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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| x
|
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 |
| ¨
|
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to
|
Commission File Number 000-26137
drugstore.com, inc.
(Exact name of registrant as specified in its charter)
| Delaware |
|
04-3416255 |
| (State or other jurisdiction of
incorporation or organization) |
|
(IRS Employer Identification
No.) |
13920 Southeast Eastgate Way, Suite 300
Bellevue, Washington 98005
(Address of principal executive offices)
(425) 372-3200
(Registrant’s telephone number)
Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
The number of shares of common stock, $.0001 par value, outstanding on August 12, 2002 was 68,135,865.
CONTENTS
| PART I—FINANCIAL INFORMATION |
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| Item 1. |
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3 |
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3 |
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4 |
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5 |
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6 |
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7 |
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| Item 2. |
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12 |
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| Item 3. |
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20 |
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| PART II—OTHER INFORMATION |
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| Item 4. |
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20 |
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| Item 5. |
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20 |
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| Item 6. |
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20 |
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21 |
PART I—FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| |
|
June 30, 2002
|
|
|
December 30, 2001
|
|
| |
|
(unaudited) |
|
|
|
|
| ASSETS |
|
|
|
|
|
|
|
|
| Current assets: |
|
|
|
|
|
|
|
|
| Cash and cash equivalents |
|
$ |
35,855 |
|
|
$ |
39,518 |
|
| Marketable securities |
|
|
30,077 |
|
|
|
39,238 |
|
| Accounts receivable, net |
|
|
13,429 |
|
|
|
10,171 |
|
| Inventories |
|
|
6,796 |
|
|
|
6,659 |
|
| Prepaid marketing expenses |
|
|
2,374 |
|
|
|
12,539 |
|
| Other current assets |
|
|
2,361 |
|
|
|
1,500 |
|
| |
|
|
|
|
|
|
|
|
| Total current assets |
|
|
90,892 |
|
|
|
109,625 |
|
| |
| Fixed assets, net of accumulated depreciation of $26,957 and $23,492, respectively |
|
|
19,228 |
|
|
|
23,948 |
|
| Intangible assets, net |
|
|
6,458 |
|
|
|
7,888 |
|
| Goodwill, net |
|
|
5,694 |
|
|
|
14,599 |
|
| Prepaid marketing expenses |
|
|
13,740 |
|
|
|
14,884 |
|
| Deposits and other assets |
|
|
378 |
|
|
|
354 |
|
| |
|
|
|
|
|
|
|
|
| Total assets |
|
$ |
136,390 |
|
|
$ |
171,298 |
|
| |
|
|
|
|
|
|
|
|
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
|
|
|
|
| Current liabilities: |
|
|
|
|
|
|
|
|
| Accounts payable |
|
$ |
23,039 |
|
|
$ |
20,309 |
|
| Accrued compensation |
|
|
2,526 |
|
|
|
2,608 |
|
| Accrued marketing expenses |
|
|
1,770 |
|
|
|
2,249 |
|
| Other current liabilities |
|
|
1,858 |
|
|
|
2,031 |
|
| Current portion of capital lease obligations |
|
|
1,027 |
|
|
|
1,612 |
|
| |
|
|
|
|
|
|
|
|
| Total current liabilities |
|
|
30,220 |
|
|
|
28,809 |
|
| Capital lease obligations, less current portion |
|
|
294 |
|
|
|
638 |
|
| Stockholders’ equity: |
|
|
|
|
|
|
|
|
| Preferred stock, $.0001 par value: |
|
|
|
|
|
|
|
|
| Authorized shares—10,000,000 |
|
|
|
|
|
|
|
|
| Issued and outstanding shares—None |
|
|
— |
|
|
|
— |
|
| Common stock, $.0001 par value, stated at amounts paid in: |
|
|
|
|
|
|
|
|
| Authorized shares—250,000,000 |
|
|
|
|
|
|
|
|
| Issued and outstanding shares—68,014,301 and 66,731,818 as of June 30, 2002 and December 30, 2001,
respectively |
|
|
744,237 |
|
|
|
742,949 |
|
| Deferred stock-based compensation |
|
|
(1,197 |
) |
|
|
(1,400 |
) |
| Accumulated deficit |
|
|
(637,164 |
) |
|
|
(599,698 |
) |
| |
|
|
|
|
|
|
|
|
| Total stockholders’ equity |
|
|
105,876 |
|
|
|
141,851 |
|
| |
|
|
|
|
|
|
|
|
| Total liabilities and stockholders’ equity |
|
$ |
136,390 |
|
|
$ |
171,298 |
|
| |
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
July 1, 2001
|
|
| Net sales |
|
$ |
47,615 |
|
|
$ |
34,035 |
|
|
$ |
91,551 |
|
|
$ |
66,804 |
|
| Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Cost of sales |
|
|
38,350 |
|
|
|
28,494 |
|
|
|
73,782 |
|
|
|
56,260 |
|
| Fulfillment and order processing(1) |
|
|
6,497 |
|
|
|
6,915 |
|
|
|
13,167 |
|
|
|
14,683 |
|
| Marketing and sales(2) |
|
|
7,589 |
|
|
|
8,263 |
|
|
|
16,305 |
|
|
|
19,205 |
|
| Technology and content(3) |
|
|
3,280 |
|
|
|
4,845 |
|
|
|
6,810 |
|
|
|
10,560 |
|
| General and administrative(4) |
|
|
2,766 |
|
|
|
3,481 |
|
|
|
5,801 |
|
|
|
7,567 |
|
| Impairment and restructuring charges |
|
|
2,450 |
|
|
|
— |
|
|
|
2,450 |
|
|
|
7,294 |
|
| Amortization of intangible assets |
|
|
716 |
|
|
|
9,681 |
|
|
|
1,430 |
|
|
|
19,392 |
|
| Amortization of stock-based compensation |
|
|
340 |
|
|
|
1,572 |
|
|
|
1,107 |
|
|
|
4,449 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total costs and expenses |
|
|
61,988 |
|
|
|
63,251 |
|
|
|
120,852 |
|
|
|
139,410 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Operating loss |
|
|
(14,373 |
) |
|
|
(29,216 |
) |
|
|
(29,301 |
) |
|
|
(72,606 |
) |
| Interest income, net |
|
|
389 |
|
|
|
1,199 |
|
|
|
740 |
|
|
|
2,933 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Loss before cumulative effect of change in accounting principle |
|
|
(13,984 |
) |
|
|
(28,017 |
) |
|
|
(28,561 |
) |
|
|
(69,673 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Cumulative effect of change in accounting principle |
|
|
— |
|
|
|
(4,121 |
) |
|
|
(8,905 |
) |
|
|
(4,121 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net loss |
|
$ |
(13,984 |
) |
|
$ |
(32,138 |
) |
|
$ |
(37,466 |
) |
|
$ |
(73,794 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Basic and diluted loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Loss before cumulative effect of change in accounting principle |
|
$ |
(0.21 |
) |
|
$ |
(0.43 |
) |
|
$ |
(0.43 |
) |
|
$ |
(1.06 |
) |
| Cumulative effect of change in accounting principle |
|
|
— |
|
|
|
(0.06 |
) |
|
|
(0.13 |
) |
|
|
(0.06 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
(0.21 |
) |
|
$ |
(0.49 |
) |
|
$ |
(0.56 |
) |
|
$ |
(1.12 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Weighted average shares outstanding used to compute basic and diluted loss per share |
|
|
67,590,381 |
|
|
|
65,940,203 |
|
|
|
67,318,948 |
|
|
|
65,705,611 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Excludes amortization of stock-based compensation of $86 and $263 for the three and six months ended June 30, 2002, respectively, and $284 and $798 for the
three and six months ended July 1, 2001, respectively. |
(2) |
|
Excludes amortization of stock-based compensation of $37 and $128 for the three and six months ended June 30, 2002, respectively, and $211 and $629 for the
three and six months ended July 1, 2001, respectively. |
(3) |
|
Excludes amortization of stock-based compensation of $121 and $393 for the three and six months ended June 30, 2002, respectively, and $599 and $1,522 for the
three and six months ended July 1, 2001, respectively. |
(4) |
|
Excludes amortization of stock-based compensation of $96 and $323 for the three and six months ended June 30, 2002, respectively, and $478 and $1,500 for the
three and six months ended July 1, 2001, respectively. |
See accompanying notes to condensed
consolidated financial statements.
4
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
(unaudited)
| |
|
Common Stock
|
|
Deferred Stock-Based Compensation
|
|
|
Accumulated Deficit
|
|
|
Total
|
|
| |
|
Shares
|
|
Amount
|
|
|
|
| Balance at December 30, 2001 |
|
66,731,818 |
|
$ |
742,949 |
|
$ |
(1,400 |
) |
|
$ |
(599,698 |
) |
|
$ |
141,851 |
|
| Exercise of stock options |
|
995,464 |
|
|
349 |
|
|
— |
|
|
|
— |
|
|
|
349 |
|
| Employee stock purchase plan |
|
34,613 |
|
|
35 |
|
|
— |
|
|
|
— |
|
|
|
35 |
|
| Issuance of common stock to settle fair market value guarantee |
|
252,406 |
|
|
— |
|
|
— |
|
|
|
— |
|
|
|
— |
|
| Deferred stock-based compensation, net of cancellations of $237 |
|
— |
|
|
904 |
|
|
(904 |
) |
|
|
— |
|
|
|
— |
|
| Amortization of stock-based compensation |
|
— |
|
|
— |
|
|
1,107 |
|
|
|
— |
|
|
|
1,107 |
|
| Net loss |
|
— |
|
|
— |
|
|
— |
|
|
|
(37,466 |
) |
|
|
(37,466 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Balance at June 30, 2002 |
|
68,014,301 |
|
$ |
744,237 |
|
$ |
(1,197 |
) |
|
$ |
(637,164 |
) |
|
$ |
105,876 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| |
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
July 1, 2001
|
|
| Operating Activities: |
|
|
|
|
|
|
|
|
| Net loss |
|
$ |
(37,466 |
) |
|
$ |
(73,794 |
) |
| Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
| Non-cash expenses: |
|
|
|
|
|
|
|
|
| Depreciation |
|
|
4,969 |
|
|
|
6,730 |
|
| Marketing and sales |
|
|
8,674 |
|
|
|
10,278 |
|
| Impairment and restructuring charges |
|
|
2,450 |
|
|
|
7,294 |
|
| Amortization of intangible assets |
|
|
1,430 |
|
|
|
19,392 |
|
| Amortization of stock-based compensation |
|
|
1,107 |
|
|
|
4,449 |
|
| Cumulative effect of change in accounting principle |
|
|
8,905 |
|
|
|
4,121 |
|
| Changes in: |
|
|
|
|
|
|
|
|
| Accounts receivable |
|
|
(3,258 |
) |
|
|
(603 |
) |
| Inventories |
|
|
(137 |
) |
|
|
2,474 |
|
| Prepaid marketing expenses |
|
|
185 |
|
|
|
126 |
|
| Other current assets |
|
|
(861 |
) |
|
|
(529 |
) |
| Deposits and other assets |
|
|
(24 |
) |
|
|
1,252 |
|
| Accounts payable and accrued expenses |
|
|
1,996 |
|
|
|
(8,441 |
) |
| Other |
|
|
(142 |
) |
|
|
(49 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash used in operating activities |
|
|
(12,172 |
) |
|
|
(27,300 |
) |
| |
| Investing Activities: |
|
|
|
|
|
|
|
|
| Purchases of marketable securities |
|
|
(31,982 |
) |
|
|
(29,837 |
) |
| Sales of marketable securities |
|
|
41,271 |
|
|
|
30,806 |
|
| Purchase of fixed assets, net of proceeds |
|
|
(235 |
) |
|
|
(430 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash provided by investing activities |
|
|
9,054 |
|
|
|
539 |
|
| |
| Financing Activities: |
|
|
|
|
|
|
|
|
| Proceeds from exercise of stock options and employee stock purchase plan |
|
|
384 |
|
|
|
171 |
|
| Principal payments on capital lease obligations |
|
|
(929 |
) |
|
|
(1,780 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash used in financing activities |
|
|
(545 |
) |
|
|
(1,609 |
) |
| |
|
|
|
|
|
|
|
|
| Net decrease in cash and cash equivalents |
|
|
(3,663 |
) |
|
|
(28,370 |
) |
| Cash and cash equivalents at beginning of period |
|
|
39,518 |
|
|
|
108,032 |
|
| |
|
|
|
|
|
|
|
|
| Cash and cash equivalents at end of period |
|
$ |
35,855 |
|
|
$ |
79,662 |
|
| |
|
|
|
|
|
|
|
|
| |
| Supplemental Cash Flow Information: |
|
|
|
|
|
|
|
|
| Cash paid for interest |
|
$ |
92 |
|
|
$ |
197 |
|
| Equipment acquired in capital lease agreements |
|
|
— |
|
|
$ |
44 |
|
| Forfeiture of cancelled lease deposit |
|
|
— |
|
|
$ |
4,500 |
|
| Equity issued to settle fair market value guarantee |
|
$ |
630 |
|
|
|
— |
|
See accompanying notes to condensed consolidated financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of
Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission. In
our opinion, the statements include all adjustments necessary (which are of a normal and recurring nature) for the fair presentation of the results of the interim periods presented. In addition, the balance sheet at December 30, 2001 has been
derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.
These condensed consolidated financial statements should be read in conjunction with our audited consolidated financial
statements, and accompanying notes, included in our Annual Report on Form 10-K for the year ended December 30, 2001, filed with the Securities and Exchange Commission on April 1, 2002. Our results of operations for any interim period are not
necessarily indicative of the results of operations for any other interim period or for a full fiscal year.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142), effective for fiscal years beginning after December 15, 2001. drugstore.com, inc. (the “Company”) adopted SFAS 142 on
December 31, 2001 (the beginning of fiscal year 2002). Under SFAS 142, goodwill is no longer being amortized over its expected useful life, but is instead assessed for impairment on an annual basis. Separately identifiable intangible assets that do
not have an indefinite useful life will continue to be amortized. The Company recorded goodwill in conjunction with the acquisition of Beauty.com that was amortized through December 30, 2001, at which time, amortization ceased. The Company expects a
reduction of $13.5 million and $1.1 million in amortization expense associated with the Beauty.com goodwill during fiscal years 2002 and 2003, respectively, due to the implementation of SFAS 142.
SFAS 142 prescribes a two-phase process for impairment testing of goodwill. The first phase, required to be completed by June 30, 2002, screens for impairment; while
the second phase (if necessary), required to be completed by December 31, 2002, measures the impairment. The Company performed both phases of the impairment test during the second quarter of 2002. In order to perform the analysis, the Company
identified its reporting units and assigned all Beauty.com goodwill to the prestige beauty reporting unit. A discounted cash flow analysis was performed to assess the fair market value of the reporting unit. Based on this analysis, the Company
determined that impairment of the Beauty.com goodwill may exist and completed phase 2 of the test – measuring the impairment. Based on the completion of phase 2, the Company has recorded an $8.9 million impairment loss associated with the
Beauty.com goodwill. Accordingly, the Company has recognized an impairment loss of $8.9 million as a cumulative effect of a change in accounting principle (as of the date of adoption) in the first quarter of 2002. Based on the requirements of SFAS
142, the Company is also required to complete the first of its annual goodwill impairment tests in the year of adoption and expects to perform this test during the fourth quarter of 2002.
In accordance with SFAS 142, the effect of this accounting change is reflected prospectively. Supplemental comparative disclosures as if the change had been retroactively
applied to the prior year periods are as follows:
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
July 1, 2001
|
|
| |
|
(in thousands except per share data) |
|
| Net loss: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net loss, as reported |
|
$ |
(13,984 |
) |
|
$ |
(32,138 |
) |
|
$ |
(37,466 |
) |
|
$ |
(73,794 |
) |
| Goodwill amortization |
|
|
— |
|
|
|
3,369 |
|
|
|
— |
|
|
|
6,738 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Adjusted net loss |
|
$ |
(13,984 |
) |
|
$ |
(28,769 |
) |
|
$ |
(37,466 |
) |
|
$ |
(67,056 |
) |
| Basic and diluted net loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net loss per share, as reported |
|
$ |
(0.21 |
) |
|
$ |
(0.49 |
) |
|
$ |
(0.56 |
) |
|
$ |
(1.12 |
) |
| Goodwill amortization |
|
|
— |
|
|
|
0.05 |
|
|
|
— |
|
|
|
0.10 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Basic and diluted adjusted net loss per share |
|
$ |
(0.21 |
) |
|
$ |
(0.44 |
) |
|
$ |
(0.56 |
) |
|
$ |
(1.02 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7
DRUGSTORE.COM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
For the six months ended June 30, 2002, changes in the carrying
amount of goodwill are as follows (in thousands):
| Balance as of December 30, 2001 |
|
$ |
14,599 |
|
| Impairment associated with goodwill recorded in conjunction with the acquisition of Beauty.com |
|
|
(8,905 |
) |
| |
|
|
|
|
| Balance as of June 30, 2002 |
|
$ |
5,694 |
|
| |
|
|
|
|
For the six months ended June 30, 2002, no intangible assets were
acquired, impaired or disposed of. Net intangible assets consist of the following (in thousands):
| |
|
As of June 30, 2002
|
|
As of December 30, 2001
|
| |
|
Gross carrying amount
|
|
Accumulated amortization
|
|
|
Intangible assets, net
|
|
Gross carrying amount
|
|
Accumulated amortization
|
|
|
Intangible assets, net
|
| Contract related |
|
$ |
12,415 |
|
$ |
(7,166 |
) |
|
$ |
5,249 |
|
$ |
12,415 |
|
$ |
(6,786 |
) |
|
$ |
5,629 |
| Customer related |
|
|
670 |
|
|
(540 |
) |
|
|
130 |
|
|
670 |
|
|
(428 |
) |
|
|
242 |
| Marketing related |
|
|
5,765 |
|
|
(4,686 |
) |
|
|
1,079 |
|
|
5,765 |
|
|
(3,748 |
) |
|
|
2,017 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Intangible assets, net |
|
$ |
18,850 |
|
$ |
(12,392 |
) |
|
$ |
6,458 |
|
$ |
18,850 |
|
$ |
(10,962 |
) |
|
$ |
7,888 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets are scheduled to be amortized over the next seven
years. Expected amortization for the next five years is as follows (in thousands):
| Remaining |
|
2002 |
|
$1,422 |
| |
|
2003 |
|
945 |
| |
|
2004 |
|
744 |
| |
|
2005 |
|
744 |
| |
|
2006 |
|
744 |
| |
|
2007 |
|
744 |
In April 2002, the FASB issued Statement of Financial Accounting
Standards No. 145, Rescission of FASB Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections (SFAS 145). For most companies, SFAS 145 will require gains and losses on extinguishments of debt to be
classified as income or loss from continuing operations rather than as extraordinary items as previously required under Statement 4. However, extraordinary treatment will be required for certain extinguishments as provided in APB Opinion No. 30. The
Company is still evaluating the impact that adoption of SFAS 145 will have on its financial statements and may be required to reclassify the $7.5 million extraordinary gain on the renegotiation of equity guarantee recorded during the third quarter
of 2001 into loss from continuing operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
2. Net Loss Per Share
Net loss per share is computed using the weighted average number of shares of common stock outstanding less the number of shares subject to repurchase or contingently issuable pursuant to contractual
terms. Shares associated with stock options and warrants are not included in the calculation of diluted net loss per share because they are antidilutive.
8
DRUGSTORE.COM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
The following table sets forth the computation of basic and diluted
net loss per share for the periods indicated:
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
July 1, 2001
|
|
| |
|
(in thousands, except share and per share data) |
|
| Loss before cumulative effect of change in accounting principle |
|
$ |
(13,984 |
) |
|
$ |
(28,017 |
) |
|
$ |
(28,561 |
) |
|
$ |
(69,673 |
) |
| Cumulative effect of change in accounting principle |
|
|
— |
|
|
|
(4,121 |
) |
|
|
(8,905 |
) |
|
|
(4,121 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net loss |
|
$ |
(13,984 |
) |
|
$ |
(32,138 |
) |
|
$ |
(37,466 |
) |
|
$ |
(73,794 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Weighted average shares outstanding |
|
|
67,639,996 |
|
|
|
66,303,953 |
|
|
|
67,408,227 |
|
|
|
66,150,074 |
|
| Less weighted average shares subject to repurchase or contingently issuable pursuant to contract terms
|
|
|
(49,615 |
) |
|
|
(363,750 |
) |
|
|
(89,279 |
) |
|
|
(444,463 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Shares used in computation of basic and diluted loss per share |
|
|
67,590,381 |
|
|
|
65,940,203 |
|
|
|
67,318,948 |
|
|
|
65,705,611 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Basic and diluted loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Loss before cumulative effect of change in accounting principle |
|
$ |
(0.21 |
) |
|
$ |
(0.43 |
) |
|
$ |
(0.43 |
) |
|
$ |
(1.06 |
) |
| Cumulative effect of change in accounting principle |
|
|
— |
|
|
|
(0.06 |
) |
|
|
(0.13 |
) |
|
|
(0.06 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Basic and diluted net loss per share |
|
$ |
(0.21 |
) |
|
$ |
(0.49 |
) |
|
$ |
(0.56 |
|
|
$ |
(1.12 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2002 and July 1, 2001, there were 17,176,145 and
16,415,750 stock options and warrants outstanding, respectively, that were excluded from the computation of diluted net loss per share, as their effect was antidilutive. If the Company had reported net income, the calculation of these per share
amounts would have included the dilutive effect of these common stock equivalents using the treasury stock method.
3. Strategic Agreements
Amazon.com
In June 2001, Amazon.com, Inc. (Amazon.com) and the Company amended their advertising and technical services agreement which was entered
into in January 2000 and subsequently amended in July 2000. The amendment revised the total consideration under the agreement to $46.3 million by reducing the minimum cash payments due under the agreement from $30.0 million to $9.0 million and
changed the termination date of the agreement to June 25, 2002. The Company amortized the remaining aggregate minimum value primarily to marketing and sales expense on a straight-line basis over the remaining term of the agreement. For the three and
six months ended June 30, 2002, the Company recognized marketing and sales expense associated with such agreement of $4.6 million and $9.1 million, respectively. For the three and six months ended July 1, 2001, the Company recognized marketing and
sales expense associated with such agreement of $4.6 million and $10.0 million, respectively.
In June 2002, the
Company and Amazon.com entered into a new agreement to maintain the drugstore.com presence on the Amazon.com Web site through March 2003.
WellPoint
Under the terms of the agreement the Company entered into with
WellPoint in June 2000, the Company issued to Wellpoint 750,000 shares of our common stock with a fair value of approximately $5.0 million. If the 750,000 shares of common stock issued to Wellpoint did not have a fair market value of $10 million at
the end of two years, the Company was required to pay WellPoint, in common stock or cash, the difference between $10 million and the then fair market value of the common stock. During the second quarter of 2001, the Company implemented the Emerging
Issues Task Force Issue 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (EITF 00-19). Based on the terms of the original agreement, EITF 00-19 required that the
transaction be recorded at fair value each quarter. Accordingly, at the end of the second quarter of fiscal year 2001, which is the effective date of EITF 00-19, the Company recorded a cumulative effect adjustment of a change in accounting principle
of $4.1 million which represents the difference between the fair value of the guarantee as of July 1, 2001, and the fair value of the guarantee on the original date of the agreement. During the third quarter of 2001, the agreement with WellPoint was
amended, changing the terms of settlement, reducing the fair market value guarantee to $2.5 million and reducing the total cash payments due to WellPoint under the agreement. As a result of the amendment, the Company was no longer required to record
changes in the fair value of the guarantee each quarter.
9
DRUGSTORE.COM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
On June 23, 2002, the second anniversary of the agreement, the fair
market value of the guarantee was $1.9 million. As required by the agreement and subsequent amendment, the Company issued 252,406 shares of common stock to WellPoint in order to settle the $2.5 million guarantee as of that date.
4. Impairment and Restructuring charges
In January 2001, the Company’s board of directors approved a restructuring plan, and the Company terminated approximately 100 employees. As a result of the
terminations, the Company consolidated certain of its corporate facilities and is attempting to sublease or exit the leases associated with the excess facilities. Accordingly, the Company recorded a $7.3 million restructuring charge, which includes
the forfeiture of a portion of our lease deposit associated with the cancellation of the Company’s lease for new office space, exiting leases associated with vacated facilities and writing off related leasehold improvements and equipment for
the period ended April 1, 2001. Included in the Company’s current liabilities as of June 30, 2002, is $0.6 million associated with exiting leases of vacated facilities.
In June 1999, in conjunction with a private placement offering, the Company received $5 million in prepaid cable television advertising rights that were to be used by the
Company over a period of three years. During 2001, the Company extended the terms of the cable television advertising agreement by an additional year to June 2003 and reduced the advertising rights recorded in prepaid marketing to $2.5 million.
During the second quarter of 2002, the Company determined that it would not be able to utilize these rights. As such, the remaining $2.5 million associated with the prepaid cable advertising rights were determined to be impaired and were written off
as of June 30, 2002.
5. Stock Options
The following table summarizes activity under the Company’s stock plans:
| |
|
Shares Available for Grant
|
|
|
Outstanding Options
|
| |
|
|
Number of Shares
|
|
|
Weighted-Average Exercise Price per Share
|
| Outstanding at December 30, 2001 |
|
7,094,494 |
|
|
12,787,853 |
|
|
$ |
7.19 |
| Additional authorizations |
|
3,336,591 |
|
|
— |
|
|
|
— |
| Options granted |
|
(3,349,600 |
) |
|
3,349,600 |
|
|
$ |
2.08 |
| Options exercised |
|
— |
|
|
(995,464 |
) |
|
$ |
0.35 |
| Options forfeited |
|
965,844 |
|
|
(965,844 |
) |
|
$ |
7.17 |
| |
|
|
|
|
|
|
|
|
|
| Outstanding at June 30, 2002 |
|
8,047,329 |
|
|
14,176,145 |
|
|
$ |
6.46 |
| |
|
|
|
|
|
|
|
|
|
In January 2002, the Compensation Committee of the Company’s
board of directors approved a grant of stock options to purchase an aggregate of approximately 2.4 million shares of its common stock to certain of its existing employees at an exercise price of $1.93 per share, which was below the fair market value
on the date of the grant. The options were granted under the Company’s 1998 Stock Plan and will vest over a four year period, with 20% of the total number of options vesting on June 30, 2002 and the remaining options vesting in equal
installments at the end of each quarter thereafter. Accordingly, the Company recorded deferred stock-based compensation of approximately $1.1 million, which is being amortized over the vesting period of the options using the multiple-option
approach.
As of June 30, 2002, 6,608,723 of the total options outstanding were exercisable with a
weighted-average exercise price of $5.82 per share.
10
DRUGSTORE.COM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
6. Commitments and Contingencies
Legal proceedings. Shareholder class action lawsuits have been filed in the United States District Court for
the Southern District of New York naming the Company as a defendant, along with the underwriters and certain of the Company’s present and former officers and directors, in connection with the Company’s July 27, 1999, initial public
offering. Plaintiffs to one of the actions filed an amended complaint which makes similar claims and factual allegations in connection with the Company’s March 15, 2000, secondary offering. The allegations in the complaints vary, but in general
they allege that the prospectuses through which the Company conducted the initial public offering and the secondary offering (together, the Offerings) were materially false and misleading for failure to disclose, among other things, that (i) the
underwriters of the Offerings allegedly had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriters allocated to those investors material portions of the restricted number of shares
issued in connection with the Offerings and (ii) the underwriters allegedly entered into agreements with customers whereby they agreed to allocate drugstore.com shares to customers in the Offerings in exchange for which customers agreed to purchase
additional drugstore.com shares in the aftermarket at predetermined prices. The complaints assert violations of various sections of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and seek unspecified
damages and other relief. The Company disputes the allegations of wrongdoing in these complaints and intends to vigorously defend itself in these matters. The Company maintains insurance policies that it believes will provide coverage for these
claims and therefore believes that these claims will not have, individually or in the aggregate, a material adverse effect on its business prospects, financial condition or operating results. However, an unfavorable resolution in these matters could
materially affect the Company’s business and future results of operation, financial position or cash flows.
From time to time, the Company also is subject to other legal proceedings and claims in the ordinary course of business. The Company is not currently aware of any such legal proceedings or claims that it believes will have,
individually or in the aggregate, a material adverse effect on its business prospects, financial condition or operation results.
11
| |
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events or the future financial and operational
performance of drugstore.com.
Words such as “expects”, “believes”, “anticipates”,
“intends”, “may”, “will”, “plan”, “continue”, “forecast”, “remains”, “would”, “should”, “predict”, “potential” and similar expressions are
intended to identify forward-looking statements. Forward-looking statements are based on current expectations, are not guarantees of future performance and involve assumptions, risks, and uncertainties. Actual performance may differ materially from
those contained or implied in such forward-looking statements. Risks and uncertainties that could lead to such differences could include, among other things: effects of changes in the economy, consumer spending, the stock market, changes affecting
the Internet, online retailing and advertising, drugstore.com’s limited operating history, the unpredictability of future revenues and expenses and potential fluctuations in revenues and operating results, risks related to business combinations
and strategic alliances, consumer trends, the level of competition, seasonality, the timing and success of expansion efforts, risks related to systems interruptions, possible governmental regulation, and the ability to manage a rapidly growing
business. Additional information, regarding factors that potentially could affect drugstore.com’s business, financial condition and operating results is included in drugstore.com’s filings with the Securities and Exchange Commission,
including in the prospectus dated March 15, 2000 relating to drugstore.com’s public offering of common stock, in the prospectus on Form S-3, effective October 2, 2000 and in our periodic filings with the SEC on Forms 10K and 10Q.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot
guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We are under no duty to update any of
the forward-looking statements to conform such statements to actual results or to changes in our expectations.
Overview
drugstore.com™ is a leading online drugstore and information site offering The Simple Way to Look and Feel Your Best™ for health, beauty, wellness, personal care and pharmacy products. We also sell prestige beauty products through the Beauty.comTM Web site, which we purchased in February 2000. The drugstore.com and Beauty.com Web sites provide a convenient,
private and informative shopping experience that encourages consumers to purchase products essential to healthy, everyday living. The drugstore.com Web store offers thousands of brand-name personal health care products at competitive prices; a
full-service, licensed retail pharmacy; and a wealth of health-related information, buying guides and other tools designed to help consumers make informed purchasing decisions.
drugstore.com has been awarded Verified Internet Pharmacy Practice Sites (VIPPS) certification by the National Association of Board of Pharmacy (NABP) as a fully licensed
facility exercising quality pharmacy practices in compliance with federal and state laws and regulations. In the year 2001, drugstore.com received a number of awards including the Platinum e-Healthcare Leadership Award for Best Online Pharmacy by
Forrester PowerRankings, which provides objective rankings of the leading e-commerce sites and during the second quarter of 2002, drugstore.com was named one of the Top 10 “ Five Star” Merchants for On-line Customer Service in a Mystery
Shopping Survey conducted by the Direct Marketing Association and the e-tailing group.
We were incorporated in
April 1998 and commercially launched our Web site on February 24, 1999. Since the commercial launch of our Web site, we have focused on acquiring and retaining customers, expanding our product offerings, building vendor relationships, promoting our
brand name, improving the efficiency of our order fulfillment processes, establishing and improving customer service operations and developing and improving our own distribution capabilities.
12
We offer a broad base of replenishment products and have expanded into niche
specialty items with high margins that differentiate drugstore.com from other retail drugstores. Our specialty offerings include home spa, sexual well being, pets, a GNC Live Well brand store, products from Philosophy, a natural store which carries
wholesome products by brands such as Burt’s Bees and Tom’s of Maine, and salon hair care products, as well as prestige beauty products available at Beauty.com. We continue to evaluate new opportunities for specialty items that will grow
our revenues, margin and customer base. Our merchandisers continue to monitor and stay ahead of the trends. With the launch of our new Baby Store, drugstore.com was prepared for this summer’s rumored baby boom. The new store offers an expanded
breadth of products that address all the essentials needed from preconception planning to potty training, adds new premium baby care brands such as Baby Bjorn, Lansinoh, Kidco and The First Years, and continues to carry hard-to-find natural baby
care brands like California Baby, Burt’s Bees Baby Bee and Nature Boy & Girl.
In the pharmacy, we
continue to develop relationships to expand our insurance coverage. During the first quarter of 2002, we entered into a network and marketing relationship with Blue Cross/Blue Shield of Massachusetts, and now have the ability to serve their 2.4
million members.
We offer and continue to develop new services for our customers that make their shopping
experience more relevant and personal. We provide personalized emails targeted to our customers buying habits; email newsletters with new product offerings, great deals and health, beauty and wellness tips; and eMedalert™, which alerts our customers to critical and timely information regarding product warnings, updates and recalls.
Customers can also register for email reminders to notify them when to reorder or refill a prescription. We continue to evaluate and launch new features that will improve a customer’s shopping experience and also help drugstore.com create
awareness for higher end, higher margin products. During the first quarter of 2002, we re-launched a streamlined homepage with improved navigational features, a more visible search function and fewer graphics for quicker load times. Image weight was
reduced by half and loading time was made faster by 5 to 10 seconds, making it that much easier for customers to shop our Web store.
Our key partnerships continue to provide us with various marketing opportunities to increase awareness about drugstore.com. In June 2002, we entered into a new marketing agreement with Amazon.com whereby drugstore.com will
maintain a presence on the Amazon.com web store through the first quarter of 2003. During the second quarter of 2002, we obtained approximately 13% of our new customers from this relationship with Amazon.com. Additionally, Rite Aid and drugstore.com
continue to jointly promote Rite Aid.com, powered by drugstore.com, a Rite Aid branded version of the drugstore.com Web site. Recently, Rite Aid has established an internet relationship with Express Scripts to be its health and beauty
business partner. With this new relationship, Rite Aid.com, linked to Express Scripts.com, now has access to the customers of three of the top five pharmacy benefit managers. In addition, our relationship with Rite Aid has begun to benefit our
customers in ways beyond pharmacy. During the first quarter of 2002, we began selling over-the-counter Rite Aid private label products. We now offer over 100 Rite Aid brand SKU’s throughout our store. By adding these products, we are able to
provide our consumers with a private label option with a competitive price, and we are able to enjoy the higher margins that private label products offer. These are unique examples of how the partnerships we have developed and continue to leverage,
can continue to improve the customer experience.
These products, services and partner offerings combine to make
the drugstore.com shopping experience unique.
Results of Operations
We have incurred net losses of $637.2 million from inception to June 30, 2002. We believe that we will continue to incur net losses for at least the next two years (and
possibly longer). We have a limited operating history on which to base an evaluation of our business and prospects. Our prospects must be considered in light of the risks, expenses, and difficulties encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets such as e-commerce.
In view of our
limited operating history and the rapidly evolving nature of our business, we believe that period-to-period comparisons of our operating results are not meaningful and should not be relied upon as an indication of future performance. It is likely
that in some future quarter our operating results may fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock may fall significantly.
13
Net Sales
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
($ in thousands) |
|
| Net sales |
|
$ |
47,615 |
|
|
40 |
% |
|
$ |
34,035 |
|
|
$ |
91,551 |
|
|
37 |
% |
|
$ |
66,804 |
|
| New customers |
|
|
205,000 |
|
|
21 |
% |
|
|
170,000 |
|
|
|
412,000 |
|
|
21 |
% |
|
|
341,000 |
|
| Orders from repeat customers as a percentage of total orders |
|
|
71 |
% |
|
|
|
|
|
69 |
% |
|
|
70 |
% |
|
|
|
|
|
68 |
% |
| % of net sales from pharmaceutical products |
|
|
60 |
% |
|
|
|
|
|
55 |
% |
|
|
59 |
% |
|
|
|
|
|
53 |
% |
Net sales includes gross revenues from sales of product and related
shipping fees, net of discounts and provision for sales returns, third-party reimbursement and other allowances. Discounts and coupons are routinely offered to customers as incentives to attract and retain customers. In addition, we generally refund
all or a portion of the sale if a customer is not satisfied with a particular product or the level of customer service we provide. Allowances for refunds and sales price incentives, including discounts and coupons, are netted against the related
sales price in net sales. Sales returns and allowances have not been significant to date. In the future, we may expand or increase the coupons and discounts we offer to our customers.
All customer orders are processed through our Web store and can be either shipped to the customer or, in the case of prescription refills, picked up by the customer at any
Rite Aid store in the United States. Orders are either billed to the customer’s credit card or, in the case of prescriptions covered by insurance, billed to third parties. Sales of pharmaceutical products covered by third parties are recorded
at the net amount to be received. We collect cash from credit card sales in two to five days from the date the order is shipped. Amounts billed to third parties are, on average, collected in approximately 30 days after the date the order is shipped;
however, such timing can vary depending on the payor.
Net sales also include consignment service fees earned
under arrangements in which we do not take title to the inventory and cannot establish pricing. Consignment service fees earned have not been significant to date.
Our net sales growth was primarily attributable to an increase in order volume and increased net sales per order. Total orders processed during the second quarter of 2002
grew by 27% year over year and net sales per order increased to $68 for the three months ended June 30, 2002 from $62 for the three months ended July 1, 2001. For the six months ended June 30, 2002, total orders processed grew by 25% year over year
and net sales per order increased to $68 from $62 during the six month period ending July 1, 2001. The increase in total orders processed is primarily attributable to our growing customer base. The increase in net sales per order is due to a higher
mix of pharmaceutical sales, and continued refinement of our pricing strategies. In addition, the percentage of net sales from pharmaceutical products grew to 60% during the second quarter of 2002 and 59% during the six-month period ending June 30,
2002, primarily as a result of the growing success of Rite Aid.com powered by drugstore.com. Revenue generated through this channel grew to 35% of total revenue for the quarter ended June 30, 2002 and 34% for the six-month period ending June 30,
2002. For the third quarter of 2002, we expect that net sales will be approximately $50 million with 55% to 60% of net sales from pharmaceutical products and we expect to add approximately 210,000 new customers.
Cost of Sales
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
($ in thousands) |
|
| Cost of sales |
|
$ |
38,350 |
|
|
35 |
% |
|
$ |
28,494 |
|
|
$ |
73,782 |
|
|
31 |
% |
|
$ |
56,260 |
|
| Percentage of net sales |
|
|
81 |
% |
|
|
|
|
|
84 |
% |
|
|
81 |
% |
|
|
|
|
|
84 |
% |
Cost of sales consists primarily of the cost of products sold to
our customers, including allowances for shrinkage and slow moving and expired inventory, as well as outbound and inbound shipping costs. Additionally, expenses related to promotional inventory included in shipments to customers are included in cost
of sales. Payments that we receive from vendors in connection with joint merchandising activities, net of related costs, are netted against cost of sales in the period in which the activities take place.
Cost of sales as a percent of net sales decreased primarily as a result of improved product and shipping margins.
We continue to improve product margin through a more favorable mix of product sales that includes specialty and seasonal merchandise and generic pharmaceutical utilization. Our shipping costs continue to exceed the amount we charge customers;
however, the amount we subsidize decreased significantly for the three and six months ended June 30, 2002 compared to the three and six months ended July 1, 2002. We expect to continue to subsidize a portion of our shipping costs for the foreseeable
future as a strategy to attract and retain customers. We expect cost of sales as a percentage of net sales for the third quarter of 2002 to be relatively consistent with the second quarter of 2002.
14
Fulfillment and Order Processing
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
|
|
|
|
|
|
($ in thousands) |
|
|
|
|
|
|
|
| Fulfillment and order processing |
|
$ |
6,497 |
|
|
(6 |
)% |
|
$ |
6,915 |
|
|
$ |
13,167 |
|
|
(10 |
)% |
|
$ |
14,683 |
|
| Percentage of net sales |
|
|
14 |
% |
|
|
|
|
|
20 |
% |
|
|
14 |
% |
|
|
|
|
|
22 |
% |
Fulfillment and order processing expenses include expenses related
to distribution center equipment and packaging supplies, per-unit fulfillment fees charged by Rite Aid, bad debt expense, credit card processing fees, and payroll and related expenses for personnel engaged in customer service, purchasing, and
distribution and fulfillment activities, including pharmacists engaged in prescription verification activities and warehouse personnel. These expenses also include rent expense and depreciation related to our distribution center.
Fulfillment and order processing expenses decreased in absolute dollars and as a percentage of net sales primarily as a result
of a decrease in variable labor costs due to the efficiencies gained in the operations of the distribution center, the mix of pharmaceutical sales and an increase in the volume of orders being processed. We expect that fulfillment and order
processing expenses for the third quarter of 2002 will be approximately 14% of net sales.
Marketing and Sales
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
|
|
|
|
|
|
($ in thousands) |
|
|
|
|
|
|
|
| Marketing and sales |
|
$ |
7,589 |
|
|
(8 |
)% |
|
$ |
8,263 |
|
|
$ |
16,305 |
|
|
(15 |
)% |
|
$ |
19,205 |
|
| Percentage of net sales |
|
|
16 |
% |
|
|
|
|
|
24 |
% |
|
|
18 |
% |
|
|
|
|
|
29 |
% |
Marketing and sales expenses include advertising and marketing
expenses, promotional expenditures and payroll and related expenses for personnel engaged in marketing and merchandising activities. Advertising expenses include various advertising contracts, including the amortization of our marketing agreement
with Amazon.com totaling $4.6 million and $9.1 million, respectively for the three and six months ended June 30, 2002. For the three and six months ended July 1, 2001, we recognized $4.6 million and $10.0 million, respectively, in marketing and
sales expense related to the marketing agreement with Amazon.com.
The decrease in marketing and sales expenses
for the three months ended June 30, 2002 is primarily attributable to a decrease in permanent and temporary employees and a reduction in obligations under marketing agreements. For the six months ended June 30, 2002, the decrease in marketing and
sales expense was attributable to the decrease in employee related expenses and a reduction in obligations under other marketing agreements including the amendment to the Amazon agreement. In addition, we have focused our marketing on more effective
and efficient marketing channels. As a result, marketing and sales expense per new customer has also decreased significantly to $37 and $40 for the three and six months ended June 30, 2002, respectively from $49 and $56 for the three and six months
ended July 1, 2001, respectively.
We expect that marketing and sales expense per new customer will be between $21
and $22 for the third quarter of 2002.
Technology and Content
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
|
|
|
|
|
|
($ in thousands) |
|
|
|
|
|
|
|
| Technology and content |
|
$ |
3,280 |
|
|
(32 |
)% |
|
$ |
4,845 |
|
|
$ |
6,810 |
|
|
(36 |
)% |
|
$ |
10,560 |
|
| Percentage of net sales |
|
|
7 |
% |
|
|
|
|
|
14 |
% |
|
|
7 |
% |
|
|
|
|
|
16 |
% |
Technology and content expenses consist primarily of payroll and
related expenses for personnel engaged in maintaining and making minor upgrades and enhancements to our Web sites and their content. These expenses also include payroll and related expenses for information technology personnel, Internet access and
hosting charges and our Web sites’ content and design expenses.
15
Technology and content expenses decreased primarily due to the reduction in
headcount and related expenses and a reduction in depreciation expense. We expect that technology and content expenses for the third quarter of 2002 will remain relatively consistent with the second quarter of 2002.
General and Administrative
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
|
|
|
|
|
|
($ in thousands) |
|
|
|
|
|
|
|
| General and administrative |
|
$ |
2,766 |
|
|
(21 |
)% |
|
$ |
3,481 |
|
|
$ |
5,801 |
|
|
(23 |
)% |
|
$ |
7,567 |
|
| Percentage of net sales |
|
|
6 |
% |
|
|
|
|
|
10 |
% |
|
|
7 |
% |
|
|
|
|
|
11 |
% |
General and administrative expenses consist of payroll and related
expenses for executive and administrative personnel, corporate facility expenses, professional services expenses, travel and other general corporate expenses.
General and administrative expenses decreased primarily due to a reduction in personnel costs, reduced rent expense and lower depreciation expense. We expect that general and administrative expenses
for the third quarter of 2002 will remain relatively consistent with the second quarter of 2002.
Impairment
and Restructuring Charges
| |
|
Three Months Ended
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
July 1, 2001
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
($ in thousands) |
|
| Impairment and restructuring charges |
|
$ |
2,450 |
|
|
— |
|
$ |
— |
|
$ |
2,450 |
|
|
(66 |
)% |
|
$ |
7,294 |
|
| Percentage of net sales |
|
|
5 |
% |
|
— |
|
|
— |
|
|
3 |
% |
|
— |
|
|
|
11 |
% |
In the first quarter of 2001, we recorded restructuring charges
primarily associated with a lease termination and vacated facilities which included forfeiture of a lease deposit and the write off of related leasehold improvements and equipment.
In June 1999, in conjunction with a private placement offering, we received $5 million in prepaid cable television advertising rights that were to be used over a period of
three years. During 2001, we extended the terms of the cable television advertising agreement by an additional year to June 2003 and reduced the advertising rights recorded in prepaid marketing to $2.5 million. During the second quarter of 2002, we
determined that we would not be able to utilize these rights. As such, the remaining $2.5 million associated with the prepaid cable advertising rights were determined to be impaired and were written off as of June 30, 2002.
Amortization of Intangible Assets
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
|
|
|
|
|
|
($ in thousands) |
|
|
|
|
|
|
|
| Amortization of intangible assets |
|
$ |
716 |
|
|
(93 |
)% |
|
$ |
9,681 |
|
|
$ |
1,430 |
|
|
(93 |
)% |
|
$ |
19,392 |
|
| Percentage of net sales |
|
|
2 |
% |
|
|
|
|
|
28 |
% |
|
|
2 |
% |
|
|
|
|
|
29 |
% |
Amortization of intangible assets includes the amortization expense
associated with the assets received in connection with agreements with General Nutrition Companies, Inc. (GNC); assets acquired in connection with the purchase of Beauty.com, including domain names; and other intangible assets, including a
technology license agreement, domain names and trademarks. For the three and six months ended July 1, 2001, amortization of intangible assets also included the amortization expense associated with the assets received in connection with agreements
with Rite Aid including access to insurance, and goodwill recorded in connection with the purchase of Beauty.com.
During fiscal year 2001, certain intangible assets were written down to their estimated fair values, thus significantly reducing the amortization recorded during the three and six
months ended June 30, 2002. In addition, as of the beginning of fiscal year 2002, due to the implementation of SFAS 142, amortization expense was further reduced because the goodwill associated with the acquisition of Beauty.com is no longer being
amortized. We expect amortization of intangible assets for the remainder of 2002 to be approximately $1.4 million.
16
Amortization of Stock-based Compensation
| |
|
Three Months Ended
|
|
|
Six Months Ended
|
|
| |
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
|
June 30, 2002
|
|
|
% Change
|
|
|
July 1, 2001
|
|
| |
|
($ in thousands) |
|
| Amortization of stock-based compensation |
|
$ |
340 |
|
|
(78 |
)% |
|
$ |
1,572 |
|
|
$ |
1,107 |
|
|
(75 |
)% |
|
$ |
4,449 |
|
| Percentage of net sales |
|
|
8 |
% |
|
|
|
|
|
5 |
% |
|
|
8 |
% |
|
|
|
|
|
7 |
% |
We record deferred stock-based compensation in connection with
stock options granted and restricted stock issued to our employees. The deferred stock-based compensation amounts represent the difference between the exercise price of stock option grants and the deemed fair value of our common stock at the time of
such grants. In the case of restricted stock, the deferred stock-based compensation represents the difference between the purchase price of the restricted stock and the deemed fair value of our common stock on the date of purchase. Such amounts are
amortized to expense over the vesting periods of the applicable agreements using the multiple option approach. The amortization expense relates to options awarded to employees in all operating expense categories.
In January 2002, we recorded additional deferred stock-based compensation of approximately $1.1 million, which is being amortized over the
vesting period of the options granted in January using the multiple-option approach.
Deferred stock-based
compensation for stock options and restricted stock issued to our employees will be subsequently recognized as an expense, subject to continuing employment, for the remainder of 2002 and each of the next three fiscal years as follows:
| Fiscal Year
|
|
Amount
|
| |
|
(in thousands) |
| Q3 2002 |
|
$271 |
| Q4 2002 |
|
210 |
| 2003 |
|
502 |
| 2004 |
|
172 |
| 2005 |
|
42 |
Interest Income and Expense
| |
|
Three Months Ended
|
|
Six Months Ended
|
| |
|
June 30, 2002
|
|
% Change
|
|
|
July 1, 2001
|
|
June 30, 2002
|
|
% Change
|
|
|
July 1, 2001
|
| |
|
|
|
|
|
|
($ in thousands) |
|
|
|
|
|
| Interest income, net |
|
$ |
389 |
|
(68 |
)% |
|
$ |
1,199 |
|
$ |
740 |
|
(75 |
)% |
|
$ |
2,933 |
Interest income consists of earnings on our cash, cash equivalents
and marketable securities, and interest expense consists of interest associated with capital lease obligations. Net interest income decreased as a result of our decreasing cash, cash equivalents and marketable securities balances as well as
decreases in interest rates. We expect net interest income to decrease in the third quarter of 2002 and fiscal year 2002 as our average outstanding balance of cash, cash equivalents and marketable securities is reduced over time.
Cumulative Effect of Change in Accounting Principle
| |
|
Three Months Ended
|
|
Six Months Ended
|
| |
|
June 30, 2002
|
|
%Change
|
|
|
July 1, 2001
|
|
June 30, 2002
|
|
% Change
|
|
|
July 1, 2001
|
| |
|
|
|
|
|
|
($ in thousands) |
|
|
|
|
|
| Cumulative effect of change in accounting principle |
|
$ |
— |
|
(100 |
)% |
|
$ |
4,121 |
|
$ |
8,905 |
|
116 |
% |
|
$ |
4,121 |
Under the terms of the agreement we
entered into with WellPoint in June 2000, we issued to Wellpoint 750,000 shares of our common stock with a fair value of approximately $5.0 million. If the 750,000 shares of common stock issued to Wellpoint did not have a fair market value of $10
million at the end of two years, we were required to pay WellPoint, in common stock or cash, the difference between $10 million and the then fair market value of the common stock. During the second quarter of 2001, we implemented the Emerging Issues
Task Force Issue 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (EITF 00-19).
17
Based on the terms of that agreement, EITF 00-19 requires that the transaction be recorded at fair value each quarter. Accordingly, at the end of the second quarter of fiscal year 2001, which is
the effective date of EITF 00-19, we recorded a cumulative effect adjustment of a change in accounting principle of $4.1 million which represents the difference between the fair value of the guarantee as of July 1, 2001, and the fair value of the
guarantee on the original date of the agreement. During the third quarter of 2001, we amended the agreement with WellPoint which changed the terms of settlement, as a result of which we are no longer required to record changes in the fair value of
the guarantee each quarter.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142), effective for fiscal years beginning after December 15, 2001. We adopted SFAS 142 on December 31, 2001 (the beginning of fiscal year 2002). SFAS 142 prescribes a
two-phase process for impairment testing of goodwill. The first phase, required to be completed by June 30, 2002, screens for impairment; while the second phase (if necessary), required to be completed by December 31, 2002, measures the impairment.
We performed both phases of the impairment test during the second quarter of 2002. In order to perform the analysis, we identified our reporting units and assigned all Beauty.com goodwill to the prestige beauty reporting unit. A discounted cash flow
analysis was performed to assess the fair market value of the reporting unit. Based on this analysis, we determined that impairment of the Beauty.com goodwill may exist and completed phase 2 of the test – measuring the impairment. Based on the
completion of phase 2, we recorded an $8.9 million impairment loss associated with the Beauty.com goodwill. Accordingly, for the six months ended June 30, 2002, we have recognized an impairment loss of $8.9 million as a cumulative effect of a change
in accounting principle as of the date of adoption in accordance with SFAS 142.
New Accounting Pronouncement
In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, Rescission of FASB
Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections (SFAS 145). For most companies, SFAS 145 will require gains and losses on extinguishments of debt to be classified as income or loss from continuing
operations rather than as extraordinary items as previously required under Statement 4. However, extraordinary treatment will be required for certain extinguishments as provided in APB Opinion No. 30. The Company is still evaluating the impact that
adoption of SFAS 145 will have on its financial statements and may be required to reclassify the $7.5 million extraordinary gain on the renegotiation of equity guarantee recorded during the third quarter of 2001 into loss from continuing operations.
Liquidity and Capital Resources
We have incurred net losses of $637.2 million from inception to June 30, 2002. We believe that we will continue to incur net losses for at least the next two years (and possibly longer). From our
inception through June 30, 2002, we have financed our operations primarily through the sale of equity securities, including common and preferred stock, yielding net cash proceeds of $377.8 million.
Net cash used in operating activities was $12.2 million and $27.3 million for the six months ended June 30, 2002 and July 1, 2001,
respectively. Net cash used in operating activities was primarily the result of net losses and changes in operating assets and liabilities offset by non-cash expenses.
Net cash provided by investing activities was $9.0 million and $0.5 million for the six months ended June 30, 2002 and July 1, 2001, respectively. Net cash provided by
investing activities consisted primarily of net sales of marketable securities.
Net cash used in financing
activities was $0.5 million and $1.6 million for the six months ended June 30, 2002 and July 1, 2001, respectively. Net cash used in financing activities was primarily the result of principle payments made under capital lease obligations.
Our principal source of liquidity is our cash, cash equivalents, and marketable securities. Our cash and cash
equivalents balance was $ 35.9 million and $39.5 million, and our marketable securities balance was $30.1 million and $39.2 million at June 30, 2002 and December 30, 2001, respectively. Combined cash, cash equivalents, and marketable securities were
$65.9 million and $78.8 million at June 30, 2002 and December 30, 2001, respectively.
18
As of June 30, 2002, our principal commitments consisted of obligations
outstanding under capital and operating leases and a strategic agreement with WellPoint and are detailed as follows (in thousands):
| |
|
Remainder of 2002
|
|
2003
|
|
2004
|
|
2005
|
|
Total
|
| Capital leases |
|
$ |
683 |
|
$ |
447 |
|
$ |
122 |
|
$ |
69 |
|
$ |
1,321 |
| Operating leases |
|
|
1,691 |
|
|
2,811 |
|
|
2,706 |
|
|
1,187 |
|
|
8,395 |
| Marketing agreements |
|
|
414 |
|
|
750 |
|
|
750 |
|
|
375 |
|
|
2,289 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
2,788 |
|
$ |
4,008 |
|
$ |
3,578 |
|
$ |
1,631 |
|
$ |
12,005 |
We believe that our existing cash, cash equivalents and marketable
securities as of June 30, 2002 will be sufficient to fund our operations until we begin generating operating cash flow. We currently expect to begin generating operating cash flow in 2003, although there can be no assurances that we will ever
generate operating cash flow. Any projections of future cash needs and cash flows are subject to substantial uncertainty. If current cash, cash equivalents and marketable securities are insufficient to satisfy our liquidity requirements, we may seek
to sell additional equity or debt securities, or to obtain credit facilities from lenders. We cannot be certain that additional financing will be available to us on acceptable terms when required, or at all.
19
| |
|
Quantitative and Qualitative Disclosures About Market Risk |
We have assessed our vulnerability to certain market risks,
including interest rate risk associated with financial instruments included in cash, cash equivalents and marketable securities. Due to the short-term nature of these investments and our investment policies and procedures, we have determined that
the risk associated with interest rate fluctuations related to these financial instruments does not pose a material risk to our company.
PART II—OTHER INFORMATION
| |
|
Submission of Matters to a Vote of Security Holders |
Our annual meeting of shareholders was held on June 13, 2001. The following matters were
voted upon at the meeting:
Proposal 1: The following directors were elected:
| Nominee
|
|
Votes for
|
|
Votes Withheld
|
| Peter M. Neupert |
|
52,168,092 |
|
97,196 |
| Kal Raman |
|
52,143,272 |
|
122,016 |
| Jeffrey P. Bezos |
|
52,026,582 |
|
238,706 |
| Brook H. Byers |
|
52,175,094 |
|
90,194 |
| L. John Doerr |
|
52,191,194 |
|
74,094 |
| Melinda French Gates |
|
52,145,586 |
|
119,702 |
| Dan Levitan |
|
52,174,794 |
|
90,494 |
| William D. Savoy |
|
52,192,781 |
|
72,507 |
Proposal 2: The ratification of the appointment of Ernst &
Young LLP to serve as our independent auditors for the 2001 fiscal year was approved, with 52,140,709 votes for, 91,400 votes against and 33,178 abstentions.
None
| |
|
Exhibits and Reports on Form 8-K |
(a) Exhibits
Exhibit 99.1 “Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002” of Kal Raman, President & Chief Executive Officer.
Exhibit
99.2 “Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002” of Robert A. Barton, Chief Financial Officer.
(b) Reports on Form 8-K
None
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| DRUGSTORE.COM, INC. (Registrant) |
| |
| By: |
|
/s/ ROBERT A.
BARTON |
| |
|
|
| |
|
Robert A. Barton Vice
President and Chief Financial Officer (principal financial and chief accounting officer) |
Date: August 14, 2002
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