<PAGE>
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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 July 2, 2000
[_] 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 0-78813
----------------
DRUGSTORE.COM, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 04-3416255
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
</TABLE>
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 1, 2000 was 53,081,644.
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<PAGE>
DRUGSTORE.COM, INC.
CONTENTS
PART I--FINANCIAL INFORMATION
<TABLE>
<C> <S> <C>
Item 1. Financial Statements............................................ 1
Condensed Consolidated Balance Sheets as of July 2, 2000 and
January 2, 2000................................................ 1
Condensed Consolidated Statements of Operations for the Three
and Six Months Ended July 2, 2000 and July 4, 1999............. 2
Condensed Consolidated Statement of Stockholders' Equity for the
Six Months Ended July 2, 2000.................................. 3
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended July 2, 2000 and July 4, 1999..................... 4
Notes To Condensed Consolidated Financial Statements............ 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 15
PART II--OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds....................... 16
Item 4. Submission of Matters to a Vote of Security Holders............. 16
Item 6. Exhibits and Reports on Form 8-K................................ 16
SIGNATURES............................................................... 17
</TABLE>
<PAGE>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
DRUGSTORE.COM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
July 2, January 2,
2000 2000
----------- ----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................ $ 88,805 $ 26,526
Marketable securities................................ 33,466 106,228
Accounts receivable, less allowance for doubtful
accounts and sales returns of $210 and $251......... 5,740 4,273
Inventories.......................................... 6,638 2,862
Prepaid marketing expenses........................... 32,061 8,010
Other current assets................................. 4,048 1,333
--------- ---------
Total current assets................................ 170,758 149,232
Fixed assets, net of accumulated depreciation of
$7,128 and $3,179................................... 41,717 25,208
Intangible assets, net of accumulated amortization of
$26,049 and $10,673................................. 224,729 200,742
Prepaid marketing expenses........................... 20,079 19,465
Note receivable from officer......................... 278 269
Deposits and other assets............................ 4,118 792
--------- ---------
Total assets........................................ $ 461,679 $ 395,708
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................... $ 24,953 $ 25,788
Accrued compensation................................. 4,302 4,231
Accrued marketing expenses........................... 8,481 8,520
Other current liabilities............................ 2,035 1,245
Current portion of capital lease obligations......... 2,794 2,488
--------- ---------
Total current liabilities........................... 42,565 42,272
Capital lease obligations, less current portion........ 2,361 2,687
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--52,958,742 and
43,508,808 as of July 2, 2000 and January 2, 2000,
respectively........................................ 665,694 485,377
Deferred stock-based compensation...................... (20,944) (10,770)
Accumulated deficit.................................... (227,997) (123,858)
--------- ---------
Total stockholders' equity............................. 416,753 350,749
--------- ---------
Total liabilities and stockholders' equity............. $ 461,679 $ 395,708
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
<PAGE>
DRUGSTORE.COM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
--------------------- ---------------------
July 2, July 4, July 2, July 4,
2000 1999 2000 1999
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Net sales........................ $ 24,602 $ 3,550 $ 47,340 $ 4,202
Costs and expenses:
Cost of sales.................. 21,899 4,879 43,495 5,551
Marketing and sales (1)........ 35,663 11,328 65,580 16,517
Technology and content (2)..... 6,698 3,229 13,639 5,942
General and
administrative (3)............ 4,949 2,204 9,755 3,917
Amortization of intangible
assets........................ 8,154 20 15,376 38
Amortization of stock-based
compensation.................. 4,204 2,326 7,547 3,583
---------- --------- ---------- ---------
Total costs and expenses..... 81,567 23,986 155,392 35,548
---------- --------- ---------- ---------
Operating loss................... (56,965) (20,436) (108,052) (31,346)
Interest income, net............. 2,308 675 3,913 993
---------- --------- ---------- ---------
Net loss......................... $ (54,657) $ (19,761) $ (104,139) $ (30,353)
========== ========= ========== =========
Basic and diluted net loss per
share........................... $ (1.07) $ (19.10) $ (2.16) $ (30.26)
========== ========= ========== =========
Weighted average shares
outstanding used to compute
basic and diluted net loss per
share........................... 50,987,471 1,034,696 48,182,988 1,003,152
========== ========= ========== =========
</TABLE>
--------
(1) Excludes amortization of stock-based compensation of $550 and $1,038 for
the three and six months ended July 2, 2000, respectively, and $1,057 and
$1,448 for the three and six months ended July 4, 1999, respectively.
(2) Excludes amortization of stock-based compensation of $790 and $1,484 for
the three and six months ended July 2, 2000, respectively, and $708 and
$1,171 for the three and six months ended July 4, 1999, respectively.
(3) Excludes amortization of stock-based compensation of $2,864 and $5,025 for
the three and six months ended July 2, 2000, respectively, and $561 and
$964 for the three and six months ended July 4, 1999, respectively.
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
DRUGSTORE.COM, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
(unaudited)
<TABLE>
<CAPTION>
Preferred
Stock Common Stock Deferred
------------- ------------------- Stock-based Accumulated
Shares Amount Shares Amount Compensation Deficit Total
------ ------ ---------- -------- ------------ ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 2,
2000................... -- $ -- 43,508,808 $485,377 $(10,770) $(123,858) $ 350,749
Issuance of common stock
for cash in secondary
public offering, net of
offering costs of
$6,400................. -- -- 6,000,000 101,600 -- -- 101,600
Issuance of common stock
for marketing services,
intangible asset and
software............... -- -- 1,816,667 34,969 -- -- 34,969
Issuance of warrant to
purchase common stock
for marketing
services............... -- -- -- 2,199 -- -- 2,199
Acquisition of
Beauty.com............. -- -- 1,266,289 37,277 (15,037) -- 22,240
Exercise of stock
options................ -- -- 276,627 208 -- -- 208
Employee stock purchase
plan................... -- -- 87,719 1,380 -- -- 1,380
Deferred stock-based
compensation, net of
cancellations.......... -- -- 2,632 2,684 (2,684) -- --
Amortization of stock-
based compensation..... -- -- -- -- 7,547 -- 7,547
Net loss and
comprehensive loss..... -- -- -- -- -- (104,139) (104,139)
---- ----- ---------- -------- -------- --------- ---------
Balance at July 2,
2000................... -- $ -- 52,958,742 $665,694 $(20,944) $(227,997) $ 416,753
==== ===== ========== ======== ======== ========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
DRUGSTORE.COM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
-------------------
July 2, July 4,
2000 1999
--------- --------
<S> <C> <C>
Operating Activities:
Net loss................................................. $(104,139) $(30,353)
Adjustments to reconcile net loss to net cash used in
operating activities:
Non-cash expenses:
Depreciation......................................... 4,971 969
Marketing and sales.................................. 5,609 3,300
Amortization of intangible assets.................... 15,376 38
Amortization of stock-based compensation............. 7,547 3,583
Changes in:
Accounts receivable.................................. (1,420) (272)
Inventories.......................................... (2,829) (1,498)
Prepaid marketing expenses........................... (1,075) 122
Other current assets................................. (2,662) (535)
Deposits and other assets............................ (3,326) (1,026)
Accounts payable and accrued expenses................ (13,385) 7,225
Other................................................ (9) (10)
--------- --------
Net cash used in operating activities.................... (95,342) (18,457)
Investing Activities:
Purchases of marketable securities....................... (23,555) --
Sales of marketable securities........................... 96,317 --
Purchase of fixed assets................................. (16,405) (3,176)
Purchase of intangible assets............................ (32) (30)
Business acquisition, net of cash received............... (335) --
--------- --------
Net cash provided by (used in) investing activities...... 55,990 (3,206)
Financing Activities:
Proceeds from sale of common stock....................... 101,600 --
Proceeds from exercise of stock options and employee
stock purchase plan..................................... 1,588 --
Proceeds from sale of preferred stock.................... -- 74,963
Proceeds from capital lease obligation................... -- 538
Principal payments on capital lease obligations.......... (1,557) (159)
--------- --------
Net cash provided by financing activities................ 101,631 75,342
--------- --------
Net increase in cash and cash equivalents................ 62,279 53,679
Cash and cash equivalents at beginning of period......... 26,526 14,408
--------- --------
Cash and cash equivalents at end of period............... $ 88,805 $ 68,087
========= ========
Supplemental Cash Flow Information:
Cash paid for interest................................... $ 179 $ 22
Equipment acquired in capital lease agreements........... $ 1,536 $ 595
Issuance of equity instruments in exchange for marketing
services, intangible assets and software................ $ 37,168 $ 5,024
Issuance of common stock in connection with business
acquisition............................................. $ 37,277 $ --
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
DRUGSTORE.COM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in conformity with generally accepted accounting principles for
interim financial information and with the instructions for 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 generally accepted accounting principles 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. These condensed consolidated
financial statements should be read in conjunction with our audited
consolidated financial statements, and accompanying notes, included in the
Company's Annual Report on Form 10-K for the year ended January 2, 2000, filed
with the Securities and Exchange Commission, on March 16, 2000. 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.
Reclassifications.
Certain prior period amounts have been reclassified to conform with the
current period presentation.
New Accounting Pronouncements.
In March 2000, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board reached a consensus on EITF Issue 00-2, "Accounting
for Web Site Development Costs." This consensus provides guidance on what
types of costs incurred to develop a Web site should be capitalized or
expensed. This consensus is effective for Web site development costs incurred
for fiscal quarters beginning after June 30, 2000. The Company does not expect
the adoption of this consensus to have a material impact on its financial
statements.
In March 2000, the Financial Accounting Standard Board (FASB) issued FASB
Interpretation (FIN) No. 44, "Accounting for Certain Transactions Involving
Stock Compensation." This Interpretation clarifies the application of
Accounting Principles Board Opinion No. 25 for certain issues related to stock
compensation. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after
either December 15, 1998, or January 12, 2000. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. The Company does not expect the adoption of this consensus
to have a material impact on its financial statements.
In May 2000, the EITF reached a consensus on EITF Issue 00-14, "Accounting
for Certain Sales Incentives." This consensus addresses the recognition,
measurement, and income statement classification for sales incentives (such as
discounts, coupons, and rebates) that a company offers to its customers for
use in a single transaction. The implementation date of this consensus is the
fourth quarter of a registrant's fiscal year beginning after December 15,
1999, or if the information is available, for financial statements issued with
the Securities and Exchange Commission after July 20, 2000. This consensus
does not have an impact on the Company's financial statements as its current
accounting policies are in accordance with EITF Issue 00-14, except for the
reclassification of the cost of certain items the Company gives away to its
customers in connection with its customer acquisition and retention activities
and its branding campaign. The Company has not completed its analysis of the
amount of such historical costs that will need to be reclassified from
marketing and sales expense to cost of sales.
In July 2000, the EITF reached a consensus on EITF Issue 99-19, "Reporting
Revenue Gross as a Principal versus Net as an Agent." This consensus provides
guidance on whether a company should recognize revenue in
5
<PAGE>
DRUGSTORE.COM, INC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the amount of the gross amount billed to the customer because it has earned
revenue from the sale of the goods or services or whether the company should
recognize revenue based on the net amount retained because, in substance, it
has earned a commission from the vendor-manufacturer of the goods or services
on the sale. As the Company's current accounting policies are in accordance
with EITF Issue 99-19, this consensus does not have an impact on the Company's
financial statements.
In July 2000, the EITF reached a consensus on EITF Issue 00-10 "Accounting
for Shipping and Handling Fees and Costs." This consensus indicates that
amounts billed to a customer in a sale transaction related to shipping and
handling, if any, represent revenue to the vendor and should be classified as
revenue. The EITF did not reach a consensus with respect to the classification
of costs related to shipping and handling incurred by the seller. As the
Company currently classifies shipping fees charged to a customer in net sales,
this consensus does not have an impact on the Company's financial statements.
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, warrants and the convertible preferred stock are not included
in the calculation of diluted net loss per share because they are
antidilutive.
The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
---------------------- ----------------------
July 2, July 4, July 2, July 4,
2000 1999 2000 1999
---------- ---------- ---------- ----------
(in thousands, except share and per share
data)
<S> <C> <C> <C> <C>
Net loss................... $ (54,657) $ (19,761) $ (104,139) $ (30,353)
========== ========== ========== ==========
Weighted average shares
outstanding............... 52,252,070 2,323,000 49,396,698 2,323,000
Less weighted average
shares subject to
repurchase or contingently
issuable pursuant to
contract terms............ (1,264,599) (1,288,304) (1,213,710) (1,319,848)
---------- ---------- ---------- ----------
Shares used in computation
of basic and diluted net
loss per share............ 50,987,471 1,034,696 48,182,988 1,003,152
========== ========== ========== ==========
Basic and diluted net loss
per share................. $ (1.07) $ (19.10) $ (2.16) $ (30.26)
========== ========== ========== ==========
</TABLE>
At July 2, 2000 there were 11,697,478 stock options and warrants
outstanding 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. Business Acquisition and Strategic Agreements
Amazon.com
In January 2000, the Company reached an agreement with Amazon.com to
provide certain advertising and technical services over a three-year term for
$105.0 million. The consideration included 1,066,667 shares of the Company's
common stock with a fair value of $30.0 million issued immediately in a
private placement transaction and minimum cash payments totaling $75.0 million
over the three-year term of the agreement. In July 2000, Amazon.com and the
Company agreed to reduce the minimum cash payments due over the three-year
6
<PAGE>
DRUGSTORE.COM, INC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
term of the agreement from $75.0 million to $30.0 million. Additionally, the
Company agreed to pay additional amounts in cash if the advertising services
exceed certain performance thresholds in the second and third year of the
agreement. The Company also issued to Amazon.com a fully vested,
nonforfeitable and exercisable warrant to purchase 2.5 million shares of the
Company's common stock at $4.94 per share. The Company estimates that the fair
value of the warrant was $7.3 million and is amortizing the aggregate minimum
value of the total consideration under the agreement of $67.3 million to
primarily marketing and sales expense on a straight-line basis over the three-
year term of the agreement. During the three and six months ended July 2,
2000, the Company recognized $4.5 million of marketing and sales expense
associated with such agreement.
Beauty.com
In February 2000, the Company acquired Beauty.com, Inc. ("Beauty.com"), an
online retailer of prestige beauty products, in exchange for 1,266,289 shares
of the Company's common stock and the assumption of outstanding stock options.
In July 2000, the Company and Beauty.com's founder amended certain provisions
of the initial purchase agreements, including eliminating the contingency on
the issuance of approximately 587,000 shares of the Company's common stock
related to the continued employment of Beauty.com's founder and reducing the
total consideration to 1,235,530 shares of the Company's common stock. The
final purchase price, as amended, was determined to be $37.6 million.
Subsequent to the amendment of the purchase agreements, all of the shares will
have been issued to the former Beauty.com shareholders except for 126,628
shares that will remain in escrow until January 2001 as security for certain
indemnification provisions of the contract. The acquisition has been accounted
for as a purchase, and all identifiable assets were assigned a portion of the
purchase price based on their respective fair values. In connection with the
acquisition and subsequent amendment of the purchase agreements, the Company
will recognize approximately $45.1 million of intangible assets that are being
allocated to domain names, customer lists and goodwill based on an independent
valuation. Of the $45.1 million, approximately $34.3 was recorded as of July
2, 2000 and the remaining $10.8 million will be recorded in the third quarter
of 2000, including $10.4 million that has been reclassified from deferred
stock-based compensation to goodwill as of the date the purchase agreements
were amended. The Company will amortize such intangible assets over the
remaining portion of their estimated useful lives of three years.
The pro forma consolidated financial information for the six month periods
ended July 2, 2000 and July 4, 1999, determined as if the Beauty.com
acquisition had occurred on January 1, 1999, would have indicated net sales of
$47.5 million and $4.2 million, net loss of $109.0 million and $40.9 million,
and basic and diluted net loss per share of $2.26 and $24.39, respectively.
This unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the results that would have been
achieved had the Company and Beauty.com been combined during the specified
periods.
Medibuy
In February 2000, the Company entered into a five-year definitive agreement
with Medibuy.com, Inc. ("Medibuy"), an e-commerce solution for healthcare
supply procurement, to develop a co-branded e-commerce marketplace targeted at
the home healthcare market. Pursuant to this agreement, the Company is
required to pay transaction fees to Medibuy for goods it sells on the co-
branded Web site as well as new customer referral fees. Medibuy is required to
pay drugstore.com a percentage of transaction fees generated on the co-branded
Web site from sellers other than drugstore.com. Medibuy is also required to
spend at least $10.0 million over the five-year term to promote the co-branded
Web site. The agreement may be terminated early by either party if certain
performance requirements are not met. As of July 2, 2000, no revenues or
expenses had been recorded as a result of this transaction. In connection with
this agreement, the Company has received warrants to purchase 700,000 shares
of Medibuy common stock. As Medibuy is a privately owned company with a
limited operating history, the Company could not determine the fair value of
the warrants; accordingly, such amounts are not reflected on the Company's
condensed consolidated balance sheet as of July 2, 2000.
7
<PAGE>
DRUGSTORE.COM, INC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
WellPoint
In June 2000, the Company entered into a five-year strategic partnership
with WellPoint Health Networks Inc. ("WellPoint"), a leading health plan owned
pharmacy benefit management company. Pursuant to this agreement, the Company
is designated as WellPoint's preferred Internet pharmacy and drugstore, with
access to WellPoint's members. In exchange, the Company issued WellPoint
750,000 shares of the Company's common stock with a fair value of
approximately $5.0 million and will make certain cash payments to WellPoint
over the five-year term of the agreement. If the 750,000 shares of the
Company's common stock do not have a fair value of $10.0 million at the end of
the second year, the Company is required to pay WellPoint the difference
between the fair value of the stock and $10.0 million, in either cash or the
Company's common stock. The Company recorded the fair value of the stock
issued in connection with this agreement as an intangible asset and will
amortize the asset over the five-year term of the agreement.
CIGNA
In June 2000, the Company entered a five-year agreement with CIGNA
HealthCare companies ("CIGNA"), one of the nation's leading providers of
health benefit programs. Pursuant to this agreement, the Company will provide
health and beauty products to CIGNA's plan participants by providing them
direct access to the Company's Web site from the home page of CIGNA's Internet
site or through CIGNA HealthCare's mail order pharmacy. In exchange, the
Company issued CIGNA Healthcare a warrant to purchase 500,000 shares of the
Company's common stock at $7.76 per share. The fair value of such warrant was
estimated at $2.2 million and will be amortized to marketing and sales expense
on a straight-line basis over the five-year term of the agreement.
4. Stockholders' Equity
On March 15, 2000, the Company completed the sale of 6,020,000 shares of
its common stock at $18.00 per share. Of the 6,020,000 shares offered,
6,000,000 were offered by the Company and 20,000 were offered by an existing
shareholder. Net proceeds to the Company aggregated approximately $101.6
million.
5. Stock Options
The following table summarizes activity under the Company's stock plans:
<TABLE>
<CAPTION>
Outstanding Options
-----------------------------------------------------
Shares Available Number of Weighted-Average
for Grant Shares Exercise Price per Share
---------------- ---------- ------------------------
<S> <C> <C> <C>
Outstanding at January
2, 2000................ 4,939,089 5,850,658 $16.49
Plan amendments......... 7,032,404 -- --
Options granted......... (6,669,618) 6,669,618 $11.92
Options exercised....... -- (276,627) $ .75
Options canceled........ 1,046,171 (1,046,171) $13.32
---------- ----------
Outstanding at July 2,
2000................... 6,348,046 11,197,478 $14.45
========== ==========
</TABLE>
As of July 2, 2000, of the total options outstanding, 747,074 were
exercisable with a weighted-average exercise price of $7.99 per share.
On May 4, 2000, the Company's board of directors granted options to
purchase an aggregate of 3,275,700 shares of its common stock to certain of
its existing employees at an exercise price of $7.00 per share. The options
were granted under the Company's 1998 stock plan and will vest over a four-
year period at the rate
8
<PAGE>
DRUGSTORE.COM, INC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
of one-fourth of the total number of shares subject to the options six months
after the grant date, with the remaining shares vesting in equal installments
at the end of each six-month period thereafter. On May 4, 2000 the closing
price of the Company's common stock was $8.625 per share. Accordingly, during
the second quarter of 2000 the Company recorded deferred stock-based
compensation of approximately $5.3 million, which is being amortized over the
vesting period of the options.
6. Subsequent Event
In August 2000, the Company completed the sale of approximately 8.1 million
shares of common stock at $4.9375 per share and approximately 46,000 shares of
preferred stock at $493.75 per share. The preferred stock is a participating,
non-voting, preferred instrument that automatically converts into common stock
upon shareholder approval at a conversion ratio of 100 shares of common stock
for one share of preferred stock. Total gross proceeds to the Company
aggregated approximately $62.7 million.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Special Note Regarding Forward-Looking Statements
This discussion contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future
financial performance. In some cases, you can identify forward-looking
statements by terminology such as may, will, should, expect, plan, intend,
anticipate, believe, estimate, predict, potential or continue, the negative of
such terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially. In evaluating
these statements, you should consider various factors, including the risks
outlined in the Factors That May Affect Our Business section of our Form 10-K,
filed with the Securities and Exchange Commission (SEC) on March 16, 2000 and,
from time to time, in other reports we file with the SEC. These factors may
cause our actual results to differ materially from any forward-looking
statement.
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 after the date of this Quarterly Report on Form 10-Q 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 A
Very Healthy Way to Shop(TM) for health, beauty, wellness, personal care and
pharmacy products. As of July 2, 2000, we have sold our products to over
1,222,000 customers. We were incorporated in April 1998 and commercially
launched our Web site on February 24, 1999. We designed our store to provide a
convenient, private and informative shopping experience that encourages
consumers to purchase products essential to healthy, everyday living. Our Web
site can be accessed 24 hours a day, seven days a week from anywhere that a
consumer has Internet access. We believe we offer a larger selection of
products than typical store-based retailers, along with a wealth of health-
related information, buying guides and other tools designed to help consumers
make more educated purchasing decisions. Our shopping lists and e-mail
reminders are designed to make it easier for our customers to regularly
purchase their preferred health and beauty products. We believe that our
online store provides a customer with a superior shopping experience.
10
<PAGE>
Results of Operations
Because we commenced commercial operations on February 24, 1999, and have a
short operating history, we believe that period-to-period comparisons are less
meaningful than an analysis of recent quarterly operating results.
Accordingly, we are providing a discussion and analysis of our results of
operations that compares the quarter ended July 2, 2000 to the quarter ended
April 2, 2000.
The following table sets forth unaudited quarterly statement of operations
data for the five quarters ended July 2, 2000. This unaudited quarterly
information has been derived from our unaudited financial statements and, in
the opinion of management, includes all adjustments, consisting only of normal
recurring adjustments necessary for a fair presentation of such information in
accordance with generally accepted accounting principles. The operating
results for any quarter are not necessarily indicative of the operating
results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
------------------------------------------------
July 4, Oct. 3, Jan. 2, Apr. 2, July 2,
1999 1999 2000 2000 2000
-------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Net sales.................... $ 3,550 $ 12,158 $ 18,488 $ 22,738 $ 24,602
Costs and expenses:
Cost of sales............... 4,879 14,066 18,823 21,596 21,899
Marketing and sales......... 11,328 16,471 28,504 29,917 35,663
Technology and content...... 3,229 4,232 4,744 6,941 6,698
General and administrative.. 2,204 3,120 4,089 4,806 4,949
Charitable contributions.... -- 3,600 -- -- --
Amortization of intangible
assets..................... 20 5,300 5,302 7,222 8,154
Amortization of stock-based
compensation............... 2,326 9,267 2,525 3,343 4,204
-------- -------- -------- -------- --------
Total costs and expenses... 23,986 56,056 63,987 73,825 81,567
-------- -------- -------- -------- --------
Operating loss............... (20,436) (43,898) (45,499) (51,087) (56,965)
Interest income, net......... 675 1,925 1,994 1,605 2,308
-------- -------- -------- -------- --------
Net loss..................... $(19,761) $(41,973) $(43,505) $(49,482) $(54,657)
======== ======== ======== ======== ========
</TABLE>
Net Sales and Cost of Sales. Net sales includes product sales and charges
to customers for shipping and handling less any allowances for product
returns, promotional discounts and coupons. Cost of sales includes related
cost of products shipped to customers and outbound and inbound shipping costs.
Net sales for the second quarter of 2000 were $24.6 million, an 8% increase
over net sales for the first quarter of 2000 of $22.7 million. Our cumulative
customer accounts increased to 1,222,000 at the end of the second quarter of
2000 from 990,000 customer accounts at the end of first quarter of 2000, an
increase of 232,000 or 23%. Orders from repeat customers also increased during
the second quarter to 59% of total orders compared to 50% in the first quarter
of 2000. Pharmaceutical product sales were 53% of net sales in the second and
first quarters of 2000. The increase in net sales was a result of an increase
in our customer base and an increase in our repeat orders as a percentage of
total orders. In the future, the level of our sales will depend on a number of
factors including, but not limited to, the following:
. The number of customers we are able to obtain;
. The frequency of our customers' purchases;
. The quantity and mix of products our customers purchase;
. The quantity of the types of products we are able to offer for sale;
. The price we charge for our products;
. The amount we charge for shipping;
11
<PAGE>
. The extent of sales price incentives, including coupons and discounts we
offer;
. The extent of reimbursement available from third-party payors;
. The level of customer returns we experience;
. The seasonality that we may experience in our business; and
. The extent and effectiveness of our marketing efforts.
Cost of sales as a percentage of net sales improved to 89% during the
second quarter of 2000 from 95% during the first quarter of 2000. This
improvement is attributable to a decrease in the number of customer orders
placed using promotional discounts as a percentage of total customer orders,
and favorable adjustments to our prices and product mix. Cost of sales as a
percentage of net sales will continue to fluctuate based on a number of
factors, including, but not limited to, the following:
. The cost of our products, including the extent of promotional
allowances, payments for joint merchandising activities and purchase
volume discounts that we are able to obtain from suppliers;
. Our pricing strategy relative to the cost of our products, including the
extent to which we offer coupons or promotional discounts;
. The mix of products our customers purchase;
. The mix of consignment service fees vs. product sales;
. The mix of cash payments vs. insurance reimbursement for our pharmacy
products;
. Our shipping pricing strategy relative to the cost of shipping; and
. The extent to which we are able to control product damage, shrinkage and
expiration through inventory management practices.
Marketing and Sales. Marketing and sales expenses consist primarily of
advertising and promotional expenditures, distribution expenses, including
order processing and fulfillment charges, equipment and supplies, and payroll
and related expenses for personnel engaged in marketing, merchandising,
customer service and distribution and fulfillment activities. Marketing and
sales expenses increased to $35.7 million in the second quarter of 2000 from
$29.9 million in the first quarter of 2000. The increase was primarily due to
expenses associated with advertising media costs as well as the launch of our
shopping "tab" at Amazon.com in April 2000. To the extent that our sales
volume increases in future periods, we expect fulfillment and order processing
expenses to increase in absolute dollars as we expand the accompanying
distribution and fulfillment activities. Customer acquisition and marketing
expenses vary considerably from quarter to quarter, depending on the timing of
our advertising and promotional campaigns.
Technology and Content. 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 site and content. These
expenses also include payroll and related expenses for information technology
personnel, Internet access and hosting charges and Web site content and design
expenses. Technology and content expenses decreased to $6.7 million in the
second quarter of 2000 from $6.9 million in the first quarter of 2000,
primarily due to a decrease in expenses related to operating the Beauty.com
Web site as a result of eliminating duplicate facilities and technology
personnel in the second quarter of 2000. Over the next several months, we
expect that our technology and content expenses will increase as we continue
to make minor upgrades and enhancements to our Web site and maintain our Web
site product listings and content.
General and Administrative. General and administrative expenses consist of
payroll and related expenses for executive and administrative personnel,
corporate facility expenses, professional services expenses, and other general
corporate expenses. General and administrative expenses increased slightly to
$4.9 million in the second quarter of 2000 from $4.8 million in the first
quarter of 2000, primarily due to additional rent expense related to
12
<PAGE>
the expansion of our corporate headquarters. We expect general and
administrative expenses to increase in absolute dollars as we expand our staff
and incur additional costs related to the anticipated growth of our business.
Amortization of Intangible Assets. Amortization of intangible assets
increased to $8.2 million in second quarter of 2000 from $7.2 million in the
first quarter of 2000, due to the amortization of intangible assets received
in connection with the acquisition of Beauty.com.
Amortization of Stock-based Compensation. Amortization of stock-based
compensation increased to $4.2 million in the second quarter of 2000 from $3.3
million in the first quarter of 2000. The increase was primarily due to
additional deferred stock-based compensation recognized as a result of the
acquisition of Beauty.com as well as additional options granted to employees
in May 2000.
On May 4, 2000, our board of directors granted options to purchase an
aggregate of 3,275,700 shares of our common stock to certain of our existing
employees at an exercise price of $7.00 per share. The options were granted
under our 1998 stock plan and will vest over a four-year period at the rate of
one-fourth of the total number of shares subject to the options six months
after the grant date, with the remaining shares vesting in equal installments
at the end of each six-month period thereafter. On May 4, 2000 the closing
price of our common stock was $8.625 per share. Accordingly, in the second
quarter of 2000 we recorded deferred stock-based compensation of approximately
$5.3 million, which is being amortized over the vesting period of the options.
In July 2000, we amended certain provisions of the Beauty.com purchase
agreements. Accordingly, in the third quarter of 2000 approximately
$10.4 million of deferred stock-based compensation (representing the
$15.0 million recognized in the initial purchase net of amortization) will be
reclassified to goodwill since none of the purchase consideration will be
contingent on the continued employment of Beauty.com's founder.
Based on the balance of deferred stock-based compensation as of July 2,
2000, as adjusted for the effect of the amendments to the Beauty.com purchase
agreements, we expect to subsequently recognize the following amounts as
expense for the remainder of fiscal year 2000 and each of the next four fiscal
years:
<TABLE>
<CAPTION>
Fiscal Year Amount
----------- --------------
(in thousands)
<S> <C>
Q3-Q4 2000.............................. $4,243
2001.................................... 3,651
2002.................................... 1,852
2003.................................... 665
2004.................................... 122
</TABLE>
Interest Income, net. Interest income represents earnings on our cash, cash
equivalents and marketable securities net of interest expense associated with
capital lease obligations. Interest income was $2.3 million in the second
quarter of 2000 and $1.6 million in the first quarter of 2000. The increase is
due to an increase in our average outstanding balance of cash, cash
equivalents and marketable securities earning interest in the second quarter
of 2000.
Liquidity and Capital Resources
We have incurred net losses of $228.0 million from inception to July 2,
2000. We believe that we will continue to incur operating and net losses for
at least the next four years and possibly longer. As of July 2, 2000 we had
$122.3 million of cash, cash equivalents and marketable securities.
Net cash used in operating activities was $95.3 million for the first six
months of fiscal 2000. Net cash used in operating activities for this period
primarily consisted of net losses and changes in operating assets and
liabilities partially offset by non-cash expenses.
13
<PAGE>
Net cash provided by investing activities was $56.0 million for the first
six months of fiscal 2000. Net cash provided by investing activities for this
period primarily consisted of net sales of marketable securities partially
offset by leasehold improvements and purchases of equipment and systems,
including computer equipment, warehouse handling equipment and furniture and
fixtures.
Net cash provided by financing activities was $101.6 million for the first
six months of fiscal 2000. Net cash provided by financing activities during
the first six months of fiscal 2000 primarily resulted from the sale of
6,020,000 shares of common stock at $18.00 per share completed in March 2000.
Net proceeds from the sale to us aggregated approximately $101.6 million.
In August 2000, we completed the sale of approximately 8.1 million shares
of common stock at $4.9375 per share and approximately 46,000 shares of
preferred stock at $493.75 per share. The preferred stock is a participating,
non-voting, preferred instrument that automatically converts into common stock
upon shareholder approval at a conversion ratio of 100 shares of common stock
for one share of preferred stock. Total gross proceeds to us aggregated
approximately $62.7 million.
Our principal commitments consist of obligations outstanding under capital
and operating leases, marketing agreements with certain Web portals, including
Yahoo!, MSNBC, and Discovery Channel, as well as long-term marketing
agreements with Amazon.com and WellPoint Health Networks Inc., aggregating
approximately $122.5 million through 2012. In addition in January, we provided
letters of credit totaling $3.5 million as security for leases. These letters
of credit must be fully collaterized by an equivalent amount of our cash. As
of July 2, 2000, this cash collateral was classified as long term and included
in deposits and other assets.
We believe that our existing cash, cash equivalents and marketable
securities as of July 2, 2000, as well as the cash received in connection with
our financing in August 2000, will be sufficient to meet our anticipated needs
for working capital and capital expenditures into the fourth quarter of 2001.
However, 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.
New Accounting Pronouncements
In March 2000, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board reached a consensus on EITF Issue 00-2, "Accounting
for Web Site Development Costs." This consensus provides guidance on what
types of costs incurred to develop a web site should be capitalized or
expensed. This consensus is effective for web site development costs incurred
for fiscal quarters beginning after June 30, 2000. We do not expect the
adoption of this consensus to have a material impact on our financial
statements.
In March 2000, the Financial Accounting Standard Board (FASB) issued FASB
Interpretation (FIN) No. 44, "Accounting for Certain Transactions Involving
Stock Compensation." This Interpretation clarifies the application of
Accounting Principles Board Opinion No. 25 for certain issues related to stock
compensation. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after
either December 15, 1998, or January 12, 2000. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. We do not expect the adoption of this consensus to have a
material impact on our financial statements.
In May 2000, the EITF reached a consensus on EITF Issue 00-14, "Accounting
for Certain Sales Incentives." This consensus addresses the recognition,
measurement, and income statement classification for sales incentives (such as
discounts, coupons, and rebates) that a company offers to its customers for
use in a single transaction. The implementation date of this consensus is the
fourth quarter of a registrant's fiscal year beginning after December 15,
1999, or if the information is available, for financial statements issued with
the
14
<PAGE>
Securities and Exchange Commission after July 20, 2000. This consensus does
not have an impact on our financial statements as our current accounting
policies are in accordance with EITF Issue 00-14, except for the
reclassification of the cost of certain items we give away to our customers in
connection with our customer acquisition and retention activities and our
branding campaign. We have not completed our analysis of the amount of such
historical costs that will need to be reclassified from marketing and sales
expense to cost of sales.
In July 2000, the EITF reached a consensus on EITF Issue 99-19, "Reporting
Revenue Gross as a Principal versus Net as an Agent." This consensus provides
guidance on whether a company should recognize revenue in the amount of the
gross amount billed to the customer because it has earned revenue from the
sale of the goods or services or whether the company should recognize revenue
based on the net amount retained because, in substance, it has earned a
commission from the vendor-manufacturer of the goods or services on the sale.
As our current accounting policies are in accordance with EITF Issue 99-19,
this consensus does not have an impact on our financial statements.
In July 2000, the EITF reached a consensus on EITF Issue 00-10 "Accounting
for Shipping and Handling Fees and Costs." This consensus indicates that
amounts billed to a customer in a sale transaction related to shipping and
handling, if any, represent revenue to the vendor and should be classified as
revenue. As we currently classify shipping fees charged to a customer in net
sales, this consensus does not have an impact on our financial statements. The
EITF did not reach a consensus with respect to the classification of costs
related to shipping and handling incurred by the seller. It is possible that
organizations responsible for promulgating accounting standards may address
the classification of costs related to shipping and handling incurred by a
seller in the future.
Item 3. 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.
15
<PAGE>
PART II--OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(c) Sales of Unregistered Securities During the Quarter
In June 2000, we issued 750,000 shares of our common stock with a fair
value of $5.0 million to WellPoint Health Networks Inc. in exchange for access
to its 22 million-member network. These securities were issued in private
placement transactions under Section 4(2) of the Securities Act, on the basis
that the transactions did not involve any public offering.
Item 4. Submission of Matters to a Vote of Security Holders
Our annual meeting of shareholders was held on June 21, 2000. The following
matters were voted upon at the meeting:
Proposal 1: The following directors were elected:
<TABLE>
<CAPTION>
Nominee Votes For Votes Withheld
------- ---------- --------------
<S> <C> <C>
Peter M. Neupert................................... 49,570,307 90,296
Jeffrey P. Bezos................................... 49,573,643 86,960
Brook H. Byers..................................... 49,576,252 84,351
L. John Doerr...................................... 49,577,512 83,091
Melinda French Gates............................... 49,576,133 93,470
Mary Sammons....................................... 49,573,022 87,581
William D. Savoy................................... 49,575,911 84,692
Howard Shultz...................................... 49,570,185 90,418
</TABLE>
Proposal 2: The amendment to our 1998 Stock Option Plan to provide for an
increase in the number of shares of common stock available for issuance was
approved, with 39,547,447 votes for, 1,637,545 votes against and 47,158
abstentions.
Proposal 3: The ratification of the appointment of Ernst & Young LLP to
serve as our independent auditors for the 2000 fiscal year was approved, with
49,586,387 votes for, 50,161 votes against and 24,055 abstentions.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
See Exhibit Index.
(b) Reports on Form 8-K
Current report on Form 8-K, filed August 7, 2000, regarding a Stock
Purchase Agreement and Preferred Stock Purchase Agreement with several
purchasers. Such purchasers agreed to purchase $62,682,811.65 of Common Stock
and Convertible, Non-Voting Preferred Stock from us.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DRUGSTORE.COM, INC.
(Registrant)
/s/ David E. Rostov
By: _________________________________
David E. Rostov
Vice President, Chief Financial
Officer and Treasurer (principal
financial and chief accounting
officer)
Date: August 11, 2000
17
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation of drugstore.com
(Incorporated by reference to exhibit number 3.2 to drugstore.com's
registration statement on Form S-1 (file number 333-78813),
filed May 19, 1999).
3.1a Certificate of Designation.
10.2 1998 Stock Plan.
10.38 Third Addendum to Fourth Amended and Restated Investors' Rights
Agreement dated January 24, 2000 (Incorporated by reference to exhibit
10.38 to drugstore.com's registration statement on Form S-1 (file
number 333-96441) filed February 9, 2000).
27.1 Financial Data Schedule.
</TABLE>
