percentage point increase in LIBOR would cause an increase to the interest expense on our revolving credit facility of $0.1 million based on the balance of our Revolving Credit Facility as at June 27, 2009.

We historically have engaged in interest rate hedging activities related to our floating rate debt. In December 2005, we entered into an interest rate swap on a portion of our Notes, the fair market value of which was $(4.4) million at December 27, 2008 and $(3.5) million at June 27, 2009, which is recorded in other long-term liabilities on the condensed consolidated balance sheets.

 

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BUSINESS

Overview

We are a leading specialty retailer and direct marketer of vitamins, minerals, herbs, supplements, sports nutrition and other health and wellness products. For each of the past five years, we have been the second largest in retail sales and the fastest growing national VMS specialty retailer. We market over 700 different nationally recognized brands as well as our proprietary Vitamin Shoppe, BodyTech and MD Select brands. We believe we offer the greatest variety of products among VMS retailers with approximately 8,000 SKUs offered in our typical store and an additional 12,000 SKUs available through our Internet and other direct sales channels. Our broad product offering enables us to provide our target customers with a selection of products not readily available at other specialty VMS retailers or mass merchants, such as drugstore chains and supermarkets. We target the dedicated, well-informed VMS consumer and differentiate ourselves by providing high quality products at competitive prices in an educational and high-touch customer service environment. 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.

We sell our products through two business segments: retail and direct. In our retail segment, we have leveraged our successful store economic model by opening a total of 171 new stores from the beginning of Fiscal 2005 through Fiscal 2008. Over the past five years, we have expanded our presence in our existing markets as well as entered many new markets such as California, Texas, Michigan, and Hawaii. As of September 25, 2009, we operated 434 stores in 37 states and the District of Columbia, located in high-traffic regional retail centers.

We also sell our products directly to consumers through our websites, including www.vitaminshoppe.com, www.bodytech.com, and our catalog. Our websites and our catalog complement our in-store experience by extending our retail product offerings with an additional 12,000 SKUs that are not available in our stores and by enabling us to access customers outside our retail markets and those who prefer to shop online. In 2008, we increased the number of active online customers by approximately 60,000 to more than 460,000.

We have grown our net sales from $436.5 million in Fiscal 2005 to $601.5 million in Fiscal 2008, representing a CAGR of 11.3%. We have achieved positive comparable store sales for 15 consecutive years (prior to which we did not track comparable store sales) and have grown our retail sales from $362.2 million in 2005 to $522.5 million in 2008, representing a CAGR of 13.0%. We believe our industry performs well through economic cycles, including the current economic recession, and we have generated comparable store sales increases of 6.2% in each of 2007 and 2008, and 4.7% and 7.2% for the six months ended June 27, 2009 and June 28, 2008, respectively.

Our company was founded as a single store in New York, New York in 1977. Our Vitamin Shoppe branded products were introduced in 1989. We were acquired in November 2002 by IPC and other investors.

Industry

According to the NBJ, sales of nutritional supplements in the United States in 2008 were approximately $25.2 billion representing a 4.9% CAGR between 2001 and 2008. The U.S. nutritional supplement category is comprised of vitamins ($8.5 billion), herbs / botanicals ($4.8 billion), specialty / other ($4.5 billion), meal supplements ($2.6 billion), sports nutrition ($2.7 billion) and minerals ($2.1 billion). The NBJ forecasts 4.5% average annual growth for U.S. nutritional supplement sales through 2014 driven primarily by consumption by the over 50 demographic, including Baby Boomers who seek to improve their health and wellness and treat and prevent disease and illness cost effectively.

The VMS industry in the United States is highly fragmented, and according to NBJ data and public filings with the SEC, no single industry participant accounted for more than 5% of total industry sales in 2008. Retailers of VMS products primarily include specialty retailers and mass merchants, such as supermarkets and

 

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drugstore chains. The specialty retailers typically cater to the more sophisticated VMS customer by focusing on selection and customer service, while the mass merchants generally offer a limited assortment comprised of more mainstream products, with less customer care. Specialty retailers comprised the largest segment of the market in 2008, with 37% market share, which is expected to grow by 4.5% annually through 2014, according to the NBJ.

According to the NBJ, during the last three years, growth in the U.S. nutritional supplement industry has been led by specialty supplements, which have grown due to increasing popularity of condition-specific products, including glucosamine / chondroitin (for joint health), homeopathics (for miscellaneous conditions), essential fatty acids (for cardiovascular health), CoQ10 (for energy and cardiac health), vitamin D (for bone support through better calcium absorption) and acidophilus (for digestive health). Consumers use nutritional supplements to improve their lifestyles, treat specific health conditions, and keep themselves feeling younger and more active. From 2008 to 2014, the U.S. specialty supplement product category is expected to grow at a 5.9% CAGR, or approximately 38% faster than the overall industry. The specialty supplements product category represented 17.9% of the total U.S. nutritional supplement industry in 2008. By way of comparison, specialty supplements generated 27.4% of our Fiscal 2008 net sales. We over-index our concentration in specialty supplements to focus on target customers who emphasize health and wellness as part of their lifestyle.

Sports nutrition products represented approximately 10.8% of the total U.S. nutritional supplement industry in 2008. By way of comparison, sports nutrition products generated 29.0% of our Fiscal 2008 net sales. We believe our sports nutrition offering emphasizes products such as protein powders which appeal to our customers’ emphasis on health and wellness rather than products taken in conjunction with a body building regimen. From 2009 to 2014, the sports nutrition product category is expected to grow at a 5.5% CAGR, representing the second fastest growing product category in the VMS industry.

We believe that one of the primary trends driving the growth in the industry is the aging U.S. population. The total U.S. population of people 50 and older is expected to increase to 115 million people in 2018 from 94 million people in 2008, a CAGR of 2.1%, which is more than twice the overall population growth rate. The aging Baby Boomer generation comprises a significant and increasing part of the 50 and older population.

Competitive Strengths

We believe we are well positioned to capitalize on the favorable VMS industry dynamics as a result of the following competitive strengths:

Most Extensive Product Selection Including a Strong Assortment of Proprietary Brands.    We believe we have the most complete and authoritative merchandise assortment and market the broadest product selection in the VMS industry with over competitively-priced 20,000 SKUs from a combination of over 700 different nationally recognized brands and our proprietary Vitamin Shoppe, BodyTech and MD Select brands. Our typical store carries approximately 8,000 SKUs, with approximately 12,000 SKUs available through our direct business. We offer high-quality, nationally recognized brands such as Natures Plus®, Solgar®, Country Life®, Nature’s Way®, and Solaray®, and our Vitamin Shoppe proprietary brand. We also carry smaller, more exclusive high end brands such as Optimum®, Garden of Life®, New Chapter®, and Life Extension™. Additionally, we offer hard-to-find doctors’ brands including Cardiovascular Research, Allergy Research, American Biologics and Pioneer.

Included in our broad product assortment is our proprietary brand merchandise sold under the Vitamin Shoppe, BodyTech and MD Select brands. Our selection of approximately 1,100 SKUs of proprietary brand merchandise, which accounted for approximately 25% of our net sales in Fiscal 2008, provides our customers the opportunity to purchase VMS products at great value while affording us higher gross margins. Our MD Select brand offers a premium product with a condition-specific focus while our Vitamin Shoppe brands offer a broad selection with a focus on specialty supplements. Our BodyTech brand is focused on sports nutrition. We are continuing to grow our proprietary merchandise product assortment by increasing our focus on sports nutrition, probiotics and essential fatty acids.

 

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In addition, unlike other VMS specialty retailers, we merchandise our product offering by intended use such as “Heart Wellness” and “Joint Support” rather than by brand. This merchandising approach allows us to address our customers’ desire for health and wellness more fully and efficiently than other specialty VMS retailers and mass merchants, such as supermarkets and drugstore chains, while limiting our dependence on the continued success on any single brand or product. Also, our merchandise assortment and sales are concentrated in the two fastest growing product categories in the VMS industry: specialty supplements and sports nutrition. In Fiscal 2008, no single product sub-category accounted for more than 6% of our net sales, and no single third-party brand accounted for more than 3% of our net sales.

Value-Added Customer Service.    We believe we offer the highest degree of customer service in the VMS retail industry, aided by the deep product knowledge of our store associates, whom we refer to as “health enthusiasts.” We believe customer service is a very important component of a VMS consumer’s shopping experience, particularly for specialty supplement purchases. We staff our stores with highly experienced and knowledgeable associates (many of whom are regular and informed nutritional supplement users) who assist our customers in product selection. We place a strong emphasis on employee training and customer service and view our sales associates as health and wellness information stewards who educate our customers while assisting them with their purchases. We ensure the consistency of our high-quality customer service by training our store associates and management (including the direct customer care team) through Vitamin Shoppe University, a web-based interactive training program which includes online courses on product knowledge, customer service and management skills. Along with Vitamin Shoppe University, we provide our associates with up-to-date news and information on VMS products through proprietary newsletters, proprietary magazines, and daily sales meetings, empowering them to provide more value-added assistance to our customers.

Our stores offer extensive access to VMS information as they are equipped with a computer terminal and web access to www.vitaminshoppe.com, offering our customers health and wellness information as well as access to our complete product line. Our stores also offer “Health Notes” (an Internet-based guide to health and VMS products that also provides information on the interaction of drugs and supplements) and reference materials.

Highly Refined Real Estate Strategy.    We apply demanding criteria to our retail site selection. We locate our stores exclusively in attractive stand-alone locations or endcap (corner) positions in retail centers available in the markets in which we compete, rather than in enclosed malls, secondary or tertiary shopping centers. Our stores are situated in highly visible locations generally within a 16 minute travel time of more than 50,000 households with a high auto traffic or pedestrian count. Our stores are not dependent on either shopping mall or general shopping center traffic for our customer traffic. We typically seek both urban and suburban locations in high traffic areas with easy access, ample drive-up parking, optimal visibility from a major roadway and strong impact signage. Management believes that the location and visibility of our real estate is our single most effective and efficient customer acquisition strategy. Our research indicates that 66% of our new customers are attained as a result of seeing one of our stores. Our high profile locations and prominent signage reduce our dependency upon traditional advertising to drive customer traffic and brand awareness, which in turn reduces our need to cluster stores to achieve advertising economies of scale. Our retail store concept has proven successful throughout the country in both suburban and urban areas.

Attractive, Loyal Customer Base.    We have a large and growing base of loyal customers who proactively manage their long-term health and wellness through the use of supplements. Many of our customers form relationships with store managers and associates who help educate and guide them through their shopping experience. In addition, our no-fee Healthy Awards Program promotes brand loyalty among our customers and allows our customers to earn points redeemable for future purchases, more than 70% of which are redeemed annually. Our Healthy Awards Program customers accounted for 87% of our overall sales in Fiscal 2008. The number of our top customers, defined by shopping frequency and annual dollars spent, grew approximately 14% to 383,000 in 2008 compared to 336,000 in 2007. These customers spend approximately four times as much as our average customers. We signed up approximately 920,000 new Healthy Awards members in our new and

 

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existing stores in 2008. The number of active members has grown to approximately 3.3 million currently from 1.0 million in 2002. Our Healthy Awards Program is a valuable tool providing us with marketing and merchandising information on customer buying habits and market trends, as well as demographic information used to select future store locations.

Multi-Channel Retailer.    We are a multi-channel retailer, distributing products through our retail stores, our websites and our catalog, enabling us to access customers outside our retail markets and those who prefer to shop online. This business model affords us multiple touch points with our customers, allows us to reach our customers where they prefer to shop and to gather data and communicate with them in person, through our call center and via the web. Our direct business provides data on our customers’ purchasing patterns that we use to enhance our email and direct mail marketing efforts as well as assist in selecting optimal future store locations. We believe this multi-channel approach, and the marketing capabilities made possible through them, have and will continue to allow us to build customer loyalty.

Experienced Management Team with Proven Track Record.    We have assembled a management team with extensive experience across a broad range of disciplines in building leading specialty retailers. Richard L. Markee previously served as non-executive Chairman of the board of directors since April 2007 and has served as Chairman and Chief Executive Officer since September 2009. He previously served in various executive capacities at Toys “R” Us, including as President of Babies “R” Us and Vice Chairman of Toys “R” Us, Inc. Mr. Markee also served as interim Chief Executive Officer of Toys “R” Us and its subsidiaries. Anthony Truesdale joined as our President and Chief Merchandising Officer in April 2006 after serving as Senior Vice President of Merchandising and Supply Chain Management of Petsmart, Inc. Louis H. Weiss joined as our Vice President, Internet and Catalog Business in December 2006 after serving as President of Gaiam Direct, the direct marketing unit of Gaiam Inc. Michael G. Archbold joined as our Executive Vice President, Chief Operating Officer and Chief Financial Officer in April 2007 after serving as Executive Vice President, Chief Financial and Administrative Officer of Saks Fifth Avenue and Executive Vice President/Chief Financial Officer of AutoZone.

Growth Strategies

We plan to execute several strategies in the future to promote our revenue growth, capture market share and drive operating income growth, including:

Expand Our Store Base.    We believe we have a highly attractive economic model for our new stores. We plan to aggressively expand our store base over the next five years, which we believe will complement the maturation of the 171 stores we have opened since January 1, 2005. We opened 62 stores in Fiscal 2008. We plan to open a total of between 35 and 40 stores in Fiscal 2009 (of which 34 were opened as of September 25, 2009) and increase our store base by approximately 10% annually thereafter. Over the next three years, we plan to locate a substantial majority of our new stores in existing markets or states. Based upon our operating experience and research conducted by The Buxton Company, we are confident that the U.S. VMS market can support over 900 Vitamin Shoppe stores operating under our current format. We also plan to explore store opening opportunities outside the United States in the next five years.

Grow Our Loyal Customer Base.    We plan to continue to grow our loyal customer base through more focused marketing initiatives and by leveraging our direct business.

Marketing Initiatives.    We have completed extensive research with our no-fee Healthy Awards Program, and we expect this knowledge to help us to enhance the efficacy of our marketing initiatives. Our customers in our Healthy Awards Program accounted for approximately 87% of our total sales in Fiscal 2008, with our top 383,000 customers in this program, defined by shopping frequency and annual dollars spent, spending four times as much as our average customer. In addition, we will continue to utilize our market activation strategies in conjunction with new store openings to accelerate our acquisition of new customers. Through market activation campaigns, we reach out to local businesses, gyms and doctors’ offices to attract new customers. We believe that this strategy helps us activate and retain loyal customers.

 

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Leverage Our Direct Business.    We intend to grow our direct business through more sophisticated customer acquisition and marketing efforts to online customers. We continue to invest in technology to enhance our direct business by further personalizing the web experience for our customers at our websites, including www.vitaminshoppe.com. We recently implemented a new web platform that improved our customer tracking capabilities and will provide new features such as creating automatically-generated emails to customers that remind them to replenish their supply based on date of last purchase and building affinities across product groups so that complementary products are automatically recommended to customers based on their current purchase. In addition, we intend to focus our customer acquisition strategy on attracting and retaining more loyal customers who will be drawn to the broad range of products and educational content we plan to provide on our principal website, www.vitaminshoppe.com, as opposed to customers who are only focused on the lowest prices. In so doing, our goal is to create, better serve and retain more loyal customers. By continuing to provide a broad assortment of products with an enhanced sense of community, we expect to continue to grow our loyal customer base.

Continue to Improve Store Productivity.    We plan to generate higher sales productivity through refined

merchandising and pricing initiatives. For example, we have implemented a sophisticated replenishment

methodology which we believe will continue to increase our return on inventory investment and improve our in-stock position. We believe that implementing this and other merchandising and pricing strategies will enhance the productivity of our stores. In addition, in the beginning of 2008 we deployed a new store design, which enabled us to decrease our opening store inventory levels and offer enhanced feature areas increasing focus on our specialty products. Due to its success, we plan to continue to implement this design going forward.

Continue to Invest in Education and Knowledge of Our Employees.    Investing in associate training and providing employees with opportunities to grow within our company is essential to our growth strategy. We believe we provide the most comprehensive training program in the VMS industry and that our sales associates’ ability to provide greater, value-added assistance to our customers helps us deliver a differentiated retail experience. To this end, we plan to continue to expand upon the scope and content of our training programs, migrate towards an incentive-based “Pay for Knowledge” compensation program and continue to invest in our Product Education Conference, which is one of the largest in the nation, and is attended by all District and Store Managers, where over 200 brands are represented. We utilize a “promote from within” employment culture in order to offer growth opportunities for our employees, reduce turnover, and provide predictable and sustainable human resources for our growth.

Sales Channels

Retail.    We believe we operate a unique retail store format 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, as well as to resort locations in Hawaii. Our stores carry a broad selection of VMS products and are staffed with experienced and knowledgeable associates who are able to educate our customers about product features and assist in product selection. We are committed to high quality real estate and target attractive stand-alone locations or end cap (corner) positions in retail centers located in high traffic urban and suburban markets. We have intentionally chosen not to locate our stores in enclosed malls, secondary or tertiary shopping centers.

 

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We operated 434 retail stores in the United States as of September 25, 2009. Since the beginning of 2005, we have aggressively pursued new store growth. From this time through September 25, 2009 we opened 205 new stores, expanding our presence in our existing markets as well as entering many new markets such as California, Texas, Michigan and Hawaii. The following table shows the change in our network of stores for the Fiscal Years 2006 through 2008, and the six months ended June 27, 2009 and June 28, 2008:

 

     Six Months Ended    Fiscal Year  
     June 27,
    2009    
    June 28,
    2008    
       2008             2007             2006      

Stores open at beginning of year

   401      341    341      306      275   

Stores opened

   25      20    62      36      32   

Stores closed

   (1   —      (2   (1   (1
                             

Stores open at end of year

   425      361    401      341      306   
                             

We plan to open a total of between 35 and 40 new stores in Fiscal 2009 (of which 34 were opened as of September 25, 2009). Thereafter, we plan to increase our store base by approximately 10% annually. Over the next three years, we plan to locate a substantial majority of our new stores in existing markets or states. Thereafter, we would continue to place our new stores predominantly in these areas but be opportunistic with regard to locations in new markets or states. While we have no plans to extend our store base outside the United States today, we do plan to explore store opening opportunities in other territories and countries in North America in the next five years.

Our new retail store operating model, which is based on our historical performance, assumes a target store size of approximately 3,600 square feet that achieves sales per square foot of $230 in the first twelve months. Our target net investment to open a retail store is approximately $230,000, which includes the build-out costs and initial inventory net of payables. The model also reflects target pre-opening expenses of $50,000. This operating model targets a 93% pre-tax cash return on investment at maturity and an average annual pre-tax cash return on investment of greater than 50% over the four-year period. Our operating model also targets a breakeven cash flow contribution in the first year of operations and 16.6% cash flow contribution margin by the fourth year of operation. Our stores typically require four years to mature, generating lower store level sales and store contribution in the initial years than our mature stores.

Direct.    Our direct segment consists of our Internet and catalog operations. The direct segment enables us to service customers outside our retail markets and provides us with data that we use to assist us in the selection of future store locations.

We currently obtain customer information from 100% of our Internet and catalog customers. As of June 27, 2009, our customer database contained approximately 8.8 million individual customer names, of which 3.4 million were households that placed an Internet or catalog order with us or made a store purchase from us within the previous 12 months.

Since 1998, our principal website located at www.vitaminshoppe.com has allowed our customers to purchase our merchandise over the Internet. Our principal website features our full assortment of SKUs and includes free educational and product information via our Health Notes periodical. We educate prospective and current Vitamin Shoppe online customers regarding product features and assist in product selection. Our principal website also includes marketing and promotional offers such as “Special,” “Sale,” and “New” items, as well as “Compare and Save.” We believe these marketing and promotional programs, which are exclusive to our Internet operations, helps us increase the unit count and dollar volume of the average Internet basket. In Fiscal 2009 and beyond, we expect to continue enhancing our website functionality by introducing more sophisticated community elements to www.vitaminshoppe.com, such as live chat with a Vitamin Shoppe customer service representative and online chat with other loyal Vitamin Shoppe customers.

 

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Properties

The following table reflects our current store count by state:

 

State

   Stores Open at
September 25, 2009
  

State

   Stores Open at
September 25, 2009

Alabama

   2    Minnesota    3

Arizona

   8    Missouri    1

California

   54    Nevada    3

Colorado

   8    New Hampshire    2

Connecticut

   7    New Jersey    23

Delaware

   2    New Mexico    2

District of Columbia

   2    New York    59

Florida

   53    North Carolina    12

Georgia

   10    Ohio    10

Hawaii

   5    Oregon    4

Idaho

   1    Pennsylvania    12

Illinois

   19    Rhode Island    1

Indiana

   7    South Carolina    7

Kansas

   2    Tennessee    6

Kentucky

   3    Texas    38

Louisiana

   3    Vermont    1

Maryland

   13    Virginia    20

Massachusetts

   10    Washington    5

Michigan

   10    Wisconsin    6
          
     

Total

   434
          

As of September 25, 2009, we leased the properties for all of our 434 stores. Our typical lease terms are ten years, with one to two five-year renewal options. We do not believe that any individual store property is material to our financial condition or results of operations. Of the leases for our stores, one expires in Fiscal 2009, six expire in Fiscal 2010, 17 expire in Fiscal 2011, 29 expire in Fiscal 2012, 62 expire in Fiscal 2013, and the balance expire in fiscal 2014 or thereafter. We have options to extend most of these leases for a minimum of five years. We opened 34 stores as of September 25, 2009, and executed 16 leases as of September 25, 2009 for planned store openings throughout the rest of 2009 and 2010.

In April 2004, we consolidated our existing warehouse and distribution centers and corporate headquarters into a new, leased, 230,000 square-foot state-of-the-art facility. The initial lease term for the facility (which commenced in 2002) is for 15 years, with one five-year renewal option. Our warehouse has the capacity to support 550 retail stores.

We believe that all of our current facilities are in good condition and are suitable and adequate for our current and reasonably anticipated future needs.

Products

We believe we market the broadest product selection in the VMS industry with over 20,000 SKUs from a combination of over 700 different nationally recognized brands and our proprietary Vitamin Shoppe, BodyTech and MD Select brands. Our typical store carries approximately 8,000 SKUs, with approximately 12,000 SKUs available through our direct business. We offer high-quality, nationally recognized brands such as Twinlab®, Solgar®, Country Life®, Nature’s Way®, and Solaray® and our Vitamin Shoppe proprietary brand. We also carry smaller, more exclusive high end brands such as Optimum®, Garden of Life®, New Chapter®, and Life Extension™. Additionally, we offer hard-to-find doctors’ brands including Cardiovascular Research, Allergy Research, American Biologics and Pioneer.

 

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Included in our broad product assortment is our proprietary brand merchandise sold under the Vitamin Shoppe, BodyTech and MD Select brands through which we offer our customers the opportunity to purchase VMS products at great value while affording us higher gross margins. In Fiscal 2008, sales of our 1,100 SKUs of our proprietary brand merchandise accounted for approximately 25% of our net sales. Our MD Select brand offers a premium product with a condition-specific focus while our Vitamin Shoppe brand offers a broad selection with a focus on specialty supplements. Our BodyTech brand is focused on sports nutrition. We are continuing to grow our proprietary merchandise product assortment by increasing our focus on sports nutrition, probiotics and essential fatty acids.

In addition, unlike other VMS specialty retailers, we merchandise our product offering by intended use such as Heart Wellness and Joint Support rather than by brand. This merchandising approach allows us to address our customers’ desire for health and wellness more fully and efficiently than other specialty VMS retailers, supermarkets, drugstore chains and other mass merchants while limiting our dependence on the continued success on any single brand or product. In addition, our merchandise assortment and sales are concentrated in the two fastest growing areas in the supplement business: specialty supplements and sports nutrition. We consider non-core products to be those products which contain stimulant and/or thermogenic ingredients. Today, our non-core products consist of thermogenic products, which account for only 3.2% of net sales during Fiscal 2008. During Fiscal 2008, no single product sub-category accounted for more than 6% of our net sales during Fiscal 2008.

Key Product Categories

Our two largest product categories are specialty supplements and sports nutrition. In Fiscal 2008, specialty supplements and sports nutrition represented 27.4% and 29.0% of total net merchandise sales, respectively.

Specialty Supplements

Specialty supplements help supply higher levels of nutrients than diet alone can provide, help people stay healthy, and support specific conditions and life stages such as childhood, pregnancy, menopause and aging. Categories of specialty supplements include essential fatty acids, probiotics and condition specific formulas. Certain specialty supplements, such as organic greens, psyllium fiber and soy proteins, are taken for added support during various life stages and are intended to supplement vital nutrients absent in an individual’s diet. Super antioxidants, such as Coenzyme Q-10, grapeseed extract and pycnogenol, are taken to address specific conditions. High ORAC (oxygen radical absorptive capacity) fruit concentrates like açai, gogi, mangosteen, pomegranate and blueberry are taken to supplement high levels of natural nutrients not available in modern diets. Other specialty supplement formulas are targeted to support specific organs, biosystems and body functions. For example, we offer Ultimate Memory Aid for brain function, Sleep Naturally for sleeplessness and various enzyme combinations for other support systems. We offer over 5,000 specialty supplement SKUs available in tablets, capsules, vegi-capsules, soft gels, gelcaps, sublingual and liquid forms.

Sports Nutrition

Our sports nutrition consumers include the sports enthusiast, weekend warrior, endurance athlete, marathoner and serious bodybuilder who seek products to help maintain or supplement a healthy lifestyle. These 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 add energy or enhance recovery after exercise. We offer over 2,000 SKUs in sports nutrition in many convenient forms such as powders, tablets, capsules, soft gels and liquids.

 

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Herbs and Botanicals

Herbs and botanicals offer a natural remedy and are taken to address specific conditions. Certain herbs can be taken to help support specific body systems, including ginkgo to support brain activity and milk thistle to help maintain proper liver function, as well as other less common herbs such as holy basil for stress relief, turmeric for inflammation support and black cohosh for menopause support. Herbal and botanical products include whole herbs, standardized extracts, herbs designed for single remedies, herb combination formulas and teas. With over 7,000 SKUs, a wide range of potency levels and multiple delivery systems, our customers have many choices to fit their individual needs. Our herb products are available in tablets, capsules, vegi-capsules, soft gels, gelcaps, liquids, tea bags and powders.

Vitamins and Minerals

Vitamins and minerals are taken to maintain health, proactively to improve health and in support of specific health conditions. These products help prevent nutrient deficiencies that can occur when diet alone does not provide all the necessary vitamins and minerals our bodies need. The vitamin and mineral product category includes multi-vitamins, which many consider to be a foundation of a healthy regime, lettered vitamins, such as Vitamin A, C, D, E, and B-complex, along with major and trace minerals such as calcium, magnesium, chromium and zinc. With over 4,000 SKUs, a wide range of potency levels and multiple delivery systems, our customers have many choices to fit their individual needs. Our vitamin and mineral products are available in tablets, capsules, vegi-capsules, softgels, gelcaps, liquids and powders.

Other

Our “Other” category represents all other product classifications we stock that do not fit within the previously described categories. These products include natural beauty and personal care, supplements, diet and weight management, as well as green living products which were newly added as of Fiscal 2008. Natural beauty and personal care products offer an alternative to traditional products that often contain synthetic and/or other ingredients that our customers find objectionable. Our customers choose these products over more traditional products because they contain organic and natural ingredients, are produced without the use of pesticides or animal testing and are more closely aligned with the health and wellness goals of our customers. Our wide variety of diet and weight management products range from low calorie bars, drinks and meal replacements to energy tablets, capsules and liquids. Our natural pet products include nutritionally balanced foods and snacks along with condition specific supplements such as glucosamine for joint health. We offer over 2,000 SKUs in our Other category.

Access to New Products and New Product Development

A key component of customer satisfaction is the introduction of new products. Over the last three fiscal years we have introduced over 1,200 new products each year, to provide the latest VMS products to our customers. We identify customer trends through interactions with our customers, attending trade shows, contacting vendors and generally being active within the marketplace. We maintain close relationships with our branded manufacturers, which allows us to be at the forefront of introducing new third-party branded products within the industry. In addition, we maintain a product development group that is staffed with employees who oversee our development of new proprietary products. We plan to develop 50 key products each year under the Vitamin Shoppe brand and controlled labels. We incurred $1.4 million, $1.6 million and $1.9 million of research and development costs for the fiscal years ended December 27, 2008, December 29, 2007 and December 30, 2006, respectively.

Healthy Awards Program

Our Healthy Awards Program, which we established over 12 years ago, promotes brand loyalty among our customers and allows our customers to earn points redeemable for future purchases, approximately 70% of which are redeemed per year. Sales to our Healthy Awards Program customers represent 87% of our overall sales. We

 

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signed up approximately 920,000 new members in our new and existing stores in 2008. The number of active members has grown to approximately 3.0 million currently from approximately 1.0 million in 2002. Our Healthy Awards Program is a valuable tool providing us with marketing and merchandising information on customer buying habits and market trends, as well as demographic information used to select locations for future stores.

Suppliers and Inventory

We consider numerous factors in supplier selection, including, but not limited to, quality, price, credit terms, and product offerings. As is customary in our industry, we generally do not have long-term contracts with any supplier and most suppliers could discontinue selling to us at any time.

We strive to maintain sufficient inventory to enable us to provide a high level of service to our customers. Inventory, accounts receivable and accounts payable levels, payment terms and return policies are in accordance with standard business procedures. We maintain a distribution center which we use in conjunction with a just-in-time inventory ordering system that we use to replenish our stores based upon customer demand of a given product or products. 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 $165,000 to $185,000 in cost for each of our stores, a portion of which is vendor-financed based upon agreed credit terms, with the remainder being purchased in cash. Thirty day payment terms are extended to us by some of our suppliers allowing us to effectively manage our inventory and working capital. We believe that our buying power enables us to receive favorable pricing terms and enhances our ability to obtain high demand merchandise.

Nature’s Value, Inc. is the only supplier from whom we purchased at least 5% of our merchandise during Fiscal 2008, 2007 and 2006. We purchased approximately 7%, 10%, and 12% of our total merchandise from Nature’s Value, Inc. in Fiscal 2008, Fiscal 2007 and Fiscal 2006, respectively.

Warehouse and Distribution

Our state of the art warehouse facility provides operating space of approximately 180,000 square feet and gives us great control over supervision costs and distribution center related inventory levels. In addition, through a combination of improved technology, processes, controls and layout, we have greatly improved our pick accuracy rates and net inventory accuracy rates. With minor physical changes, systems enhancements and West Coast third party logistics solutions, we believe we have sufficient capacity for the next several years. We currently operate two shifts, seven days a week, and have the ability to expand our schedule and capacity to meet future demand in our facility.

Quality Control

The FDA is the regulatory authority charged with overseeing the products marketed by us and the products found in our stores. The FTC regulates the advertising of the products marketed by us and the products found in our stores.

Our Scientific and Regulatory Affairs (“S&RA”) department reviews all aspects of our Company’s FDA and FTC regulatory processes, ensuring compliance with regulations. We have established processes to review the underlying safety and efficacy of our Vitamin Shoppe and BodyTech branded products. These processes include review of the ingredients’ safety information, product formulation, product form, product labeling, the efficacy and claim support for the product and any marketing materials. All consumer communications that deal with product and health issues must be approved by S&RA prior to being disseminated to the public.

We have standard procedures whereby all potential Vitamin Shoppe contract manufacturers are reviewed and approved before they can supply any of our Vitamin Shoppe or BodyTech branded products. In addition, all potential new products are vetted and approved prior to being accepted into our Vitamin Shoppe or BodyTech branded product line.

 

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Our three primary suppliers for our Vitamin Shoppe and BodyTech branded products are Nature’s Value, Inc., Main Street Ingredients, and Softgel Technology, Inc, which together produce over half of our Vitamin Shoppe and BodyTech branded products. We have long-term relationships with these suppliers of over ten years. There are numerous contract manufacturers in our industry and we do not believe it would be difficult to source our products from other vendors, should all of our three primary suppliers cease providing us with supplies. Our relationships with manufacturers require that all Vitamin Shoppe and BodyTech branded products not be adulterated or misbranded under any provisions of the Federal Food, Drug, and Cosmetic Act (“FDCA”) and the regulations promulgated thereunder. This includes, but is not limited to, compliance with applicable Good Manufacturing Practices (“GMP”). This means that ingredients in our products must be tested for identity, purity, quality, strength, and composition before being incorporated into our Vitamin Shoppe or BodyTech branded products, and that our final Vitamin Shoppe and BodyTech branded products must again be tested for identity, purity, quality, strength, and composition prior to being released. All of these products require a certificate of analysis, which includes certification to 100% of label claim.

We have established a standard quality control operating procedure that calls for on-site audits of our contract manufacturers’ facilities and processes, and have established an internal team that will audit each of these facilities and work with our contract manufacturers to resolve any noncompliance with dietary supplement GMP regulations. We require that our manufacturers have certificates of analysis (such as for microbe testing and label testing).

Additionally, we have established standard quality control operating procedures to review vendors of third-party products and require them to carry adequate insurance policies to satisfy our standards. We further review each new product proposed to be carried by us to assure the safety of the ingredients. We reject those products that we believe may be unsafe. Our third-party manufacturers and distributors and contract manufacturers deliver finished products to our warehouse and distribution center in New Jersey, which then supplies our retail and direct channels with products.

Competition

The U.S. nutritional supplements retail industry is highly competitive and fragmented. According to the NBJ and public filings with the SEC, no single retailer accounted for more than 5% of total industry sales in 2008. Competition is based primarily on quality, product assortment, price, customer service, marketing support and availability of new products. We compete with publicly and privately owned companies with broad geographical market coverage and product categories. We compete with other specialty and mass market retailers including Vitamin World®, GNC®, Whole Foods®, Costco® and Wal-Mart®, Internet and mail order companies including Puritan’s Pride®, vitacost.com, Bodybuilding.com® , Doctors Trust®, Swanson® and iHerb® in addition to a variety of independent health and vitamin stores.

Insurance and Risk Management

We purchase insurance to cover standard risks in our industry, including policies to cover general and products liability, workers compensation, travel liability, auto liability and other casualty and property risks. Our insurance rates are based on our safety record as well as trends in the insurance industry.

We face an inherent risk of exposure to product liability claims in the event that, among other things, the use of our products results in injury. With respect to product liability coverage, we carry insurance coverage typical of our industry and product lines. Our coverage involves self-insured retentions with primary and excess liability coverage above the retention amount. We have the ability to refer claims to our contract manufacturers, third-party vendors and their respective insurers to pay the costs associated with any claims arising from such contract manufacturers’ or third-party vendors’ products. Our insurance covers any claims that are not adequately covered by a contract manufacturer’s or third-party vendor’s insurance and provides for excess secondary coverage above

 

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the limits provided by our contract manufacturers or third-party vendors. We believe we have obtained a prudent amount of insurance for the insurable risks associated with our business. Our experience is that our insurance costs have increased in the past, and may increase in the future.

Trademarks and Other Intellectual Property

We believe trademark protection is particularly important to the maintenance of the recognized proprietary brand names under which we market our products. We own material trademarks or trade names that we use in conjunction with the sale of our products, including the Vitamin Shoppe, BodyTech and MD Select brand names. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. We protect our intellectual property rights through a variety of methods including trademark and trade secret laws, as well as confidentiality agreements and proprietary information agreements with vendors, employees, consultants and others who have access to our proprietary information. Protection of our intellectual property often affords us the opportunity to enhance our position in the marketplace by precluding our competitors from using or otherwise exploiting our technology and brands. The recorded value of our trademarks, which are indefinite lived intangible assets, was $68.7 million at December 27, 2008, and $68.2 million at December 29, 2007.

Employees

As of December 27, 2008, we had a total of 1,946 full-time and 1,168 part-time employees, of whom 2,612 were employed in our retail channel and 502 were employed in corporate, distribution and direct channel support functions. None of our employees belongs to a union or is a party to any collective bargaining or similar agreement. We consider our relationships with our employees to be good.

Environmental

We are subject to numerous federal, state, local and foreign laws and regulations governing our operations, including the handling, transportation and disposal of our products and our non-hazardous and hazardous substances and wastes, as well as emissions and discharges into the environment, including discharges to air, surface water and groundwater. Failure to comply with such laws and regulations could result in costs for corrective action, penalties or the imposition of other liabilities. Changes in environmental laws or the interpretation thereof or the development of new facts could also cause us to incur additional capital and operation expenditures to maintain compliance with environmental laws and regulations. We also are subject to laws and regulations that impose liability and cleanup responsibility for releases of hazardous substances into the environment without regard to fault or knowledge about the condition or action causing the liability. Under certain of these laws and regulations, such liabilities can be imposed for cleanup of previously owned or operated properties. The presence of contamination from such substances or wastes could also adversely affect our ability to utilize our leased properties. Compliance with environmental laws and regulations has not had a material effect upon our earnings or financial position; however, if we violate any environmental obligation, it could have a material adverse effect on our business or financial performance.

Legal Proceedings

Dwight Thompson v. The Vitamin Shoppe and Consolidated Actions.    The Company reclassified its California store managers as non-exempt employees in January 2004. On February 25, 2005, plaintiff Dwight Thompson (“Thompson”), a former store manager, filed suit on behalf of himself and other “similarly situated” current and former California store managers and assistant store managers in the Superior Court of the State of California for the County of Orange (“Orange County Superior Court”), alleging causes of action for alleged wage and hour violations, unfair business practices, unfair competition under Cal. Bus. & Prof. Code §§ 17000 et seq. (“UCL”) and penalties under the Labor Code Private Attorneys General Act, Cal. Labor Code §§ 2698 et seq. (“PAGA”) (the “Thompson Action”). Almost one year later, on July 7, 2006, the same group of plaintiffs’ attorneys who were representing Thompson filed another wage and hour lawsuit against The Vitamin Shoppe

 

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based on substantively identical allegations in the Orange County Superior Court, entitled Estel v. The Vitamin Shoppe Industries Inc. (Case No. 06CC07852) (the “Estel Action”). Plaintiffs in the Estel Action were already class members in the Thompson Action. In January 2008, the Court consolidated the Thompson and Estel actions. In the consolidated complaint, Plaintiffs assert nine claims for relief against the Company: (1) failure to pay overtime wages; (2) unfair business practices in violation of Cal. Bus. & Prof. Code §§ 17000 et seq.; (3) conversion; (4) failure to provide meal periods; (5) failure to provide rest periods; (6) unfair competition under the UCL; (7) failure to provide itemized wage statements; (8) failure to provide wages and accrued vacation upon termination; and (9) recovery of civil penalties under PAGA. Plaintiffs purport to bring their UCL and PAGA claims as representative actions and the remaining claims on behalf of a class composed of all current and former assistant managers and managers of the Company who were employed on or after April 14, 2006 (the “Amended Thompson Action”). The Company intends to defend the Amended Thompson Action vigorously and has filed a motion for summary judgment on the grounds that Dwight Thompson, the only named plaintiff to act as a class representative, lacks standing to pursue such class action claims and that he can not sustain a claim for PAGA penalties. At this time, the Company does not have sufficient information to determine the amount or range of any potential loss. Accordingly, as of June 27, 2009, the Company has not accrued any liabilities related to this litigation.

California District Attorney’s Letter.    On May 17, 2007, the Company received a letter from the Napa County (California) District Attorney alleging that six of the Company’s private label products contain levels of lead that, pursuant to California’s Proposition 65, Cal. Health & Safety Code section 25249.5 et seq., (“Proposition 65”) require the products to bear a warning when sold in California. The letter claims that 12 other public prosecutors in California, including the California Attorney General, “are involved in a joint investigation of dietary supplements containing lead in amounts that expose users to lead in excess of 0.50 micrograms (ug) per day.” The letter demands that the Company immediately cease all sales of these products in California unless it provides a warning to consumers. It also notes that Proposition 65 provides for civil penalties of up to $2,500 per violation per day. The Company has met with the California Attorney General and certain District Attorneys, and is investigating these allegations and consulting with its third-party suppliers of these products. The Company has withdrawn certain named products from the California market and has provided warnings with respect to other products still available in California pending discussions with the public prosecutors. The Napa County District Attorney has expressed concerns on several occasions as to the method of warning employed by the Company and the completeness of its implementation. The Company has revised its warnings and reviewed its procedures for implementing warnings. The Company has responded to all outstanding requests for information and has met in person with representatives of the Napa County District Attorney and the California Attorney General to attempt to resolve this matter. At this time it is premature to address any potential loss as a result of these claims, or the amount or range of potential loss. As of June 27, 2009, the Company has not accrued any liabilities related to this litigation.

The People of the State of California v. 21st Century Healthcare, Inc.    On October 22, 2008, a private enforcer named Vicky Hamilton sent over 70 manufacturers and retailers of multivitamin products, including the Company, various Sixty-Day Notices of Violation of Proposition 65, Cal. Health & Safety Code section 25249.5 et seq. alleging that certain products contain lead and lead compounds and were sold in California without a Proposition 65 warning threatening litigation pertaining to two of the Company’s multivitamin products. On December 23, 2008, the California Attorney General and nine California District Attorneys filed a complaint on behalf of the People of the State of California against a number of companies who received notices of violation from Ms. Hamilton, including the Company in Alameda County Superior Court. The action alleges violations of both Proposition 65 and the UCL and supplants the litigation Ms. Hamilton sought to bring against the Company on the claims stated in her Notice of Violation. Penalties under Proposition 65 may be assessed at the maximum rate of $2,500 per violation per day. Penalties under the UCL may be assessed at the same rate and are cumulative to those available under Proposition 65. Injunctive relief and attorneys fees are also available. The Company is investigating these claims and discussing them with the California Attorney General and District Attorneys. At this time it is premature to determine the extent of any potential loss. Accordingly, as of June 27, 2009, the Company has not accrued any liabilities related to this litigation.

 

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J.C. Romero v. ErgoPharm Inc., Proviant Technologies Inc., VS Holdings Inc, d/b/a Vitamin Shoppe, and General Nutrition Centers Inc.    On April 27, 2009, plaintiff, a professional baseball player, filed a complaint against us, among others, in Superior Court of New Jersey (Law Division/Camden County). Plaintiff alleges that he purchased from one of our stores and consumed 6-OXO Extreme, which is manufactured by a third party, and in August 2008, allegedly tested positive for a banned substance. Plaintiff served a 50 game suspension imposed by Major League Baseball. The seven count complaint asserts, among other things, claims for negligence, strict liability, misrepresentation, breach of implied warranty and violations of the New Jersey Consumer Fraud Act, and seeks unspecified monetary damages. We deny any and all liability and intend to vigorously defend these claims. Any liabilities that may arise from this matter are not probable or reasonably estimable at this time. Accordingly, as of June 27, 2009, the Company has not accrued any liabilities related to this litigation.

The Company is party to various lawsuits arising from time to time in the normal course of business, many of which are covered by insurance. Except as described above, as of June 27, 2009, the Company was not party to any material legal proceedings. Although the impact of the final resolution of these matters on the Company’s financial condition, results of operations or cash flows is not known, management does not believe that the resolution of these lawsuits will have a material adverse effect on the financial condition, results of operations or liquidity of the Company.

Government Regulation

The formulation, manufacturing, processing, labeling, packaging, advertising and distribution of our products are subject to regulation by several federal agencies, including the FDA, the FTC, the Consumer Product Safety Commission, the DOA and the EPA. These activities are also regulated by various agencies of the states and localities in which our products are sold. Pursuant to the FDCA, the FDA regulates the processing, formulation, safety, manufacture, packaging, labeling and distribution of dietary supplements (including vitamins, minerals, and herbs) and cosmetics. The FTC has jurisdiction to regulate the advertising of these products.

The FDCA has been amended several times with respect to dietary supplements, in particular by the Dietary Supplement Health and Education Act of 1994 (“DSHEA”). DSHEA established a new framework governing the composition, safety, labeling and marketing of dietary supplements. “Dietary supplements” are defined as vitamins, minerals, herbs, other botanicals, amino acids and other dietary substances for human use to supplement the diet, as well as concentrates, metabolites, constituents, extracts or combinations of such dietary ingredients. Generally, under DSHEA, dietary ingredients that were on the market prior to October 15, 1994 may be used in dietary supplements without notifying the FDA. New dietary ingredients (i.e., not marketed in the U.S. prior to 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 being “chemically altered.” A new dietary ingredient notification must be submitted to the FDA at least 75 days before the initial marketing of the new dietary ingredient. There is no certainty that the FDA will accept any particular evidence of safety for any new dietary ingredient. The FDA’s refusal to accept such evidence could prevent the marketing of such dietary ingredients.

DSHEA permits “statements of nutritional support” to be included in labeling for dietary supplements without premarket FDA approval. Such statements must be submitted to the FDA within 30 days of marketing and must bear a label disclosure 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.” 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 body structure, function or well-being, but may not expressly or implicitly represent that a dietary supplement will diagnose, cure, mitigate, treat, or prevent a disease. A company that uses a statement of nutritional support in labeling must possess scientific evidence substantiating that the statement is truthful and not misleading. If the FDA were to determine that a particular

 

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statement of nutritional support was an unacceptable drug claim or an unauthorized version of a disease claim for a food product, or if the FDA were to determine that a particular claim was not adequately supported by existing scientific data or was false or misleading, we would be prevented from using that claim.

In addition, DSHEA provides that so-called “third-party literature,” e.g. a reprint of a peer-reviewed scientific publication linking a particular dietary ingredient with health benefits, may be used “in connection with the sale of a dietary supplement to consumers” without the literature being subject to regulation as labeling. Such literature must not be false or misleading; the literature may not “promote” a particular manufacturer or brand of dietary supplement; and a balanced view of the available scientific information on the subject matter must be presented. If the literature fails to satisfy each of these requirements, we may be prevented from disseminating such literature with our products, and any dissemination could subject our product to regulatory action as an illegal drug. The FDA in June 2007 adopted final regulations setting forth the GMP in manufacturing, packing, or holding dietary ingredients and dietary supplements which apply to the products we distribute and which are enforced by the FDA through its facilities inspection program. These regulations require dietary supplements to be prepared, packaged and held in compliance with strict rules, and require quality control provisions similar to those in the GMP regulations for drugs. We or our third party manufacturers have incurred and continue to incur additional expenses in complying with the new rules.

The FDA has broad authority to enforce the provisions of the FDCA applicable to foods, dietary supplements, and cosmetics including powers to issue a public warning letter to a company, to publicize information about illegal products, to request a recall of illegal products from the market, and to request the Department of Justice to initiate a seizure action, an injunction action, or a criminal prosecution in the United States courts. The regulation of foods, dietary supplements and cosmetics may increase or become more restrictive in the future.

Legislation has been passed that imposes substantial new regulatory requirements for dietary supplements. This new law imposes adverse event reporting, and some post-market surveillance requirements on the OTC and dietary supplement industries. Other legislation expected to be introduced in the current Congress could impose new requirements which could raise our costs and hinder our business.

The FTC exercises jurisdiction over the advertising of foods, dietary supplements and cosmetics. In recent years, the FTC has instituted numerous enforcement actions against dietary supplement companies for failure to have adequate substantiation for claims made in advertising or for the use of false or misleading advertising claims. As a result of our efforts to comply with applicable statutes and regulations, we have from time to time reformulated, eliminated or relabeled certain of our products and revised certain provisions of our sales and marketing program. The FTC has broad authority to enforce its laws and regulations applicable to foods, dietary supplements and cosmetics, including the ability to institute enforcement actions which often result in consent decrees, injunctions, and the payment of civil penalties by the companies involved. Failure to comply with the FTC’s laws and regulations could impair our ability to market our products.

 

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MANAGEMENT

The following table sets forth information regarding the board of directors of VS Parent, Inc. as of October 9, 2009. Prior to completion of this offering, we expect to consummate our corporate reorganization whereby VS Parent, Inc. will be merged with and into VS Holdings, Inc., with VS Holdings, Inc. being the surviving entity of the merger. A majority of the current directors of VS Parent, Inc. will become directors of the surviving entity, which will be renamed Vitamin Shoppe, Inc. Effective upon consummation of this offering, we intend to appoint at least two additional independent persons to our board of directors. The composition of the committees of the board of directors will be determined at that time. Executive officers serve at the request of the board of directors:

 

NAME

   AGE   

POSITION

Richard L. Markee

   56    Chief Executive Officer, Chairman of the Board, Director

Anthony Truesdale

   46    President and Chief Merchandising Officer

Michael G. Archbold

   49    Executive Vice President, Chief Operating Officer and Chief Financial Officer

Cosmo La Forgia

   54    Vice President, Finance

Louis H. Weiss

   40    Chief Marketing Officer

James M. Sander

   53    Vice President, General Counsel and Corporate Secretary

B. Michael Becker

   64    Director

Catherine Buggeln

   48    Director

John H. Edmondson

   63    Director

David H. Edwab

   54    Director

John D. Howard

   57    Director

Douglas R. Korn

   47    Director

Richard L. Perkal

   55    Director

Beth M. Pritchard

   61    Director

Katherine Savitt-Lennon

   46    Director

Richard L. Markee has served as a Director of the Board of VS Parent, Inc., since September, 2006, and was non-executive Chairman of the Board and Director of the Board from April 2007 to September 2009. On September 8, 2009, Mr. Markee was appointed as the Company’s Chief Executive Officer and serves as Chairman of the Board of Directors and a Director of the Board. Mr. Markee was appointed to the Nomination and Corporate Governance Committee in January 2007. He previously served as the President of Babies “R” Us since August 2004 and Vice Chairman of Toys “R” Us, Inc. since May 2003 through November 2007. Mr. Markee also served as interim chief executive officer of Toys “R” Us, Inc. and its subsidiaries from July 2005 to February 2006. Mr. Markee served as President of Toys “R” Us U.S. from May 2003 to August 2004. From January 2002 to May 2003, he was executive vice president – president – Specialty Businesses and International Operations of Toys “R” Us. Mr. Markee was an Operating Partner of Irving Place Capital Management, L.P., a private equity firm focused on making equity investments in middle-market companies from 2008 to September 2009. From 2006 to 2008, Mr. Markee was an Operating Partner of Bear Stearns Merchant Banking, the predecessor to Irving Place Capital Management, L.P. He has also been a director of Dorel Industries since November 2008. From June 2005 through July 2006, he served on the Board of Directors of The Sports Authority, Inc. From October 1999 to January 2002, he served as Executive vice president, president of Babies “R” Us and the Chairman of Kids “R” Us.

Anthony N. Truesdale has served as our President and Chief Merchandising Officer since April 2006. Prior to joining us, he was Senior Vice President of Merchandising and Supply Chain Management at Petsmart, Inc., holding various positions of increasing responsibility since January 1999. Before joining Petsmart, Inc., Mr. Truesdale worked for two years at Sainsbury’s in the United Kingdom as the senior manager for produce and for 16 years with various operations and merchandising roles at Shaws Supermarkets in New England.

Michael G. Archbold has served as our Executive Vice President, Chief Operating Officer and Chief Financial Officer since April 2007. Mr. Archbold served as Executive Vice President / Chief Financial and

 

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Administrative Officer of Saks Fifth Avenue from 2005 to 2007. From 2002 to 2005 he served as Chief Financial Officer for AutoZone, originally as Senior Vice President, and later as Executive Vice President. Mr. Archbold currently serves as Lead Independent Director of the Borders Group board of directors. Mr. Archbold is a Certified Public Accountant, and has 20 years of financial experience in the retail industry.

Cosmo La Forgia has served as our Vice President, Finance since September 2004. Mr. La Forgia joined our Company as Corporate Controller in January 2003. Prior to that time, Mr. La Forgia was Divisional Controller for The Home Depot, Inc. from June 1998 to December 2002.

Louis H. Weiss has served as our Vice President, Internet and Catalog Business since December 2006 and was promoted to chief marketing officer in Fiscal 2009. Prior to December 2006, Mr. Weiss served as president for Gaiam Direct, the direct marketing unit of Gaiam Inc., in 2005 and 2006. In 2004 and 2005 he was senior vice president of Good Times Entertainment. In July 2005, Good Times Entertainment filed a petition under Chapter 11 of the Federal Bankruptcy Act and was acquired by Gaiam, Inc. later that year. In 2003 and 2004 Mr. Weiss served as a strategic consultant to various online direct marketing companies. From 2000 through 2003 Mr. Weiss was with Blue Dolphin, Inc. in various executive capacities, and was President thereof at the time he left the company.

James M. Sander has served as our Vice President, General Counsel and Corporate Secretary since November 2008. Prior to joining The Vitamin Shoppe, Mr. Sander was Senior Vice President, General Counsel and Secretary at Sharper Image Corporation from July 2007 to July 2008. Sharper Image Corporation filed for protection under Chapter 11 of the Bankruptcy Code in February 2008. From August 2005 to July 2007, Mr. Sander was in private practice with Holsworth Sander and Associates in Pittsburgh, PA. From October 1988 to August 2005, Mr. Sander was counsel for General Nutrition Companies, Inc. and its subsidiaries, serving as their Vice President, Chief Legal Officer and Corporate Secretary from February 1993, and as their Senior Vice President, Chief Legal Officer and Corporate Secretary from December 2003. Mr. Sander has his Juris Doctor Degree from the Duquesne University School of Law.

B. Michael Becker has served as Director of VS Parent, Inc. since January 2008. Mr. Becker was a former audit partner for Ernst & Young LLP prior to his retirement in 2006. Mr. Becker is a member of the Audit Committee of VS Parent, Inc. Mr. Becker is currently a senior consultant on airline risks to Pay Pal, Inc., and from August 2006 to August 2008 had a consulting practice which had an arrangement with Ernst & Young LLP to provide consulting services for two of its clients in the capacity of accounting and audit. Mr. Becker served as an audit partner for Ernst & Young LLP since 1979, where he spent the entirety of his career prior to his retirement. Mr. Becker holds an MBA and is a Certified Public Accountant.

Catherine E. Buggeln has agreed to join the Board as a Director of Vitamin Shoppe, Inc. upon the completion of the offering. Ms. Buggeln currently serves as a director of The Dress Barn, Inc., which is publicly traded, Noble Biomaterials Inc. and Stuart Weitzman LLC. Ms. Buggeln also serves on the Governing Board of the Business Council for Peace. Ms. Buggeln has provided business strategy and brand management consulting services within the past five years. Ms. Buggeln was Senior Vice President, Strategic Planning and Business Development for Coach, Inc. from 2001 to 2004.

John H. Edmondson has served as a Director of VS Parent, Inc. since June 2006, and prior to that time, he served as a Director of VS Holdings, Inc. since April 2006. He has been a member of the Audit Committee of VS Parent, Inc. since July 2006. Mr. Edmondson was appointed to the Nomination and Corporate Governance Committee in January 2007. In addition to our board, Mr. Edmondson serves on the board of Cabela’s Sporting Goods, and is a member of its audit committee. Mr. Edmondson served as chief executive officer and director of West Marine, Inc., a NASDAQ retail company selling boating supplies and accessories in 38 states, Puerto Rico and Canada, from December 1998 until January 2005. Mr. Edmondson has been pursuing his personal interests since January 2005.

David H. Edwab has served as a Director of VS Parent, Inc. since June 2006 and prior to that time, he served as a Director of VS Holdings, Inc. since November 2005. He became the Chairman of the Audit Committee of VS Parent, Inc. in January 2006 (prior to June 12, 2006, of VS Holdings, Inc.), and remained as

 

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Chairman until September 2008. He also became a member of the Compensation Committee of VS Parent, Inc. in March 2006 (prior to June 12, 2006, of VS Holdings, Inc.). Mr. Edwab has served as an officer and director of Men’s Wearhouse for over 15 years, starting as Vice President of Finance and Director in 1991, serving as Chief Operating Officer from 1993 to 1997, where he was elected President in 1997. In November 2000, Mr. Edwab joined Bear, Stearns & Co. Inc. as a Senior Managing Director, Head of the Retail Group in the Investment Banking Department. At such time, Mr. Edwab resigned as President of Men’s Wearhouse and was then named Vice Chairman of the Board of Directors. In February 2002, Mr. Edwab re-joined Men’s Wearhouse and continues to serve as Vice Chairman of its Board of Directors. Mr. Edwab previously served as a Senior Advisor to Bear Stearns Merchant Banking, LLC, an affiliate of Bear Stearns & Co. Inc. and the predecessor to Irving Place Capital Management, L.P., a private equity firm focused on making equity investments in middle-market companies, until April 2008, and is a director of New York & Company, Inc. and Stuart Weitzman. Mr. Edwab also serves as Vice Chairman of the Zimmer Family Foundation. Mr. Edwab is a Certified Public Accountant and was previously a partner with Deloitte & Touche.

John D. Howard has served as a Director of VS Parent, Inc. since June 2006 and prior to that time, he served as a Director of VS Holdings, Inc. since 2002. He is currently the chief executive officer of Irving Place Capital Management, L.P., a private equity firm focused on making equity investments in middle-market companies. From its inception in 1997 until 2008, Mr. Howard was the head of Bear Stearns Merchant Banking, an affiliate of Bear, Stearns & Co. Inc and the predecessor to Irving Place Capital Management, L.P., as well as a Senior Managing Director of Bear, Stearns & Co. Inc. From 1990 to 1997, he was a co-Chief Executive Officer of Vestar Capital Partners, Inc., a private investment firm specializing in management buyouts. Previously he was a senior vice president of Wesray Capital Corporation, a private investment firm specializing in leveraged buyouts. Mr. Howard currently serves as a director of Universal Hospital Services, Inc., as well as a director and member of the Corporate Governance Committee and Compensation Committee of New York & Company, Inc., and as a director of Aéropostale, Inc., all of which are publicly traded companies.

Douglas R. Korn has served as a Director of VS Parent, Inc. since June 2006, and as a Director of VS Holdings, Inc., Vitamin Shoppe Industries Inc. and VS Direct Inc. since 2002 and became the Chairman of the Compensation Committee in March 2006. Mr. Korn was appointed to the Nomination and Corporate Governance Committee in January 2007. He is currently a Senior Managing Director of Irving Place Capital Management, L.P., a private equity firm focused on making equity investments in middle-market companies. From 1999 to 2008, Mr. Korn was a Senior Managing Director of Bear, Stearns & Co. Inc. and a Partner and Executive Vice President of Bear Stearns Merchant Banking, an affiliate of Bear, Stearns & Co. Inc and the predecessor to Irving Place Capital Management, L.P. Prior to joining Bear Stearns in January 1999, Mr. Korn was a Managing Director of Eos Partners, L.P., an investment partnership. Mr. Korn previously worked in private equity with Blackstone Group and in investment banking with Morgan Stanley. Mr. Korn is currently a director of several private companies and charitable organizations.

Richard L. Perkal has served as a Director of VS Parent, Inc. since June 2006, and as a Director of VS Holdings, Inc., Vitamin Shoppe Industries Inc. and VS Direct Inc. and member of the Audit Committee of VS Parent, Inc. since 2002 (prior to June 12, 2006, of VS Holdings, Inc.). Mr. Perkal was appointed to the Nomination and Corporate Governance Committee in January 2007. Mr. Perkal is currently a Senior Managing Director of Irving Place Capital Management, L.P., a private equity firm focused on making equity investments in middle-market companies. From 2000 to 2008, Mr. Perkal was a Senior Managing Director of Bear, Stearns & Co. Inc. and a Partner of Bear Stearns Merchant Banking, an affiliate of Bear, Stearns & Co. Inc and predecessor to Irving Place Capital Management, L.P. Prior to joining Bear, Stearns & Co. Inc. in 2000, Mr. Perkal was a senior partner in the law firm of Kirkland & Ellis LLP where he headed the Washington D.C. corporate transactional practice, primarily focusing on leveraged buyouts and recapitalizations. Mr. Perkal currently serves as a director of New York & Company, Inc., a publicly traded company, as well as several private companies.

Beth M. Pritchard, has served as Director of VS Parent, Inc. since January 2008. Ms. Pritchard served as Vice Chairman of Dean & Deluca until November 2008. Ms. Pritchard joined Dean & Deluca in 2006, having previously served as President and Chief Executive Officer of Organized Living from 2004 until May 2005,

 

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when it filed a reorganization petition under Chapter 11 of the federal bankruptcy code and was subsequently liquidated. She also served as President and Chief Executive Officer of Bath & Body Works where she spent 12 years of her career helping to develop it into a specialty retail chain. Ms Pritchard has served on the board of Borders Group, Inc., and currently serves as a director and member of the finance and compensation committees of Ecolab.

Katherine Savitt-Lennon has agreed to join the Board as a Director of Vitamin Shoppe, Inc. upon the completion of the offering. Since 2009, Ms. Savitt-Lennon has served as the Chief Executive Officer of Lockerz, LLC. From March 2006 to 2009, Ms. Savitt-Lennon served as the Executive Vice President and Chief Marketing Officer of American Eagle Outfitters, Inc. From 2002-2006, she served Vice President, Strategic Communications, Content and Initiatives of Amazon.com. Ms. Savitt-Lennon serves on the Advisory Board of Liberty Media, the board of directors of the Build-A-Bear Workshop, Inc. and as a board member of the Carnegie Museum of Art.

 

Term of Directors and Composition of Board of Directors

Upon the consummation of this offering, our certificate of incorporation will authorize a board of directors consisting of at least three, but no more than fifteen, members, with the number of directors to be fixed from time to time by a resolution of the board. Our board of directors currently consists of eight directors.

Upon consummation of this offering, our certificate of incorporation will be amended to provide for the election of each director on an annual basis.

Board Committees

We will be a “controlled company” under NYSE rules, and will therefore not need to have an independent board, compensation committee or nominating and governance committee. A company of which more than 50% of the voting power is held by an individual, a group or another company is considered to be a “controlled company” under NYSE rules.

Audit Committee.    The audit committee of the board consists of four members. The committee assists the board in its oversight responsibilities relating to the integrity of our financial statements, the qualifications, independence and performance of our independent auditors, the performance of our internal audit function and the compliance of our company with any reporting and regulatory requirements we may be subject to. Upon the consummation of this offering, we will have three independent directors serving on our audit committee. We intend to have a completely independent audit committee within one year of the date of this prospectus. Three of the four members of our Audit Committee (Mr. Edwab, Mr. Edmondson and Mr. Becker) have been declared by our Board to be “independent” as defined under NYSE rules and Rule 10A-3 of the Securities Exchange Act, as amended.

Compensation Committee.    The compensation committee of the board is authorized to review our compensation and benefits plans to ensure they meet our corporate objectives, approve the compensation structure of our executive officers and evaluate our executive officers’ performance and advise on salary, bonus and other incentive and equity compensation.

Nominating and Corporate Governance Committee.    The nominating and governance committee of the board assists the board in identifying individuals qualified to become board members, makes recommendations for nominees for committees and develops, recommends to the board and reviews our corporate governance principles.

Compensation Committee Interlocks and Insider Participation

None of our executive officers serves as a member of the compensation committee or board of directors of any other entity that has an executive officer serving as a member of our board of directors or compensation committee.

 

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COMPENSATION DISCUSSION AND ANALYSIS

Compensation Committee Process

The Compensation Committee of the Board of Directors approves all compensation and awards to the individuals included on the Summary Compensation Table (the “named executive officers”). Annually, the Compensation Committee will review the performance and compensation of the Chief Executive Officer and, following discussions with the Chief Executive Officer and, where it deems appropriate, other advisors, establish all executives’ compensation levels for the subsequent year. For the remaining named executive officers, the Chief Executive Officer makes recommendations to the Compensation Committee for approval.

The Compensation Committee met once in 2008 and twice in 2007. The Compensation Committee’s charter provides that it will (i) develop, approve, and report to the Board regarding the Company’s overall compensation philosophy and strategy, (ii) establish corporate goals and objectives relevant to Chief Executive Officer compensation, evaluate the Chief Executive Officer’s performance in light of those goals and objectives, and determine and approve the Chief Executive Officer’s compensation level based on this evaluation, (iii) review and approve the compensation structure for the other executive officers and review and approve the Chief Executive Officer’s recommendations with respect to executive officer compensation, (iv) oversee Chief Executive Officer and executive succession planning and development, and (v) make recommendations to the Board with respect to director compensation. In addition to the committee members, in the past the Chief Executive Officer, the President and Chief Merchandising Officer, the Chief Financial Officer and Chief Operating Officer, the Corporate Secretary/General Counsel and the Vice President of Human Resources have attended its meetings, and other officers from the Company may be asked to attend from time to time as the committee deems appropriate. Other members of the Board of Directors have also attended the Compensation Committee’s meetings. The Compensation Committee makes reports to the full Board of Directors based on its activities and, for certain activities, such as the granting of options, the Compensation Committee will make recommendations to the full Board for approval.

General Compensation Philosophy, Objectives and Purpose

We work to attract and retain proven, talented, industry executives who we feel will help to put us in the best position for continued growth and to meet our Company’s objectives. We attempt to recruit executives with retail or other experience that we believe is transferable to our business with the expectation that they will share their knowledge to create and manage a large successful retail organization. We strive to provide our named executive officers with a compensation package that is competitive for a given position in our industry and geographic region. The purpose of our executive compensation program is to provide incentives for our executives to meet or exceed expectations, and to meet specific individualized goals. We believe our compensation objectives are achieved through a combination of base salary, annual bonus, equity compensation and other benefits. With the exception of equity, or stock-based compensation, all compensation is paid in cash.

Though we are currently not a publicly-owned company, our stock-based compensation provides a means for our executives to obtain a degree of ownership of our Company, through ownership in our parent company, VS Parent, Inc., and therefore align corporate and individual goals. The issuance of equity compensation is generally not based on performance but rather is a component of each officer’s initial compensation offering package (see narrative below accompanying the Summary Compensation Table for details), as well as for promotions, further compensation incentives, and retention. As cash bonuses are based on both individual and company-wide performance and objectives, we offer a market-competitive base salary for the executive position so as to mitigate the volatility we may experience with regards to overall performance and objectives. It is our philosophy that bonuses are to be used to provide an added incentive to meet additional objectives which exceed ordinary expectations and not as salary itself.

 

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Determination of Executive Compensation

Review of External Data

In 2004 we retained the services of an outside compensation consulting firm, Compensation Resources, Inc., to assess the market ranges of total compensation for our executive positions. We have not subsequently employed these or any similar services to review total compensation. At the time market ranges were assessed in determining our executives’ total compensation packages, we targeted a competitive level of the total compensation value of a comprehensive benchmark analysis. Compensation Resources, Inc. utilized fifteen benchmark surveys covering both retail and non-retail positions. Each year subsequent to the above analysis, the Compensation Committee has reviewed the total compensation package of each named executive officer based upon the recommendations of the Chief Executive Officer and such outside consultants as the Compensation Committee deemed appropriate. We determined, and continue to believe, that we should be market competitive with compensation and should align our compensation packages with our business goals and objectives. However, we strongly believe in engaging the best talent in critical functions, and this may entail negotiations with individual executives who have significant compensation and/or retention packages in place with other employers. In order to attract such individuals, the Compensation Committee may from time to time determine that it is in the Company’s best interests to negotiate compensation packages that deviate from the general principle of targeting a competitive compensation package, including compensating an executive for bonuses and/or other incentives that the executive may forfeit upon leaving a prior position. Similarly, the Compensation Committee may determine to provide compensation outside of the normal cycle to certain individuals to address retention issues.

In December 2006 the Compensation Committee engaged The Hay Group for the purpose of reviewing the Company’s bonus program (as described below in “Elements of Compensation”). The Hay Group was chosen at that time as they had conducted an annual survey of total compensation in the retail industry covering over 70 companies. In determining whether to recommend any changes to our bonus program, including the percentages of base salary that are used for target bonuses and the percentage breakdown of target bonuses between individual and corporate objectives, the Compensation Committee and the Hay Group considered the results of the Hay Group survey regarding what bonus program structures were common in the retail industry and considered the level of incentive that would be provided to employees by each program feature as compared to its relative cost. Neither the Hay Group nor the Compensation Committee engaged in any benchmarking in their analyses. Based upon the results of their review in December 2006, the Compensation Committee recommended to the Board, and the Board adopted, certain revisions to the Company’s bonus plan which were accepted in Fiscal 2007 and continued through Fiscal 2008. The revisions pertained to the target bonus percentage for our named executive officers who are vice presidents, and included a revised payout formula for exceeding or failing to achieve the Company’s target objectives by a pre-defined amount. The revisions were as follows: target EBITDA was divided into a range between a minimum target threshold and a maximum target threshold; the minimum payout percentage of previously defined target EBITDA was revised downward from 100% to 50%, and a payout percentage of 150% was established for the maximum threshold. Based upon a review of the compensation arrangements discussed below, we believe that the value and design of our executive compensation program adequately addresses our goals and compensation philosophy.

Elements of Total Compensation

Components of our executive compensation are as follows:

Base Salary.    Base salary for our executives is determined based on the specific level of the executive, responsibilities of a position, competitive pressures and other labor market factors such as competing negotiations and other offers received by the executive. Generally, the goal is to achieve a salary that is competitive with the salary for similar positions in similar industries within our Company’s geographic region. We believe we offer market-competitive base salaries for executives in similar positions with similar responsibilities at comparable companies so as to mitigate the volatility we may experience with regard to overall Company performance and objectives. Salaries are reviewed during the annual review process when an increase,

 

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if any, is determined. Any increase in salary for the named executive officers is subject to Compensation Committee approval. In addition, base salaries may be adjusted, on occasion at the Compensation Committee’s discretion, to realign a particular salary or salaries with current market conditions.

Annual Bonus.    It is our philosophy that bonuses are to be used to provide an added incentive to meet additional objectives which exceed ordinary expectations. For Fiscal 2006, the target bonuses were 100% of base salary for the Chief Executive Officer, 50% of base salary for the President and Chief Merchandising Officer, and 25% of base salary for the other named executive officers. Based upon the recommendation of the Hay Group, for 2007 the target bonus for each other named executive officer was increased to 30% of his base salary from 20%. Upon the hiring of the Chief Financial Officer and Chief Operating Officer in 2007, the Compensation Committee determined that the target bonus for this position should be 50% of base salary.

The Company-wide dollar target necessary for the issuance of cash bonuses for Fiscal 2008, was an internal EBITDA target of $60.5 million. Internal EBITDA represents net income before provision for income tax, interest income and expense, depreciation and amortization, and deferred rent expense, as well non-cash stock-compensation expense, management fees to IPC Manager II, LLC, and certain other unusual items. For Fiscal 2008, the internal EBITDA target was met and the individual target bonuses were 50% of base salary for the President and Chief Merchandising Officer, and Chief Financial Officer and Chief Operating Officer, and 30% of base salary for the other named executive officers. With the exception of our Chief Executive Officer, whose annual bonus is established by the Compensation Committee in a manner consistent with his employment contract, annual bonuses are determined based on the guidelines of our Management Incentive Plan (“MIP”). Pursuant to his employment agreement, the Chief Executive Officer’s target bonus is 100% of his base salary. Bonuses for Fiscal 2009 will continue to be based on internal EBITDA and similar methodologies employed in prior years, along with an adjustment for capital employed during the year.

In Fiscal 2008, the Compensation Committee determined that the Chief Executive Officer earned 95% of his target bonus and each other named executive officers, except the Vice President and General Manger- Direct, earned 100% of their target bonus as described below. This resulted in a payout to the Chief Executive Officer of 95% of his base salary; to each of the President, and Chief Merchandising Officer and the Chief Financial Officer and Chief Operating Officer of 50% of his base salary; and to the Vice President of Finance of 30% of his base salary. The Vice President and General Manager –Direct earned 90% of his target bonus of 30% of his base salary. In Fiscal 2007, the Compensation Committee determined that the Chief Executive Officer earned 85% of his target bonus and each other named executive officer earned 100% of his target bonus. This resulted in a payout to the Chief Executive Officer of 85% of his base salary; to each of the President and Chief Merchandising Officer and the Chief Financial Officer and Chief Operating Officer of 50% of his base salary; and to the Vice President of Finance of 30% of his base salary. The Vice President and General Manager –Direct received an aggregate bonus of 30% of his base salary, consisting of the guaranteed bonus provided for in his employment contract and a portion of the Company’s MIP bonus. In 2006 our Company’s financial performance was such that the Chief Executive Officer earned 100% of his target bonus and all other named executive officers earned 130% of their target bonus. This resulted in a payout to the Chief Executive Officer of 100% of his base salary; to the President and Chief Merchandising Officer of 65% of his base salary; and to each other named executive officer who worked for the Company that year of 32.5% of his base salary.

The MIP is a cash-based, pay-for-performance annual incentive plan which was adopted in December 2004. The MIP allows for a range of cash awards based on the participant’s base salary, level of employment, our operating results and individual objectives. Individual objectives are established by the employee’s supervisor and the Chief Executive Officer. The annual bonus for all participants in the MIP is based upon a combination of Company-wide (75%) and individual (25%) objectives, subject to the Committee’s discretion to award lesser amounts to individual executives based upon performance and the recommendation of the Chief Executive Officer. Under the MIP, awards will be calculated and paid after our financial results have been reviewed, at which time the cash awards are processed and paid before March 15th of the following year. In order to maintain the tax deductibility of payments under the MIP in the year accrued, the Compensation Committee has

 

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authorized the payment of the bonus based upon unaudited financial data which is discussed by the Chairman of the Compensation Committee with the Company’s outside auditors. The Compensation Committee plans to review the plan periodically, and present any proposed changes to the Board.

The formula below provides an illustration as to how the annual bonus award pursuant to the MIP is calculated.

Annual Compensation x Participant’s Target Bonus x Corporate Multiplier = MIP Award

Annual Compensation.    Annual Compensation is the participant’s base salary for the fiscal year for which the bonus is being paid.

Participant’s Target Bonus.    Each position has a target bonus, which is a percentage of the individual’s base salary. The target bonus for the Chief Executive Officer was established pursuant to his employment contract at 100% of his base salary. In 2008, these target objectives were 50% of base salary for both the President and Chief Merchandising Officer, and the Chief Financial Officer and Chief Operating Officer, and 30% of base salary for the other named executive officers. The participant’s target bonus is divided into two components: corporate objectives, which aggregate to 75% of the participant’s target bonus, and individual objectives, which aggregate to 25% of the participant’s target bonus.

The Corporate Objectives.    The corporate performance objective(s) are established each year by the Compensation Committee and Board as part of the budgeting process. Each year, corporate objective(s) are reviewed by the Compensation Committee and approved by our Board. To date, the corporate objectives have always been financial, although the Compensation Committee may in the future designate objectives that include both financial (objective) criteria and/or subjective criteria. In Fiscal 2004 and prior years, if the target Company performance objective was not satisfied, there was no bonus payout for any eligible participant. As of Fiscal 2005, the MIP was revised so that individuals would be paid a bonus based upon the satisfaction of their individual objective(s), even if the corporate objective were not satisfied.

Individual Objectives.    The individual component of the bonus is customized to each individual’s position at the Company. In 2006 a named executive officer could satisfy some of his individual performance objectives even if the Company did not satisfy its performance objectives and receive a bonus payment under the MIP. Effective for Fiscal 2007 and Fiscal 2008 the MIP was further revised, and if our Company does not achieve 95% of its Company performance objective, individual performance bonuses will not be paid.

Corporate Multiplier.    In Fiscal 2006 and prior, the MIP provided that if the corporate performance objective was exceeded, there would be an increase in the bonus payout based upon step increments. Beginning in Fiscal 2007 and continuing through Fiscal 2008, the bonus payout ranged from 50% to 150% of the participant’s target bonus based upon the achievement of certain corporate performance objectives. In addition, we have also determined that for Fiscal 2007 and subsequent years, if we attain between 95% and 100% of the corporate performance objectives, but if we do not show improvement in the operating (non-sales) components of our business, there will be no payments under the MIP.

Individual Bonus Plans.    On occasion, we have determined that it is desirable to adopt an individualized bonus plan for certain executives in order to entice them to leave alternate employment. We adopted such a plan for Mr. Weiss, our Vice President and General Manager- Direct, which is more fully set forth in his employment agreement, described in the narrative accompanying the Summary Compensation Table.

Long-term Incentive Compensation.    Granting stock options encourages our executives to focus on our Company’s future success. Our parent company, VS Parent, Inc., issues grants for stock options under the 2006 Plan. The predecessor plan was the 2002 Stock Option Plan of VS Holdings, Inc., which was converted in June 2006 into the 2006 Plan in connection with the formation and merger of VS Parent, Inc. Our named executive officers and certain outside directors participate in the 2006 Plan. The number of grants recipients receive is

 

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generally based on their particular position within the Company. In the case of certain named executive officers the number of options was a negotiated part of their individual employment packages, which are detailed in the “Grants of Plan Based Awards” discussion. All grants to officers require the approval of our Board.

Other.    Perquisites are awarded on a case by case basis based on individual employment agreements. They are determined based on a given hiring situation and approved by the Compensation Committee and Board. Compensation components classified as Other that are offered to the named executive officers along with all employees of Vitamin Shoppe include a 401(k) plan with a Company match, and Company-paid disability and life insurance.

For Fiscal 2008 we did not have a pension program for our employees.

We adopted a deferred compensation plan in Fiscal 2007 for senior level employees. The authorization for such plan prohibits any Company contributions on behalf of any officer (other than the voluntary election to defer the payment of a portion of such individual’s salary) without further Compensation Committee authorization. There were no Company contributions authorized during Fiscal 2007 or Fiscal 2008.

Compensation Recovery Policies

Recoupment of Certain Sign-on/Relocation Bonuses.    As of December 27, 2008, we had no outstanding recoupment arrangements with any of our named executives.

Ownership Guidelines

Share Retention Guidelines.    In October 2002, our then Chief Executive Officer, Mr. Thomas Tolworthy, borrowed the sum of $1.5 million on a partial recourse basis from VS Holdings, Inc. to assist with the purchase of 75,750 shares of the Company’s common stock and 9,343 shares of preferred stock so that Mr. Tolworthy had an aggregate level of ownership appropriate to that position. The note bears interest at 3.06% and of the $1.5 million borrowed the Company has recourse on $375,000. At the time the Company was organized, Mr. Tolworthy, who was then the President and Chief Operating Officer of the Company, purchased his current interest in the equity of the Company. VS Holdings, Inc. has since assigned the note evidencing this debt to VS Parent, Inc. In July 2008, the Company paid a dividend to VS Parent, Inc., its parent company, of approximately $561,000. This dividend was used for the redemption of 358 of VS Parent, Inc.’s preferred shares including the associated preferred dividends in arrears held by Mr. Tolworthy). Mr. Tolworthy sold shares of VS Parent, Inc. common stock to VS Parent, Inc. at his original cost of $754,970 ($10 per share) and the proceeds from the repurchase were used to reduce Mr. Tolworthy’s promissory note owed to VS Parent, Inc. Mr. Tolworthy surrendered 634 shares of Series A Preferred Stock to VS Parent, Inc. in satisfaction of the remaining balance on the promissory note. In addition, Mr. Tolworthy has forfeited 130,535 vested options. To date, we have not established any guidelines that would require any of our named executive officers to own stock in VS Parent, Inc.

 

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We currently have no trading policies as our stock is presently not offered to the public. All of the stock is subject to the terms and provisions of that certain Amended and Restated Securityholders Agreement by and among VS Parent, Inc. and our stockholders (the “Amended and Restated Securityholders Agreement”).

Summary Compensation Table

 

Name and Principal

Position

  Year   Salary $   Bonus $   Stock
Awards $
  Option
Awards $ (1)
  Non-Equity
Incentive
Plan Comp $
  All Other
Compensation $
  Total $

Thomas Tolworthy

Chief Executive Officer (2)

  2006
2007
2008
  475,000
506,214
512,404
  475,000
425,000
487,011
 

 

 

  24,562
26,335
26,366
  974,562
957,549
1,025,781

Michael Archbold (3)

Executive Vice President,

Chief Operating Officer and

Chief Financial Officer

  2006
2007
2008
 
320,192
461,245
 
225,000
230,623
 

 
3,875,281

 

 

263
9,276

 
4,420,736
701,144

Anthony N. Truesdale (3)

President and Chief

Merchandising Officer

  2006
2007
2008
  337,500
471,154
486,825
  292,500
235,577
243,413
 

  2,238,429

 

  158,125
11,818
11,583
  3,026,554
718,549
741,821

Cosmo La Forgia

VP, Finance

  2006
2007
2008
  254,000
267,661
273,816
  82,550
80,160
82,216
 
 

11,715

 

  18,239
10,315
10,761
  354,789
369,851
366,793

Louis Weiss

VP, General Manager-Direct

  2006
2007
2008
 

295,385
340,385

 

90,000
91,904

 

  354,565

324,999
 

 

413
11,444

  354,565
385,798
768,732

 

(1) The value of option awards granted to our named executive officers has been estimated pursuant to requirements under SFAS No. 123(R) for grants issued subsequent to December 31, 2005, and SFAS No. 123 for those granted prior to January 1, 2006. All grants issued to Mr. Tolworthy and those grants issued to Mr. La Forgia prior to 2007 were valued under SFAS No. 123, as they were granted prior to the adoption of SFAS No. 123(R), and thus have not been recorded as compensation expense in our consolidated financial statements. The remainder were valued under SFAS No. 123(R), as they were granted subsequent to the adoption of SFAS No. 123(R), and as such have been recorded as compensation expense in our consolidated financial statements. The assumptions used for estimating the fair value for those compensatory grants, are outlined in Note 3 to our financial statements. The weighted average fair value of our options granted during Fiscal 2008, Fiscal 2007, and Fiscal 2006 calculated pursuant to SFAS No. 123(R), was $14.74, $13.10 and $6.09, respectively. See Note 3, “Summary of Significant Accounting Policies — Stock-Based Compensation.” for further discussion.
(2) Effective as of September 8, 2009 Mr. Tolworthy resigned from his position as Chief Executive Officer.
(3) Mr. Archbold’s Fiscal 2007 compensation represents amounts earned commencing in April 2007, his month of hire, through December 2007. Mr. Truesdale’s Fiscal 2006 compensation represents amounts earned commencing in April 2006, his month of hire, through December 2006. These amounts do not represent a full year’s compensation.

 

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Perquisites Table

 

          Mr. Tolworthy    Mr. Archbold    Mr. Truesdale    Mr. La Forgia    Mr. Weiss

Car Allowance (1)

   2006
2007
2008
   $
 
 
12,000
12,000
12,000
         $ 7,200   

Life Insurance Premiums (2)

   2006
2007
2008
    

 

 

540

450

450

    
 
263
450
    

 

 

360

450

450

    

 

 

540

450

450

    

 

413

450

Relocation Allowance

   2006
2007
2008
           82,500      

401(k) Company Contribution

   2006
2007
2008
    
 
 
12,022
13,885
13,916
     8,826     
 
11,368
11,133
    
 
 
10,499
9,865
10,311
     10,994

Miscellaneous (3)

   2006
2007
2008
           75,265      
                                     

Totals

   2006    $ 24,562    $    $ 158,125    $ 18,239    $

Totals

   2007    $ 26,335    $ 263    $ 11,818    $ 10,315    $ 413

Totals

   2008    $ 26,366    $ 9,276    $ 11,583    $ 10,761    $ 11,444

 

(1) Mr. La Forgia’s car allowance was integrated into his salary beginning in 2007.
(2) The amounts shown represent premiums paid by the Company on behalf of the Executive.
(3) Represents the grossed-up taxes paid on relocation allowance.

Employment Agreements

As of December 27, 2008, all of our named executive officers were employed with us pursuant to written employment agreements. We expect that each of these employment agreements will remain in place following this offering.

Mr. Markee.    Mr. Markee’s employment agreement, dated September 9, 2009, is for a term of employment ending December 31, 2011, unless earlier terminated. Pursuant to the agreement, Mr. Markee will earn a base salary of $600,000 per annum. Mr. Markee is eligible for an annual cash bonus award. For the 2009 fiscal year, Mr. Markee will receive an annual cash bonus of $300,000, payable in calendar year 2010 at the same time annual bonuses are paid to other senior executives of the Company. For each fiscal year thereafter during the term of the employment agreement, Mr. Markee will be eligible for an annual cash bonus, based on a target opportunity of 100% of his base salary, payable at the same time annual bonuses are paid to other senior executives of the Company, based on criteria established by the Company’s Compensation Committee of the Board of Directors at least thirty days after the commencement of the calendar year. Mr. Markee will be entitled to participate in any health, disability and life insurance and other employee benefit plans and programs made available by the Company to its senior management employees generally. Mr. Markee will receive a monthly automobile allowance of $1,000 for automobile expenses and reimbursement of legal fees incurred in connection with the negotiation of his employment documents up to a maximum of $10,000. Mr. Markee will be entitled to five weeks of vacation time per fiscal year.

The Company granted Mr. Markee options to purchase 200,000 shares of common stock of the Company (the “Common Stock”) under the Amended and Restated 2006 Stock Option Plan, as adopted by the Company. The options will (i) have a strike price of $28.13 per share of Common Stock, (ii) vest in equal quarterly installments commencing upon the three-month anniversary of September 8, 2009 and become fully vested on

 

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the fourth annual anniversary of September 8, 2009, (iii) expire on March 8, 2017 and (iv) be subject to all terms and conditions of the plan. The Company issued to Mr. Markee 48,658 restricted shares of common stock under the 2009 Equity Incentive Plan. These restricted shares (i) vest annually over four years, 25% on each anniversary of September 8, 2009 (ii) are subject to all terms and conditions of the plan.

Mr. Markee purchased from the Company 26,839 shares of common stock at a price per share of $28.13, for an aggregate cash purchase price of $754,981.

If Mr. Markee is terminated “with cause” he will be entitled to any vested right of benefits payable under any retirement or pension plan or under any other employee benefit plan of the Company, and all such benefits will continue, in accordance with, and subject to, the terms and conditions of such plans, to be payable in full after such termination. If Mr. Markee is terminated “without cause” or for “Good Reason” he shall be entitled to his base salary from the date of the termination of his employment through the earlier to occur of (1) the last date of the term of the employment agreement and (2) the date that is twelve months following his termination. Mr. Markee shall also be entitled to the full amount of any unpaid annual cash bonus for any calendar year of the Company prior to the calendar year in which his employment is terminated and for the calendar year in which his employment is terminated, on a pro rata basis and the Company will continue to pay its share of his health insurance costs for twelve months.

Mr. Tolworthy.    Mr. Tolworthy’s amended employment agreement, dated September 8, 2009, provides for “at will” employment and does not have a specified term. The agreement provides for an annual base salary of $300,000. Mr. Tolworthy may be awarded a bonus in the sole discretion of the Company. The agreement provides that upon termination Mr. Tolworthy would qualify for severance under the Company’s severance policies as then in effect, but such policy is to provide an amount of severance equal to at least three months of an executive’s base salary. If Mr. Tolworthy is terminated for “Cause” or resigns from employment within twelve months of the date that he entered into his amended employment agreement, certain of the equity he holds is subject to repurchase for the lesser of the amount Mr. Tolworthy paid for such equity and the fair market value of such equity on the date of repurchase. Pursuant to his employment agreement, Mr. Tolworthy is prohibited from competing with the Company or soliciting its business or employees for the three year period following his employment.

Mr. Truesdale.    Mr. Truesdale’s amended employment agreement, dated September 25, 2009, sets forth an initial term ending March 31, 2012 and automatic renewal for up to three successive one year periods unless either Mr. Truesdale or the Company notifies the other of intent not to renew the agreement. The agreement provides for an annual base salary and an annual bonus based on achievement of Company performance objectives, as well as a relocation bonus. This relocation bonus which totaled $157,765, $82,500 for relocation fees and $75,265 for income tax gross-up. Mr. Truesdale’s agreement provides for severance payments upon termination of his employment without “cause” (as such term is defined in the agreement) conditioned upon Mr. Truesdale delivering a general release in favor of the Company. The severance provisions provide that Mr. Truesdale will receive, subject to compliance with certain non-compete, non-solicitation and other obligations, an amount equal to (i) his annual base salary through the earlier of (x) twelve months after the date of termination and (y) the last day of either the initial term or the renewal term, (ii) the full amount of any unpaid bonus in respect of the immediately prior calendar year, (iii) if he has worked for the Company for at least six months during such year, a portion of bonus for the calendar year in which employment is terminated, and (iv) the other benefits provided to him under his employment agreement, until the earlier of (x) twelve months or (y) the time when he becomes eligible for such benefits offered by any subsequent employer. If Mr. Truesdale resigns his employment due to a “change of control” (as such term is defined in the agreement) of the Company followed within twelve months by a material adverse change in status (as such terms are defined in the agreement), the severance provisions provide that he will receive, subject to compliance with certain non-compete, non-solicitation and other obligations, an amount equal to (i) his annual base salary for twelve months after the date of termination, (ii) the full amount of any unpaid bonus in respect of the immediately prior calendar year, (iii) if he has worked for the Company for at least six months during such year, a portion of the

 

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bonus for the calendar year in which employment is terminated, and (iv) the other benefits provided to him under his employment agreement, until the earlier of (x) twelve months or (y) the time when he becomes eligible for such benefits offered by any subsequent employer. The employment agreement provides that if Mr. Truesdale’s employment is terminated due to the Company not renewing either the initial term of employment or any of the one-year extension periods, or upon the expiration of the third one-year extension of the employment term, then Mr. Truesdale will be entitled to receive the same severance he would receive if the Company had terminated him without cause. Mr. Truesdale’s employment contract also provides that in the event that his employment is terminated by the Company without cause (or due to its non-renewal of the employment term as described above), the component of his severance that is determined by reference to continued payment of his base salary will be paid as continued payment of his base salary until the date that is twelve months following Mr. Truesdale’s termination of