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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 8-K
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CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
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Date of report (Date of earliest event reported): February 9, 2000
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drugstore.com, inc.
(Exact name of Registrant as specified in its charter)
Delaware 0-26137 04-3416255
(State or other jurisdiction (Commission File Number) (I.R.S. Employer
of incorporation or Identification Number)
organization)
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13920 Southeast Eastgate Way, Suite 300
Bellevue, Washington 98005
(Address of principal executive offices) (Zip code)
(425) 372-3200
(Registrant's telephone number, including area code)
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<PAGE>
Item 5. Other Events
In connection with the filing of a Registration Statement on Form S-1, the
Registrant is filing this Current Report on Form 8-K which includes, as
Exhibit 99.1, a table setting forth Selected Consolidated Financial Data of
the Registrant for the fiscal year ended January 2, 2000 and for the period
from April 2, 1998 (inception) to December 31, 1998, and management's
discussion and analysis of financial condition and results of operations for
such periods.
Item 7. Exhibits
99.1 Selected Consolidated Financial Data of the Registrant for the fiscal
year ended January 2, 2000 and for the period from April 2, 1998
(inception) to December 31, 1998, and management's discussion and
analysis of financial condition and results of operations for such
periods.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, hereunto duly authorized.
drugstore.com, inc.
/s/ David Rostov
By: _________________________________
David Rostov,
Vice President, Chief Financial
Officer and Treasurer
Dated: February 9, 2000
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S>
99.1 Selected Consolidated Financial Data
of the Registrant for the fiscal year
ended January 2, 2000 and for the
period from April 2, 1998 (inception)
to December 31, 1998, and
management's discussion and analysis
of financial condition and results of
operations for such periods.
</TABLE>
<PAGE>
Exhibit 99.1
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
Period from
April 2, 1998
(Inception) to Year Ended
December 31, 1998 January 2, 2000
----------------- ---------------
(in thousands, except share and
per share data)
<S> <C> <C>
Consolidated Statements of Operations Data:
Net sales.................................... $ -- $ 34,848
Cost and expenses:
Cost of sales.............................. -- 38,440
Marketing and sales........................ 3,092 61,492
Technology and content..................... 2,178 14,918
General and administrative................. 1,861 11,126
Charitable contribution.................... -- 3,600
Amortization of intangible assets.......... 33 10,640
Amortization of stock-based compensation... 1,037 15,375
------- ----------
Total cost and expenses.................. 8,201 155,591
------- ----------
Operating loss............................... (8,201) (120,743)
Other income (expense):
Interest income............................ 177 5,036
Interest expense........................... (3) (124)
------- ----------
Net loss..................................... $(8,027) $ (115,831)
======= ==========
Basic and diluted net loss per share......... $(14.70) $ (6.13)
======= ==========
Weighted average shares outstanding used to
compute
basic and diluted net loss per share....... 546,149 18,880,969
======= ==========
Pro forma basic and diluted net loss per
share (unaudited)........................... $ (3.73)
==========
Weighted average shares outstanding used to
compute
pro forma basic and diluted net loss per
share (unaudited)......................... 31,045,835
==========
<CAPTION>
December 31, 1998 January 2, 2000
----------------- ---------------
(in thousands)
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents and marketable
securities.................................. $14,408 $ 132,754
Working capital.............................. 17,050 106,960
Total assets................................. 22,517 395,708
Capital lease obligations, less current
portion..................................... 975 2,687
Total stockholders' equity................... 19,347 350,749
</TABLE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Selected
Consolidated Financial Data. The following discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results could
differ materially from the results contemplated by these forward-looking
statements as a result of certain factors, including those discussed below.
Overview
drugstore.com is a leading online drugstore: a retail store and information
site for health, beauty, wellness, personal care and pharmacy products and
information. We offer a larger selection of products than typical store-based
retailers at competitive prices, along with a wealth of health-related
information, buying guides and other tools designed to help consumers make
more educated purchasing decisions.
We were incorporated in April 1998 and commercially launched our Web site
on February 24, 1999. From the period from inception through the commercial
launch of our site, our primary activities consisted of:
. Developing our business model;
. Raising funds and developing strategic alliances;
. Designing and developing our Web site;
. Recruiting and training employees;
. Selecting our fulfillment partners and integrating their systems and
processes with ours;
. Negotiating advertising contracts with several of the major Web portals;
and
. Developing the drugstore.com brand.
Since the commercial launch of our site, we have continued these operating
activities and have also 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 customer service operations and developing our own distribution
capabilities.
All customer orders are processed through our Web store and can be either
shipped to the customer or, in the case of refills of existing Rite Aid
prescriptions, 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. Generally, 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; however, such
timing can vary depending on the payor. Sales billed to third party insurance
companies and PBMs through our relationships with Rite Aid and PCS currently
represent a significant percentage of our pharmacy sales. We expect that sales
billed to these third parties will continue to represent a significant
percentage of our pharmacy sales for the forseeable future.
We routinely offer discounts and coupons to customers. In addition, if a
customer is not satisfied with a particular product or the level of customer
service we provide, we generally refund all or a portion of the sale.
Allowances for refunds and sales price incentives, including discounts and
coupons, are netted against the related sales price in net sales. We may in
the future expand or increase the coupons and discounts we offer to our
customers.
In January 2000, we began limited operations at our own 290,000 square foot
distribution center, and we are in the process of transitioning our
distribution capabilities for pharmaceutical and non-pharmaceutical
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products from third party distributors to our center. In connection with
opening our distribution center, we also opened our own pharmacy as part of
our agreement with Rite Aid. Operating our own distribution facility will
require us, in the near term, to hire and train a significant number of new
employees, increase inventory levels substantially and establish a significant
number of direct relationships with manufacturers. In addition, as we
transition to our own distribution center, order fulfillment through multiple
channels and underutilization of our own distribution capacity could result in
cost and service level inefficiencies.
Currently, we purchase substantially all of our pharmaceutical products
from RxAmerica and more than half of our nonpharmaceutical products from
Walsh. We also purchase pharmaceutical products from Rite Aid. Products are
purchased from RxAmerica, Walsh and Rite Aid after the customer submits an
order, and we maintain an inventory of nonpharmaceutical products that are not
available from Walsh. As we transition customer order fulfillment to our own
distribution center, we intend to establish relationships directly with
product manufacturers, and we expect that order fulfillment through Walsh will
cease by the end of the second quarter of 2000. In addition, in connection
with establishing our own distribution center, we are obligated to buy our
pharmaceutical products from Rite Aid, unless we are able to obtain better
overall terms from other vendors. As the number of orders filled out of the
pharmacy operation in our distribution center increases, we expect that
purchases from Rite Aid will account for an increasingly significant portion
of our total pharmaceutical product purchases.
On February 2, 2000, we acquired Beauty.com, a Web store specializing in
prestige beauty products, and entered into an agreement to retain the
employment of its founder, Roger Barnett, for a total of 1,266,289 shares of
drugstore.com common stock (approximately $40.4 million based on the price of
our common stock on January 12, 2000, the date the transaction was announced).
Beauty.com maintains an inventory of all products that it sells and we expect
our inventory to increase significantly relative to our current levels as a
result of the acquisition. Beauty.com currently outsources its fulfillment
operations to Keystone Corporation and we expect to begin integrating
Beauty.com's fulfillment operations into our own while keeping the Beauty.com
Web store intact. A significant portion of the shares of common stock that we
issued under the acquisition agreement are subject to the terms of an escrow
agreement and will be forfeited by Mr. Barnett if he does not remain employed
at Beauty.com for the two year period following the acquisition. We will
account for the acquisition as a purchase.
We have incurred net losses of $123.9 million from inception to January 2,
2000. We believe that we will continue to incur net losses for at least the
next four years (and possibly longer) and that the rate at which we will incur
such losses will likely increase significantly from current levels. 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. See "Factors That May Affect Our Business" for a more complete
description of the many risks we face.
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.
The Securities and Exchange Commission and the Emerging Issues Task Force
of the Financial Accounting Standards Board are reviewing the financial
statement classification of, and accounting for, fulfillment and order
processing costs and other items by a number of e-commerce companies,
including drugstore.com. Our fulfillment and order processing costs include
distribution center equipment and packaging supplies, per-unit fulfillment
fees charged by third parties, 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. We classify all of these
costs in marketing and sales expense. The SEC has
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advised us that it may decide to require that some or all of our fulfillment
and order processing costs be classified as costs of sales. In addition, the
SEC may require us to capitalize certain of these costs in inventory. We
currently expense these costs as incurred. We will adjust our accounting and
classification of fulfillment and order processing costs if required by the
SEC. Any such adjustments or reclassifications are not expected to have a
significant impact on our sales, operating profit or loss, net income or loss,
or cash flow, although such adjustments or reclassifications could result in
an increase in our cost of sales as a percentage of our net sales.
Net Sales. Net sales includes gross revenues from sales of products and
related shipping fees, net of discounts and provisions for sales returns,
third-party reimbursement and other allowances. We generally refund all or a
portion of the selling price, including related shipping fees, if applicable,
in the event the customer is not satisfied with the product purchased or the
quality of customer service provided. Sales returns and allowances have not
been significant to date.
Revenues from sales of products shipped to customers, and related shipping
fees, are recognized upon shipment. We arrange for shipment of products to
customers through various contractual relationships with third-party
fulfillment partners. Revenues from sales of certain pharmaceutical products
ordered through our Web store for delivery at a Rite Aid store are recognized
when the product is delivered to the customer.
Upon receiving and validating a customer's order for products that will be
purchased by us from a fulfillment partner, and subsequently shipped or
delivered to the customer by that fulfillment partner, we submit relevant
order information and, if applicable, shipping instructions to that
fulfillment partner for processing. We believe we act as a principal in
connection with orders shipped or delivered to customers by fulfillment
partners on our behalf because, among other things, we establish the retail
prices of our non-pharmaceutical and non-insured pharmaceutical products (and
accept contractual reimbursement amounts from third-party payors for insured
pharmaceutical products) and shipping fees; contractually take title to, and
assume risk of loss of, products prior to their shipment; bear credit and
collection risk from the customer or, in the case of certain pharmaceutical
sales, third-party payors; and bear the risk that the product will be
returned. Title to products ordered by customers and shipped or delivered by a
fulfillment partner passes to us at the fulfillment partners' distribution
center or, for certain pharmaceutical sales, when the pharmaceuticals are made
available for customer retrieval at a Rite Aid store.
In the future, the level of our net 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;
. 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; and
. The seasonality that we may experience in our business.
Cost of Sales. 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. Payments
that we expect to receive from vendors in connection with joint merchandising
activities, net of related costs, will be netted against cost of sales in the
period in which the related inventory is sold. We expect
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cost of sales to increase in absolute dollars to the extent that our sales
volume increases. Cost of sales as a percentage of net sales will 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 though inventory management practices.
Marketing and Sales. Marketing and sales expenses consist primarily of
fulfillment and order processing expenses and customer acquisition and
marketing expenses. Fulfillment and order processing expenses include
distribution center equipment and packaging supplies, per-unit fulfillment fees
charged by third parties, 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. We expect fulfillment and
order processing expenses to increase during the next two quarters due to
duplicative costs that we will incur while we complete the transition of our
customer order fulfillment operations from third party distributors, including
those operated on behalf of Beauty.com, to our own distribution facilities.
Additionally, 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 include advertising and
marketing expenses, promotional expenditures, credit card processing fees and
payroll and related expenses for personnel engaged in marketing and
merchandising activities. Promotional expenses include the cost of certain
items we give away to our customers in connection with our customer acquisition
and retention activities and our branding campaign. These items include sample
merchandise in sizes or quantities not normally sold on our Web site, certain
drugstore.com-branded products and the cost of products given away in our one
cent sales promotions. Advertising expenses include media, agency and
production costs associated with our branding campaign. We intend to continue
to pursue an aggressive branding and marketing campaign and, therefore, we
expect customer acquisition and marketing expenses to increase significantly in
absolute dollars. Customer acquisition and marketing expenses may also vary
considerably from quarter to quarter, depending on the timing of our
advertising campaigns. We currently intend to pursue an independent branding
and marketing strategy for the Beauty.com Web store. Accordingly, we expect
that customer acquisition and marketing expenses will increase after the
Beauty.com acquisition is consummated.
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.
Over the next several months, we expect that our technology and content
expenses will increase as we:
. Continue to make minor upgrades to improve our systems relating to in-
store prescription pickup at Rite Aid stores;
. Make minor enhancements to our Web site to display additional product
offerings; and
. Maintain our Web site product listings and content.
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We believe that continued investment in these areas is critical to attaining
our strategic objectives and, as a result, we expect technology and content
expenses to increase significantly in absolute dollars.
General and Administrative. 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. 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 and being a public company.
Amortization of Intangible Assets. In July 1999, we consummated a series of
agreements with Rite Aid and GNC to issue 12,282,599 shares of Series E
preferred stock in exchange for an aggregate of $10 million in cash and other
consideration, including access to insurance coverage, advertising
commitments, exclusivity agreements, a technology licensing agreement and
other obligations with an estimated fair value of $233.9 million. The $233.9
million non-cash portion of the consideration from the Rite Aid and GNC
agreements was allocated to the following components based on a valuation
obtained from an independent valuation expert (in millions):
<TABLE>
<S> <C>
Access to insurance coverage .................................... $182.0
Advertising commitments.......................................... 22.9
Vendor agreement................................................. 29.0
------
$233.9
======
</TABLE>
The access to insurance coverage and the vendor agreement have been
classified as intangible assets and the advertising commitments have been
classified within prepaid marketing expenses. All of the assets are being
amortized on a straight-line basis over their contractual lives of 10 years,
which is also their estimated useful lives. Amortization of the advertising
commitments is included in marketing and sales expense. As a result of our
acquisition of Beauty.com, we expect that amortization of intangible assets
will increase substantially from current levels. We intend to obtain an
independent valuation in order to allocate the purchase price to the net
assets acquired, including any goodwill. We expect that such valuation will be
completed in the first quarter of 2000.
Amortization of Stock-based Compensation. We have recorded total deferred
stock-based compensation of $27,596,000 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, resulting in amortization of stock-based
compensation totaling $1,037,000 for the period from April 2, 1998 (inception)
to December 31, 1998 and $15,375,000 for the fiscal year ended January 2,
2000. The amortization expense relates to options awarded to employees in all
operating expense categories. Deferred stock-based compensation as of January
2, 2000 for stock options and restricted stock issued to our employees will be
subsequently recognized as expense for each of the next five fiscal years as
follows:
<TABLE>
<CAPTION>
Fiscal Year Amount
----------- --------------
(in thousands)
<S> <C>
2000 $5,715
2001 2,976
2002 1,500
2003 468
2004 111
</TABLE>
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We expect that a significant percentage of the consideration for the
Beauty.com acquisition will be deemed to be deferred stock-based compensation.
Any deferred stock-based compensation will be amortized over a two-year period
and, accordingly, we expect that amortization of stock-based compensation for
fiscal 2000 and 2001 will be significantly higher than the amounts in the
above table.
Interest Income and Expense. Interest income consists of earnings on our
cash and cash equivalents and interest expense consists of interest associated
with capital lease obligations.
Income Taxes. There was no provision or benefit for income taxes for any
period since inception due to our operating losses. As of January 2, 2000, we
had approximately $98.4 of net operating loss carryforwards for federal income
tax purposes, which expire beginning in 2018. In 1999, due to the issuance and
sale of Series D and Series E preferred stock, we incurred ownership changes
pursuant to applicable regulations in effect under the Internal Revenue Code
of 1986, as amended. Therefore, our use of losses incurred through the date of
these ownership changes will be limited during the carryforward period. We
estimate that the use of the approximately $53.9 million of net operating
losses incurred prior to the date of the ownership change would be limited to
approximately $6.6 million per year in order to offset future taxable income.
To the extent that any single-year loss is not utilized to the full amount of
the limitation, such unused loss is carried over to subsequent years until the
earlier of its utilization or the expiration of the relevant carryforward
period. Our initial public offering did not cause an additional ownership
change that would result in additional limitations on the utilization of net
operating loss carryforwards. We have provided a full valuation allowance on
the deferred tax asset, consisting primarily of such net operating loss
carryforwards, because management has determined that it is more likely than
not that we will not earn income sufficient to realize the deferred tax assets
during the carryforward period.
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Quarterly Results of Operations
Because we were a development stage company prior to the launch of our Web
site in February 1999 and have a short operating history, we believe that
period-to-period comparisons for periods prior to 1999 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 is
focused on the seven quarters ended January 2, 2000.
The following table sets forth unaudited quarterly statement of operations
data for the seven quarters ended January 2, 2000. This unaudited quarterly
information has been derived from our unaudited financial statements and, in
the opinion of management, include all adjustments, consisting only of normal
recurring adjustments necessary for a fair presentation of such information in
accordance with accounting principles generally accepted in the United States.
The operating results for any quarter are not necessarily indicative of the
operating results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
-----------------------------------------------------------------
Sept. Dec.
June 30, 30, 31, April 4, July 4, Oct. 3, Jan. 2,
1998 1998 1998 1999 1999 1999 2000
-------- ------- ------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales............... $ -- $ -- $ -- $ 652 $ 3,550 $ 12,158 $ 18,488
Cost and expenses:
Cost of sales......... -- -- -- 672 4,879 14,066 18,823
Marketing and sales... -- 313 2,779 5,189 11,328 16,471 28,504
Technology and
content.............. 104 522 1,552 2,713 3,229 4,232 4,744
General and
administrative....... 71 511 1,279 1,713 2,204 3,120 4,089
Charitable
contribution......... -- -- -- -- -- 3,600 --
Amortization of
intangible assets.... 8 10 15 18 20 5,300 5,302
Amortization of stock-
based compensation... 166 350 521 1,257 2,326 9,267 2,525
----- ------- ------- -------- -------- -------- --------
Total cost and
expenses............ 349 1,706 6,146 11,562 23,986 56,056 63,987
----- ------- ------- -------- -------- -------- --------
Operating loss.......... (349) (1,706) (6,146) (10,910) (20,436) (43,898) (45,499)
Other income (expense):
Interest income....... -- 36 141 332 701 1,958 2,045
Interest expense...... -- -- (3) (14) (26) (33) (51)
----- ------- ------- -------- -------- -------- --------
Net loss................ $(349) $(1,670) $(6,008) $(10,592) $(19,761) $(41,973) $(43,505)
===== ======= ======= ======== ======== ======== ========
</TABLE>
Quarterly Periods from Inception to April 4, 1999
Net Sales and Cost of Sales. We commercially launched our Web site on
February 24, 1999. There were no net sales or cost of sales prior to the
quarter ended April 4, 1999. Net sales approximated the cost of sales in the
quarter ended April 4, 1999 due to promotional sales discounts and coupons
associated with the commercial launch of the Web site.
Marketing and Sales. Marketing and sales expenses increased in each of the
four quarters ended April 4, 1999, primarily due to expenses associated with
the addition of marketing and merchandising personnel. We also increased our
advertising on major Web portals, including AOL, Excite and Yahoo!, in the
quarter ended April 4, 1999 in connection with the commercial launch of our
Web site. Additionally, we recognized $1,007,000 of non-cash advertising
expenses under our technology license and advertising agreement with
Amazon.com in the quarter ended April 4, 1999.
Technology and Content. Technology and content expenses increased in each
of the four quarters ended April 4, 1999, primarily due to increased expenses
associated with the addition of information technology personnel and
additional use of consultants and contract labor to help maintain the systems
supporting our Web site.
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General and Administrative. General and administrative expenses increased
in each of the four quarters ended April 4, 1999, primarily due to increased
expenses associated with the addition of general and administrative personnel,
additional professional fees and the cost of corporate facilities.
Amortization of Intangible Assets. Amortization of intangible assets during
the four quarters ended April 4, 1999 primarily represented the amortization
of the technology license obtained from Amazon.com and certain domain names
owned by us.
Amortization of Stock-based Compensation. Amortization of stock-based
compensation increased in each of the four quarters ended April 4, 1999,
primarily due to the grant of stock options to new employees prior to our
initial public offering on July 27, 1999, as well as an increase in the
difference between the grant price and the deemed fair value of our common
stock, particularly in the quarter ended April 4, 1999.
Three Quarterly Periods Ended January 2, 2000
Net Sales and Cost of Sales. We have been operating our Web store for three
full fiscal quarters. The following table sets forth net sales for each of
these quarters by category:
<TABLE>
<CAPTION>
Quarter Ended
------------------------------------
July 4, Oct. 3, Jan. 2,
1999 1999 2000
---------- ----------- -----------
Category Amount % Amount % Amount %
-------- ------ --- ------- --- ------- ---
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Pharmaceutical products................. $1,094 31% $ 7,107 58% $10,453 57%
Non-pharmaceutical products and other... 2,456 69 5,051 42 8,035 43
------ --- ------- --- ------- ---
Total................................. $3,550 100% $12,158 100% $18,488 100%
====== === ======= === ======= ===
New customers........................... 150,000 260,000 267,000
Orders from repeat customers as a
percentage of total orders............. 26% 33% 44%
</TABLE>
Our net sales in each category have increased in each quarter since we
commenced operations due to increases in new customers and increased repeat
orders. The substantial increase in pharmaceutical product sales as a percent
of total net sales in the quarter ended October 3, 1999 was primarily related
to the commencement of the Rite Aid in-store pickup service for prescription
refills. Consignment fees related to our agreement with GNC are included in
net sales of non-pharmaceutical products and other and were insignificant
relative to the total.
Cost of sales exceeded net sales in each of the three quarters ended
January 2, 2000. Such excess was primarily the result of a decrease in net
sales due to sales price incentives offered to customers, including
promotional coupons and discounts. We continue to offer promotional coupons
and discounts as a strategy to attract new customers, although such discounts
and coupons have decreased over time as a percentage of net sales. Promotional
coupons can only be used by customers to offset the price of non-
pharmaceutical products. Additionally, our shipping costs exceeded the amount
we charged our customers for shipping in each of the three quarters ended
January 2, 2000. We expect to continue to subsidize a portion of our shipping
costs for the foreseeable future as a strategy to attract and retain
customers.
Marketing and Sales. Marketing and sales expenses increased in each of the
three quarters ended January 2, 2000 due to increases in both fulfillment and
order processing expenses and customer acquisition and marketing expenses.
Fulfillment and order processing expenses increased in each of the three
quarters ended January 2, 2000 primarily due to the increases in order volume.
Volume-related expenses primarily responsible for the increased costs include
permanent and temporary labor required to validate prescriptions and fulfill
both pharmaceutical and non-pharmaceutical orders, per-unit fulfillment fees
charged by our fulfillment partners, depreciation expense related to
additional capital investments and packaging materials.
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The increases in customer acquisition and marketing expenses are primarily
attributable to increased media, agency and production costs associated with
our branding campaign which commenced in the quarter ended July 4, 1999.
Additionally, the cost of promotional items given to new and existing
customers has increased in each quarter. We expect to continue to pursue an
aggressive branding and marketing campaign for the foreseeable future and
expect such expenditures to increase accordingly. Included in customer
acquisition and marketing expenses are $2,293,000, $1,074,000 and $573,000 of
non-cash advertising expenses incurred under our agreements with Amazon.com
and Rite Aid for the second, third and fourth quarters of fiscal 1999,
respectively.
Technology and Content. Technology and content expenses increased in each
of the three quarters ended January 2, 2000, primarily due to increased
expenses associated with the addition of information technology personnel and
additional use of consultants and contract labor. Such personnel assisted in
maintaining and making minor upgrades and enhancements to our Web store as
well as maintaining the systems supporting the Web site.
General and Administrative. General and administrative expenses increased
in each of the three quarters ended January 2, 2000 primarily due to increased
expenses associated with the addition of general and administrative personnel,
additional professional fees and the cost of corporate facilities.
Charitable Contribution. In the third quarter of fiscal 1999, we donated
200,000 shares of our common stock to a foundation established by us and
recognized an expense of $3,600,000 in that quarter based on the fair value of
the donated common stock.
Amortization of Intangible Assets. Amortization of intangible assets
increased significantly in the quarters ended October 3, 1999 and January 2,
2000, to $5,300,000 and $5,302,000, respectively, primarily due to the
amortization of intangible assets received in connection with the Rite Aid and
GNC transactions completed in July 1999.
Amortization of Stock-based Compensation. Amortization of stock-based
compensation increased in the third quarter of fiscal 1999, primarily due to a
separation agreement we entered into with our founder.
Liquidity and Capital Resources
In July 1999, we completed our initial public offering and issued 5,750,000
shares of our common stock at an initial public offering price of $18.00 per
share. Net cash proceeds to us from the initial public offering were
approximately $94.6 million. Concurrently with our initial public offering, we
received $10 million in cash from our private placement of 555,555 shares of
our common stock with Amazon.com. From our inception until our initial public
offering, we financed our operations primarily through private sales of
preferred stock which yielded net cash proceeds of $106.8 million.
We have incurred net losses of $123.9 million from inception to January 2,
2000. We believe that we will continue to incur net losses for the foreseeable
future and that the rate at which we will incur such losses will increase
significantly from current levels. Net cash used in operating activities was
$56.8 million for the year ended January 2, 2000, and $6.3 million in the
period from April 2, 1998 (inception) to December 31, 1998. Net cash used in
operating activities for each of these periods primarily reflects our net
losses offset by a net source of funds from working capital.
Net cash used in investing activities was $120.0 million for the year ended
January 2, 2000, and $1.5 million in the period from April 2, 1998 (inception)
to December 31, 1998. Net cash used in investing activities for the year ended
January 2, 2000 was primarily related to the investment of the proceeds from
our initial public offering in marketable securities with an original maturity
greater than 90 days. Additionally, net cash used in investing activities for
both periods included leasehold improvements and purchases of equipment and
systems, including warehouse handling equipment, computer equipment and
fixtures and furniture.
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For the year ended January 2, 2000, net cash provided by financing
activities was $188.9 million and consisted primarily of $104.6 million in net
proceeds from the issuance of common stock in our initial public offering and
the concurrent private placement, and $84.6 million in net proceeds from the
issuance of convertible preferred stock.
During the period from April 2, 1998 (inception) to December 31, 1998, net
cash provided by financing activities was $22.2 million, consisting primarily
of cash proceeds of $4.0 million from the issuance of 10,000,000 shares of
Series A preferred stock and cash proceeds of $18.2 million from the issuance
of 5,446,268 shares of Series B preferred stock.
As of January 2, 2000, we had $132.8 million of cash, cash equivalents and
marketable securities. As of that date, our principal commitments consisted of
obligations outstanding under capital and operating leases and marketing
agreements with certain Web portals, including America Online, MSNBC and
Discovery Channel, aggregating approximately $80.0 million through 2012.
Subsequent to January 2, 2000, we entered into a strategic agreement with
Amazon.com to integrate various shopping features of our Web sites and create
a persistent drugstore.com shopping presence on Amazon.com's Web site. Under
the terms of the agreement, we agreed to pay Amazon.com a total of $105
million over a three-year period, of which $30 million was paid at the time
the agreement was executed. In addition, in January 2000, we provided letters
of credit totaling $16.4 million as security for leases and certain other
operating agreements. These letters of credit must be fully collateralized by
an equivalent amount of our cash. If our cash balance falls below $25 million
we are contractually obligated to increase these letters of credit and related
cash collateral to $20.7 million. Although we have no material commitments for
capital expenditures, we anticipate a substantial increase in our capital
expenditures and lease commitments consistent with anticipated growth in
operations, infrastructure and personnel. We recently began limited operations
at our own distribution center to improve the customer experience by locating
closer to a greater percentage of our customers, exerting greater control over
the distribution process and ensuring adequate supplies of products to our
customers. We also expect to devote substantial resources to technology and
systems upgrades to support the new distribution center and our ability to
provide in-store prescription pick up at Rite Aid stores as well as to
advertising and promotional activities. During 2000, we expect to incur
approximately $15 million of additional costs for these technology and systems
upgrades and toward the new distribution center.
We believe that our existing cash, cash equivalents and marketable
securities will be sufficient to meet our anticipated needs for working
capital and capital expenditures into the second half of 2000. We may need to
raise additional funds prior to the expiration of such period if, for example,
we pursue business or technology acquisitions or experience operating losses
that exceed our current expectations. If we raise additional funds through the
issuance of equity, equity-related or debt securities, such securities may
have rights, preferences or privileges senior to those of the rights of our
common stock and our stockholders may experience additional dilution. We
cannot be certain that additional financing will be available to us on
acceptable terms when required, or at all.
Year 2000
Many existing computer programs were designed and developed without
addressing the impact of the upcoming change in the century. If not corrected,
many computer software applications could fail or create erroneous results by,
at or beyond the year 2000. Prior to the end of 1999, we completed a review of
the year 2000 compliance of our internally developed proprietary software,
including testing to determine how our systems will function at and beyond the
year 2000. Based upon our assessment, we believe that our internally developed
proprietary software is year 2000 compliant. In addition, we assessed the year
2000 readiness of our third-party supplied software, computer technology and
other services, which include software for use in our accounting, database and
security systems, and implemented corrective actions that we believed were
necessary to address potential year 2000 issues in these areas. To date, we
have not experienced any year 2000-related problems with our internally
developed software or our third-party supplied software and computer systems,
and we are not aware of any failure by our third-party suppliers to be year
2000 compliant that could impact our
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business or operations. In addition, to date, we are not aware of any failure
by Rite Aid, RxAmerica or Walsh Distribution to be year 2000 compliant that
could impact our business or operations. However, such problems or failures
could arise or become apparent in the future, and any such problems or
failures could have negative consequences for us. Such consequences could
include difficulties in operating our Web site effectively, taking customer
orders, making product deliveries or conducting other fundamental parts of our
business.
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 us.
Factors That May Affect Our Business
If any of the following risks actually occurs, our business, financial
condition or operating results could be materially adversely affected. In such
case, the trading price of our common stock could decline.
We Are an Early Stage Company in a New and Rapidly Evolving Market, Which
Makes It Difficult for Investors to Determine Whether We Will Accomplish
Our Objectives
Because drugstore.com was founded in April 1998 and we only began selling
products in February 1999, we have a limited operating history on which
investors can base an evaluation of our business strategy. We have limited
insight into trends that may emerge and affect our business. An investor in
our common stock must consider the risks and difficulties frequently
encountered by early stage companies, as well as the risks we face due to our
participation in a new and rapidly-evolving market. These challenges include
our:
. Need to increase our brand awareness;
. Need to attract and retain customers at a reasonable cost;
. Dependence on Web site and transaction processing performance and
reliability;
. Need to compete effectively;
. Need to establish ourselves as an important participant in the evolving
market for healthcare products and services on the Internet; and
. Need to establish and develop relationships in the healthcare industry,
particularly in the areas of reimbursement and managed care.
Consumers of Health, Beauty, Wellness, Personal Care and Pharmacy Products
May Not Accept Our Solution, Which Would Harm Our Revenues and Prevent Us
From Becoming Profitable
If we do not attract and retain a high volume of online customers to our
store at a reasonable cost, we will not be able to increase our revenues or
achieve profitability. We may not be able to convert a large number of
customers from traditional shopping methods to online shopping for health,
beauty, wellness, personal care and pharmacy products. Even if we are
successful at attracting online customers, we expect it will take several
years to build a critical mass of these customers. Specific factors that could
prevent widespread customer acceptance include:
. Shipping charges, which do not apply to shopping at traditional
drugstores;
. Delivery time associated with Internet orders, as compared to the
immediate receipt of products at a physical store;
. Pricing that does not meet customer expectations of "finding the lowest
price on the Internet;"
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. Additional steps and delays in ensuring insurance coverage for
prescription products;
. Lack of coverage of customer prescriptions by some insurance carriers;
. Lack of consumer awareness of our online pharmacy;
. Customer concerns about the security of online transactions and the
privacy of their personal health information;
. Product damage from shipping or shipments of wrong or expired products
from us or our fulfillment partners or other vendors, resulting in a
failure to establish customers' trust in buying drugstore items online;
. Delays in responses to customer inquiries or in deliveries to customers;
. Inability to serve the acute care needs of customers, including
emergency prescription drugs and other urgently needed products; and
. Difficulties in returning or exchanging orders.
We Expect Significant Increases in Our Operating Expenses and Continuing
Losses for the Next Several Years
We incurred net losses of $123.9 million for the period from inception
through January 2, 2000. We have not achieved profitability. We only began
selling products in February 1999 and cannot be certain that we will obtain
enough customer traffic or a high enough volume of purchases to generate
sufficient revenues and achieve profitability. We believe that we will
continue to incur operating and net losses for at least the next four years
(and possibly longer) and that the rate at which we will incur such losses
will increase significantly from current levels. We intend to increase our
operating expenses substantially as we:
. Increase our sales and marketing activities, particularly advertising
efforts;
. Provide our customers with promotional benefits, such as selling
selected products or offering shipping below our actual costs;
. Increase our general and administrative functions to support our growing
operations;
. Expand our customer and pharmacist support organizations to better serve
customer needs;
. Develop enhanced technologies and features to improve our Web site;
. Enhance our distribution fulfillment processes; and
. Begin operating our own distribution facility and possibly buy or build
additional distribution facilities.
Because we will spend these amounts before we receive any incremental
revenues from these efforts, our losses will be greater than the losses we
would incur if we developed our business more slowly. In addition, we may find
that these efforts are more expensive than we currently anticipate, which
would further increase our losses.
We May Not Succeed in Establishing the drugstore.com Brand, Which Would
Adversely Affect Customer Acceptance and Our Revenues
Due to the early stage and competitive nature of the online market for
drugstore products, if we do not establish our brand quickly, we may lose the
opportunity to build a critical mass of customers. Promoting and positioning
our brand will depend largely on the success of our marketing efforts and our
ability to provide consistent, high quality customer experiences. To promote
our brand, we have incurred and expect to continue to incur substantial
expense in our advertising efforts on major Internet destinations such as
Amazon.com, America Online and Yahoo! and other Web sites our customers are
likely to visit, as well as other forms of media such as television and
magazines. We will also need to spend money to attract and train customer
service personnel. If these brand promotion activities do not yield increased
revenues, we will incur additional losses. Even if our
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efforts are successful, adverse publicity about our strategic partners could
damage our brand and negatively affect customer acceptance of our site.
We Expect Our Quarterly Financial Results to Fluctuate And Our Early Stage
of Development Limits Our Ability to Predict Revenues and Expenses
Precisely
Historical trends and quarter-to-quarter comparisons of our operating
results are not a good indicator of our future performance. It is likely that
in some future quarter our operating results may be below the expectations of
public market analysts and investors. In this event, the price of our common
stock may fall. Our revenues and operating results are expected to vary
significantly from quarter to quarter due to a number of factors, including:
. Demand for our products;
. Our ability to attract visitors to our Web store and convert those
visitors into customers;
. The frequency of repeat purchases by customers;
. Shifts in the nature and amount of publicity about us or our
competitors;
. Changes in the growth rate of Internet usage;
. Average order size;
. The mix of products sold;
. Our ability to enhance our technology to accommodate any future growth
in our operations or customers;
. Our ability, including through our fulfillment partners, to manage
inventory levels and ensure sufficient product supply, particularly as
we transition customer order fulfillment to our own distribution
facility;
. Changes in our pricing policies or the pricing policies of our
competitors;
. Changes in government regulation;
. The availability of reimbursement for pharmacy products; and
. Costs related to potential acquisitions of technology or businesses.
Our operating expenses are largely based on anticipated revenue trends and a
high percentage of our expenses are fixed in the short term. As a result, a
delay in generating or recognizing revenue for any reason could result in
substantial additional operating losses. The volume and timing of orders of
health, beauty, wellness, personal care and pharmacy products on our Web store
are difficult to predict because the online market for such products is in its
infancy. Due to the limited operating history of our Web store, we do not yet
have sufficient historical data on which to predict future business from
repeat customers. Accordingly, we may have difficulty forecasting revenue from
regular customers or overall anticipated revenue trends.
A portion of our revenues may also be seasonal in nature, especially with
respect to the sale of certain beauty products, which depend to some extent on
seasonal product changes and seasonal purchasing patterns. Consumer "fads" and
other changes in consumer trends may cause shifts in purchasing patterns,
resulting in significant fluctuations in our operating results from one
quarter to the next. Our limited operating history makes it difficult to fully
assess the impact of these factors.
If We Are Unable to Obtain Insurance Reimbursement Coverage for Our
Customers, Our Ability to Sell Pharmacy Products Online Could Decrease,
Which Would Harm Our Revenues
To obtain reimbursement on behalf of our customers for the prescription
products that they purchase on our Web site, we must maintain relationships
with insurance companies and PBMs, either directly or through our relationship
with Rite Aid. We currently rely primarily on Rite Aid's relationships with
insurance companies and PBMs, and the extension of these relationships to
cover prescriptions processed by us. To the extent Rite Aid is unable to
maintain these relationships, or if these relationships do not extend to cover
the prescriptions we
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process, our ability to obtain reimbursement coverage for our customers would
be reduced. This would reduce the number of customers that fill prescriptions
through our Web site, which would reduce our revenues.
Our ability to enter into direct relationships with insurance companies and
PBMs, or retain our existing relationships for an extended period of time, is
uncertain for the following reasons:
. Many of these companies are in the early stages of evaluating the impact
of the Internet and online pharmacies on their businesses. These
companies may delay their decisions to contract with online pharmacies
or may decide to develop their own Internet capabilities that may
compete with us.
. Many insurance companies have existing contracts with chain drugstores
and PBMs that have announced their intentions to establish online
pharmacies.
. Some insurance companies and PBMs will likely contract with only one or
a limited number of online pharmacies. If our online competitors obtain
these contracts and we do not, we would be at a competitive
disadvantage.
Other than our contract with PCS Health Systems, Inc., which is a 10-year
agreement, many of our agreements with insurance companies and PBMs are short-
term and may be terminated with less than 30 days' prior notice. In addition,
we must process each insurance application individually, which may raise the
costs of processing prescription orders and delay our order processing time.
Customers may not initially embrace our online insurance coverage procedure.
We Depend on a Limited Number of Distribution Partners; If They Do Not
Perform, We Will Not Be Able to Effectively Ship Orders
We currently rely to a large extent on rapid distribution by third parties.
Since inception, we have purchased a substantial majority of our
pharmaceutical products from one vendor, RxAmerica L.L.C., and in connection
with operating our own distribution center, we will become obligated to
purchase all of our pharmaceutical products from Rite Aid unless we are able
to obtain better overall terms from another vendor. We also currently purchase
a substantial majority of our non-pharmaceutical products from one vendor,
Walsh Distribution, Inc., which accounted for 68% of our non-pharmaceutical
cost of sales from launch of our Web store to January 2, 2000. However, as we
transition customer order fulfillment to our own distribution center, we
intend to establish relationships directly with product manufacturers, and we
expect that order fulfillment through Walsh Distribution will cease by the end
of the second quarter of 2000. Our business could be significantly disrupted
if RxAmerica, Rite Aid or, in the near term, Walsh Distribution were to breach
their contracts or suffer adverse developments that affect their ability to
supply products to us. In addition, RxAmerica is a joint venture owned by
American Stores Company (which was recently acquired by Albertson's, Inc.) and
Longs Drugs, both of which are potential competitors of drugstore.com, and
actual competitors with Rite Aid, one of our principal stockholders and
business partners. If for any reason RxAmerica, Rite Aid or Walsh Distribution
is unable or unwilling to supply products to us in sufficient quantities and
in a timely manner, we may not be able to secure alternative fulfillment
partners on acceptable terms in a timely manner, or at all. For a discussion
of certain potentially adverse developments at Rite Aid, see "--Our
Relationship with Rite Aid Involves Many Risks and May Restrict Our Ability to
Promote, Contract With, or Operate Traditional Retail Stores."
Because we rely primarily on third parties to fulfill orders, we depend on
their systems for tracking inventory and financial data. If our distribution
partners' systems fail or are unable to scale or adapt to changing needs, or
if we cannot integrate information systems with any new distributors, we may
not have adequate, accurate or timely inventory or financial information.
We also rely on third-party carriers for shipments to and from distribution
facilities and to customers. We are therefore subject to the risks, including
employee strikes and inclement weather, associated with our distribution
partners and of our carriers' ability to provide product fulfillment and
delivery services to meet our distribution and shipping needs. Failure to
deliver products to our customers in a timely and accurate manner would harm
our reputation, the drugstore.com brand and our results of operations.
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Opening and Operating Our Own Distribution Center Will Require Significant
Investments in Management Resources
We began limited operations at our own 290,000 square foot distribution
center in January 2000 to achieve greater control over the distribution
process and to ensure adequate supplies of products to our customers. Opening
and operating this distribution center will require additional capital
investments in facilities and equipment and will require us to:
. Hire and train a significant number of new employees;
. Establish a significant number of direct relationships with
manufacturers in the near term;
. Substantially increase our inventory levels in the near term;
. Effectively manage our product purchasing function and our inventory
levels to avoid product shortages or markdowns due to unpopular or
expired inventory; and
. Control product damage and shrinkage through effective security measures
and inventory management practices.
We have limited experience processing customer order fulfillment through our
distribution center and managing significant levels of inventory, and issues
arising with respect to the opening and operation of our distribution center
could divert management attention from other aspects of our business. In
addition, we may be unable to obtain products on terms as favorable as our
distribution partners. In connection with the opening of our distribution
center, we also expanded our pharmacy operations through our arrangement with
Rite Aid. Our pharmacy operations will subject us to additional regulatory
requirements and related costs.
We believe that our new distribution center will provide us with sufficient
distribution capacity for the foreseeable future. However, we may need to
increase our distribution capacity sooner than anticipated, and any further
expansion would require additional financing that may not be available to us
on favorable terms when required, or at all.
Any Errors in the Filling or Packaging of the Prescription Drugs We
Dispense May Expose Us to Liability and Negative Publicity
Pharmacy errors relating to prescriptions, dosage and other aspects of the
medication dispensing process can produce liability for us that our insurance
may not cover. For example, a study of community pharmacies appearing in the
December 1995 issue of American Pharmacy found that 24% of prescriptions
contained dispensing errors and 4% of prescriptions contained errors that were
clinically significant. Because we distribute pharmaceutical products directly
to the consumer, we are the most visible participant in the medication
distribution chain and therefore have more exposure to liability claims.
Our pharmacists are required by law to offer counseling, without additional
charge, to our customers about medication, dosage, delivery systems, common
side effects and other information deemed significant by the pharmacists. Our
pharmacists may have a duty to warn customers regarding any potential adverse
effects of a prescription drug if the warning could reduce or negate such
effects. This counseling is in part accomplished through e-mail and inserts
included with the prescription, which may increase the risk of
miscommunication because the customer is not personally present or may not
have provided all relevant information. We also post product information on
our Web store. Providing information on pharmaceutical and other products
creates the potential for claims to be made against us for negligence,
personal injury, wrongful death, product liability, malpractice, invasion of
privacy or other legal theories based on our product or service offerings. Our
general liability, product liability and professional liability insurance may
not cover potential claims of this type or may not be adequate to protect us
from all liability that may be imposed.
Pharmacy errors either by drugstore.com or our competitors may also produce
significant adverse publicity either for us or the entire online pharmacy
industry. Because of the significant amount of recent press coverage on
Internet retailing and online pharmacies, we believe that we will be subject
to a higher level of media scrutiny
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than other pharmacy product channels. The amount of negative publicity that we
or the online pharmacy industry receive as a result of pharmacy or
prescription processing errors could be disproportionate in relation to the
negative publicity received by other pharmacies making similar mistakes. We
have no control over the pharmacy practices of our competitors, and we cannot
ensure that our pharmacists or our prescription processing will be able to
operate without error. We believe customer acceptance of our online shopping
experience is based in large part on consumer trust, and negative publicity
could erode such trust, or prevent it from growing. This could result in an
immediate reduction in the amount of orders we receive and adversely affect
our revenue growth.
We Face the Risk of Systems Interruptions and Capacity Constraints on Our
Web Site, Possibly Resulting in Adverse Publicity, Revenue Losses and
Erosion of Customer Trust
The satisfactory performance, reliability and availability of our Web site,
transaction processing systems and network infrastructure are critical to our
reputation and our ability to attract and retain customers and to maintain
adequate customer service levels. Any future systems interruption that results
in the unavailability of our Web site or reduced order fulfillment performance
could result in negative publicity and reduce the volume of goods sold and the
attractiveness of our Web store, which could negatively affect our revenues.
From time to time, we have experienced temporary system interruptions for a
variety of reasons, including power failures, software bugs and an
overwhelming number of visitors trying to reach our Web site. We may not be
able to correct any problem in a timely manner. Because we outsource certain
aspects of our system and because some of the reasons for a systems
interruption may be outside of our control, we also may not be able to
exercise sufficient control to remedy the problem quickly or at all.
We opened our site for customers in February 1999 and to the extent that
customer traffic grows substantially, we will need to expand the capacity of
our systems to accommodate a larger number of visitors. Any inability to scale
our systems may cause unanticipated system disruptions, slower response times,
degradation in levels of customer service, impaired quality and speed of order
fulfillment, or delays in reporting accurate financial information. We are not
certain that we will be able to project the rate or timing of increases, if
any, in the use of our Web site accurately or in a timely manner to permit us
to effectively upgrade and expand our transaction-processing systems or to
integrate smoothly any newly developed or purchased modules with our existing
systems.
We Have Grown Very Rapidly, and We Need to Manage Changing and Expanding
Operations
We have rapidly and significantly expanded our operations, and anticipate
that we will continue to expand. Our number of employees has grown from 85 on
December 31, 1998 to 408 on January 2, 2000. This growth has placed, and our
anticipated future operations will continue to place, a significant strain on
our management systems and resources. We will not be able to implement our
business strategy in a rapidly evolving market without an effective planning
and management process. We will not be able to increase revenues unless we
continue to improve our transaction-processing, operational, financial and
managerial controls and reporting systems and procedures, expand, train and
manage our work force and manage multiple relationships with third parties.
Many of our senior management have no prior senior management experience at
public companies, and none of our executive officers have prior management
experience in the healthcare or retail drugstore industry.
Expanding the Breadth and Depth of Our Product and Service Offerings Is
Expensive and Difficult, and We May Receive No Benefit From Our Expansion
We intend to expand the breadth and depth of our product and service
offerings by promoting new or complementary products or sales formats. We
cannot be certain that these new offerings will generate sufficient revenues
for the costs involved. Expansion of our offerings in this manner could
require significant additional expenditures and could strain our management,
financial and operational resources. For example, we may need to incur
significant marketing expenses, develop relationships with new fulfillment
partners or manufacturers, or comply with new regulations. We cannot be
certain that we will be able to expand our product and service offerings in a
cost-effective or timely manner. Furthermore, any new product or service
offering or sales format
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that is not favorably received by consumers could damage the reputation of our
brand. The lack of market acceptance of such efforts or our inability to
generate satisfactory revenues from such expanded offerings to offset their
cost could harm our business. Finally, our agreement with Amazon.com contains
prohibitions that limit our ability to work with other companies in markets
for products and services that are competitive with those offered by
Amazon.com, although we are able to sell products and services in these
markets ourselves. See "--Our Relationship With Amazon.com May Restrict Some
of Our Activities."
Our Relationship With Amazon.com May Restrict Some of Our Activities
Our relationship with Amazon.com may restrict our activities and is subject
to change. We entered into a technology license and advertising agreement in
August 1998 with Amazon.com. In addition, in January 2000 we entered into a
three-year agreement with Amazon.com to integrate various shopping features of
our Web sites and create a persistent drugstore.com shopping presence on the
Amazon.com Web site. Amazon.com is currently our largest stockholder and
Jeffrey P. Bezos, Amazon.com's chairman of the board and chief executive
officer, is a member of our board of directors. Our relationship with
Amazon.com has received significant media attention, but the parties'
obligations to provide support to each other are limited.
Pursuant to these agreements, each party has committed to providing the
other with advertising on our respective Web sites. The agreement we entered
into in January 2000 contains provisions restricting the percentage of total
revenues we can obtain from the sale on our Web site of products or services
other than health, beauty, wellness, personal care and pharmaceutical
products. We may not assign this agreement without Amazon.com's consent. Under
the technology license and advertising agreement, we are restricted from
promoting on our Web site any company that sells products or services
competitive with those that Amazon.com offers or is preparing to produce or
market. If we were acquired by a competitor of Amazon.com and Amazon.com did
not vote in favor of the transaction, we would lose our rights to advertise on
Amazon.com's Web site and to use Amazon.com's technology (if we are then using
any). In addition, we have agreed not to sell advertising on our Web site to
any company that sells products or services competitive with those offered by
Amazon.com, although the sale of advertising on our Web site is not presently,
and is not expected to be, part of our business strategy.
In addition, due to Amazon.com's significant ownership of our common stock,
it will be able to significantly influence all matters requiring approval by
our stockholders, including the election of directors and the approval of
mergers or other business combination transactions.
Our Relationship with Rite Aid Involves Many Risks and May Restrict Our
Ability to Promote, Contract With, or Operate Traditional Retail Stores
In June 1999, we entered into a series of agreements with Rite Aid. These
agreements involve many aspects of our businesses and the operation of our
respective Web sites, the fulfillment of orders and the extension of Rite
Aid's insurance relationships to cover prescriptions processed by us. This
type of arrangement is complex and requires a great deal of effort to operate
successfully. As a result, there are many risks related to these arrangements,
including some that we may not have foreseen. It is difficult to assess the
likelihood of occurrence of these risks, including the lack of success of the
overall arrangement to meet the parties' objectives. In the event that we do
not realize the intended benefits of these relationships, we will have
expended a great deal of time and effort that could have been directed to more
beneficial activities. In addition, customer perceptions and our business may
be adversely impacted if these relationships are not successful.
While Rite Aid has committed to promoting drugstore.com in its stores and in
its advertising, we do not control the choice of ads that will feature us and
this form of advertising may not result in additional drugstore.com customers.
While the Rite Aid relationship substantially broadens our ability to provide
prescription medications to consumers with insurance reimbursement plans, it
may not allow all of our potential customers to purchase these medications
from drugstore.com and receive insurance reimbursement, which could adversely
affect consumer perceptions and our revenues. We have agreed not to promote
any other traditional chain drugstore or operate one ourselves. We have also
agreed not to contract with another traditional retail store
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to fill pharmacy product orders we receive unless a Rite Aid store is not
conveniently located. These restrictions could limit our flexibility and
ability to grow our business if our relationship with Rite Aid does not
develop successfully.
Rite Aid has recently received significant negative publicity regarding its
financial situation following its announcements regarding the restructuring
and extension of its banking facilities, including amendments to financial
covenants, the planned restatements of its 1999, 1998 and 1997 financial
statements and the resignation of its independent auditors in November 1999.
Rite Aid has since engaged new auditors and made significant changes to its
senior management team. Our relationship with Rite Aid is important to us,
particularly in our pharmacy fulfillment operations. If Rite Aid's financial
condition were to worsen, it may be unable to continue to fulfill its
obligations to us under our agreements, and this would have an adverse effect
on our business. In addition, negative publicity regarding Rite Aid could
negatively affect the drugstore.com brand and our stock price.
Rite Aid owns a significant percentage of our common stock and, as a result,
Rite Aid is able to significantly influence all matters requiring approval by
our stockholders, including the election of directors and the approval of
mergers or other business combination transactions.
We Are Dependent on Our Strategic Relationships to Help Promote Our Web
Site and Expand Our Product Offerings; If We Fail to Maintain or Enhance
These Relationships, Our Development Could Be Hindered
We believe that our strategic relationships with Amazon.com, Rite Aid, PCS
and GNC as well as portals and third party distributors are critical to
attract customers, facilitate broad market acceptance of our products and the
drugstore.com brand and enhance our sales and marketing capabilities. If we
are unable to develop or maintain key relationships, our ability to attract
customers would suffer and our business would be adversely affected. In
addition, we are subject to many risks beyond our control that influence the
success or failure of our strategic partners. Our business could be harmed if
any of our key strategic partners were to experience financial or operational
difficulties or if other corporate developments adversely affect their ability
to perform under our agreements.
We Face Uncertainty Related to Pharmaceutical Costs and Pricing, Which
Could Affect Our Revenues and Profitability
We expect that pharmacy sales will account for a significant percentage of
our total sales. Sales of our products will depend in part on the availability
of reimbursement from third-party payors such as government health
administration authorities, private health insurers, health maintenance
organizations (HMOs), PBMs and other organizations. Because these
organizations are traditionally focused on reduced cost to employer groups,
whereas we are focused more on direct customer service, we must devote time
and resources to develop third-party payor confidence in our approach.
In addition, third-party payors are increasingly challenging the price and
cost-effectiveness of medical products and services. The efforts of third-
party payors to contain costs will place downward pressures on profitability
from sales of prescription drugs. Our revenues from prescription drug sales
may also be affected by health care reform initiatives of federal and state
governments, including proposals designed to significantly reduce spending on
Medicare, Medicaid and other government programs, changes in programs
providing for reimbursement for the cost of prescription drugs by third-party
payors and regulatory changes related to the approval process for prescription
drugs. Such initiatives could lead to the enactment of federal and state
regulations that may adversely impact our prescription drug sales.
We cannot be certain that our products or services will be considered cost
effective or that adequate third-party reimbursement will be available to
enable us to maintain price levels sufficient to realize a profit.
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Competition From Both Traditional and Online Retailers May Result in Price
Reductions and Decreased Demand for Our Products and Services
We compete in a market that is highly competitive and expect competition to
intensify in the future. We currently or potentially compete with a variety of
companies, many of which have significantly greater financial, technical,
marketing and other resources. These competitors include (1) various online
stores that sell pharmaceutical as well as over-the-counter drug and health,
wellness, beauty and personal care items; (2) mail service pharmacies; and (3)
existing drugstores. Most of these drugstores, which include national,
regional and local drugstore chains, discount drugstores, supermarkets,
combination food and drugstores, discount general merchandise stores, mass
market retailers, independent drugstores and local merchants, have existed for
a longer period, have greater financial resources, have established marketing
relationships with leading manufacturers and advertisers, and have secured
greater presence in distribution channels. Some of these companies may also
commence or expand their presence on the Internet. We also compete with
hospitals, HMOs and mail order prescription drug providers, all of whom are or
may begin offering products and services over the Internet. Finally, we are
aware of numerous other smaller entrepreneurial companies that are focusing
significant resources on developing and marketing products and services that
will compete directly with those offered at drugstore.com.
We believe that there may be a significant advantage in establishing a large
customer base before our competitors do so. If we fail to attract and retain a
large customer base and our competitors establish a more prominent market
position relative to ours, this could inhibit our ability to grow.
We also believe we may face a significant competitive challenge from our
competitors forming alliances with each other. Our direct online competitors
may form partnerships with PBMs, HMOs or chain drugstores. For example,
PlanetRx, an online pharmacy, recently formed an alliance with Express
Scripts, a PBM. The combined resources of these partnerships could pose a
significant competitive challenge to drugstore.com. In addition, certain PBMs
and HMOs could form alliances with our competitors that would prevent them
from also entering into relationships with drugstore.com. Our inability to
partner with a major PBM or HMO could be a major competitive disadvantage to
us.
We believe the principal factors that will draw end users to an online
shopping application include brand availability, selection, personalized
services, convenience, price, accessibility, customer services, quality of
search tools, quality of content, and reliability and speed of fulfillment for
products ordered. We will have little or no control over how successful our
competitors are in addressing these factors. In addition, with little
difficulty, our online competitors can duplicate many of the products,
services and content offered on our site.
Increased competition could result in price reductions, fewer customer
orders, fewer search queries served, reduced gross margins and loss of market
share.
Acquisitions Could Result in Dilution, Operating Difficulties and Other
Harmful Consequences
If appropriate opportunities present themselves, we intend to acquire
complementary or strategic businesses, technologies, services or products. For
example, we recently acquired Beauty.com, an online retailer of prestige
beauty products. The process of integrating an acquired business, technology,
service or product into our business and operations may result in unforseen
operating difficulties and expenditures. Integration of an acquired company
may also require significant management resources that would otherwise be
available for ongoing development of our business. Moreover, the anticipated
benefits of any acquisition may not be realized or may depend on the continued
service of acquired personnel who could choose to leave. We currently do not
have any understandings, commitments or agreements with respect to any other
acquisition and no other material acquisition is currently being pursued.
Future acquisitions could also result in potentially dilutive issuances of
equity securities, the incurrence of debt, contingent liabilities or
amortization expenses related to goodwill and other intangible assets, any of
which could harm our business.
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Our Systems and Operations, and Those of Our Distributors, Are Vulnerable
to Natural Disasters and Other Unexpected Problems
Substantially all of our computer and communications hardware is located at
our leased facility in Bellevue, Washington and our systems infrastructure is
hosted at an Exodus Communications facility in Tukwila, Washington. Our
systems and operations are vulnerable to damage or interruption from fire,
flood, power loss, telecommunications failure, earthquakes and similar events.
In addition, our servers are vulnerable to computer viruses, physical or
electronic break-ins and similar disruptions, which could lead to
interruptions, delays, loss of data or the inability to accept and fulfill
customer orders. We do not currently have redundant systems or a formal
disaster recovery plan and do not carry sufficient business interruption
insurance to compensate for all losses that may occur. The facilities of our
current fulfillment partners, Walsh and RxAmerica, which are located in Texas,
as well as our distribution facility in New Jersey, also face these risks. In
particular, RxAmerica only has a single location and no back-up facility.
We depend on the efficient operation of Internet connections from customers
to our systems. These connections, in turn, depend on the efficient operation
of Web browsers, Internet service providers and Internet backbone service
providers, all of which have had periodic operational problems or experienced
outages. Any system delays, failures or loss of data, whatever the cause,
could reduce customer satisfaction with our applications and services and harm
our sales.
We retain confidential customer and patient information in our processing
centers. Therefore, it is critical that our facilities and infrastructure
remain secure and that our facilities and infrastructure are perceived by the
marketplace to be secure. A material security breach could damage our
reputation or result in liability to us.
Governmental Regulation of Our Business Could Require Significant Expenses,
and Failure to Comply With Certain Regulations Could Result in Civil and
Criminal Penalties
Our business is subject to extensive federal, state and local regulations.
In particular, entities engaging in the practice of pharmacy are subject to
federal and state regulatory and licensing requirements. Regulations in this
area often require subjective interpretation, and we cannot be certain that
our attempts to comply with these regulations will be deemed sufficient by the
appropriate regulatory agencies. Violations of any regulations could result in
various civil and criminal penalties, including suspension or revocation of
our licenses or registrations, seizure of our inventory, or monetary fines,
which could adversely affect our operations.
We are also subject to laws and regulations regarding homeopathic drugs, and
we may face enforcement actions, lawsuits or claims asserting that we have not
complied with these laws and regulations. As we expand our product and service
offerings, more of our products and services will likely be subject to
regulation by the FDA, which regulates drug advertising and promotion.
Complying with FDA regulations is time consuming, burdensome and expensive,
and could delay our introduction of new products or services.
The U.S. House of Representatives Committee on Commerce and the General
Accounting Office are conducting a review of online pharmacies, including the
current laws that govern pharmacy operations, and the potential for abuses by
some online sites, focusing on those that do not require the submission of a
valid prescription issued by the customer's physician. In addition, in
December 1999 the Clinton administration announced a proposal to eliminate
illegal sales of prescription drugs over the Internet by unlicensed Web site
operators. If approved by Congress, the proposal would, among other things,
establish new federal requirements for Internet pharmacies to ensure that they
comply with state and federal laws, create new civil penalties for the illegal
sale of pharmaceuticals, and authorize additional federal enforcement powers.
We believe that any regulations resulting from these investigations or the
Clinton administration's proposal will likely result in increased reporting
and monitoring requirements, which could be burdensome and increase our
expenses. Other legislation and regulations currently being considered at the
federal and state level could affect our business, including legislation or
regulations relating to confidentiality of patient records, including
electronic access and storage of such records, as well as the inclusion of
prescription drugs as a Medicare benefit. In addition, various state
legislatures are considering new legislation related to the regulation of
nonresident pharmacies. Compliance with new laws or regulations could increase
our expenses.
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The Health Insurance Portability and Accountability Act of 1996 mandates the
use of standard transactions, standard identifiers, security and other
provisions by the year 2000. Regulations have been proposed to implement these
requirements, and we are designing our applications to comply with the
proposed regulations. However, until these regulations become final, possible
changes in these regulations could cause us to use additional resources and
lead to delays as we revise our Web site and operations.
Until recently, Health Care Financing Administration guidelines prohibited
transmission of Medicare eligibility information over the Internet. We are
also subject to extensive regulation relating to the confidentiality and
release of patient records. Additional legislation governing the distribution
of medical records exists or has been proposed at both the state and federal
level. It may be expensive to implement security or other measures designed to
comply with any new legislation. Moreover, we may be restricted or prevented
from delivering patient records electronically. This could have an adverse
impact on our ability to gain and retain customers.
Failure to Attract and Retain Experienced Personnel and Senior Management
Could Hurt Our Ability to Grow Our Business
We intend to continue to hire a significant number of additional sales,
support and marketing personnel, as well as pharmacists, software developers
and personnel to staff our recently established distribution facility.
Competition for these individuals is intense, and we may not be able to
attract, assimilate or retain additional highly qualified personnel in the
future. Our future success also depends upon the continued service of our
executive officers and senior management. None of our employees is bound by an
employment agreement for any specific term. We do not have "key person" life
insurance policies covering any of our employees. In addition, none of the
members of our senior management team have prior experience in the healthcare
industry or in drugstore operations.
We Cannot Be Certain That We Will Be Able to Protect Our Intellectual
Property, and We May Be Found to Infringe Proprietary Rights of Others,
Which Could Harm Our Business
We rely or may in the future rely on a combination of patent, trademark,
trade secret and copyright law and contractual restrictions to protect our
intellectual property. These afford only limited protection. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy aspects of our sales formats or to obtain and use information that we
regard as proprietary, such as the technology used to operate our Web site,
our content and our trademarks.
We have filed applications for U.S. trademark registrations for
"drugstore.com" and twelve other trademarks. We may be unable to secure these
registrations. It is also possible that our competitors or others will adopt
service names similar to ours, thereby impeding our ability to build brand
identity and possibly leading to customer confusion. In addition, there could
be potential trade name or trademark infringement claims brought by owners of
other registered trademarks or trademarks that incorporate variations of the
term drugstore.com or our other trademark applications. Any claims or customer
confusion related to our trademarks, or our failure to obtain any trademark
registration, could negatively affect our business.
Litigation or proceedings before the U.S. Patent and Trademark Office may be
necessary in the future to enforce our intellectual property rights, to
protect our trade secrets and domain name and determine the validity and scope
of the proprietary rights of others. Any litigation or adverse priority
proceeding could result in substantial costs and diversion of resources and
could seriously harm our business and operating results. Finally, we may in
the future sell our products internationally, and the laws of many countries
do not protect our proprietary rights to as great an extent as do the laws of
the United States.
Third parties may also claim infringement by us with respect to past,
current or future technologies. We expect that participants in our markets
will be increasingly subject to infringement claims as the number of services
and competitors in our industry segment grows. Any such claim, whether
meritorious or not, could be time-consuming, result in costly litigation,
cause service upgrade delays or require us to enter into royalty or licensing
agreements. Such royalty or licensing agreements might not be available on
terms acceptable to us or at all.
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We May Not Be Able to Protect Our Domain Names In All Countries or Against
All Infringers, Which Could Decrease the Value of Our Brand Name and
Proprietary Rights
We currently hold the Internet domain name "drugstore.com," as well as
various other related names. Domain names generally are regulated by Internet
regulatory bodies. The regulation of domain names in the United States and in
foreign countries is subject to change. Regulatory bodies could establish
additional top-level domains, appoint additional domain name registrars or
modify the requirements for holding domain names. As a result, we may not
acquire or maintain the "drugstore.com" domain name in all of the countries in
which we conduct business.
The relationship between regulations governing domain names and laws
protecting trademarks and similar proprietary rights is unclear. Therefore, we
could be unable to prevent third parties from acquiring domain names that
infringe or otherwise decrease the value of our brand name, trademarks and
other proprietary rights.
We May Face Liability for Content on Our Web Site
Because we post product information and other content on our Web site, we
face potential liability for negligence, copyright, patent, trademark,
defamation, indecency and other claims based on the nature and content of the
materials that we post. Such claims have been brought, and sometimes
successfully pressed, against Internet content distributors. In addition, we
could be exposed to liability with respect to the unauthorized duplication of
content or unauthorized use of other parties' proprietary technology. Although
we maintain general liability insurance, our insurance may not cover potential
claims of this type or may not be adequate to indemnify us for all liability
that may be imposed. Any imposition of liability that is not covered by
insurance or is in excess of insurance coverage could harm our business.
Our Officers, Directors and Certain Existing Stockholders Control the
Majority of Our Common Stock, Which Could Discourage an Acquisition of Us
or Make Removal of Incumbent Management More Difficult
Executive officers, directors and entities affiliated with them beneficially
own approximately 74.2% of our outstanding common stock. These stockholders,
if acting together, would be able to significantly influence all matters
requiring approval by our stockholders, including the election of directors
and the approval of mergers or other business combination transactions. In
addition, Amazon.com beneficially owns approximately 26.8% and Rite Aid
beneficially owns 20.3% of our outstanding common stock. Therefore, Amazon.com
and Rite Aid will each be able to significantly influence all matters
requiring approval by our stockholders, including the election of directors
and the approval of mergers or other business combination transactions.
Amazon.com's and Rite Aid's substantial equity stakes in drugstore.com could
also make us a much less attractive acquisition candidate to potential
acquirors, because either Amazon.com or Rite Aid alone could have sufficient
votes to prevent the tax-free treatment of an acquisition.
We May Need Additional Capital in the Future to Support Our Growth, and
Such Additional Financing May Not Be Available To Us
Our available funds will not be sufficient to meet all of our long-term
business development requirements, and we may seek to raise additional funds
through public or private debt or equity financings in order to:
. Take advantage of favorable business opportunities, including
acquisitions of complementary businesses or technologies;
. Develop and upgrade our technology infrastructure;
. Enhance and increase our distribution capacity;
. Develop new product and service offerings; and
. Respond to competitive pressures.
We cannot assure you that any additional financing we may need will be
available on terms favorable to us, or at all.
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Our Net Sales Would Be Harmed if We Experience Significant Credit Card
Fraud
A failure to adequately control fraudulent credit card transactions would
harm our net sales and results of operations because we do not carry insurance
against this risk. Under current credit card practices, we are liable for
fraudulent credit card transactions because we do not obtain a cardholder's
signature.
Certain Antitakeover Provisions and Significant Equity Ownership by
Amazon.com and Rite Aid Could Preclude an Acquisition
Provisions of our certificate of incorporation, bylaws, Washington law and
Delaware law could make it more difficult for a third party to acquire us,
even if doing so would be beneficial to our stockholders. Further, because
Amazon.com and Rite Aid each own a significant percentage of our capital
stock, a competitor of Amazon.com or Rite Aid as well as other potential
acquirors could determine not to merge with or acquire us. In addition, if we
were acquired by an Amazon.com competitor and Amazon.com did not vote in favor
of the transaction, we would lose our rights to promotional placements on
Amazon.com's Web site, and to use Amazon.com's technology (if we are then
using any). The potential loss of these rights could inhibit offers to acquire
us.
We Depend on Continued Use of the Internet and Growth of the Online
Drugstore Market
Our future revenues and profits, if any, substantially depend upon the
widespread acceptance and use of the Internet as an effective medium of
business and communication by our target customers. Rapid growth in the use of
and interest in the Internet has occurred only recently. As a result,
acceptance and use may not continue to develop at historical rates, and a
sufficiently broad base of consumers may not adopt, and continue to use, the
Internet and other online services as a medium of commerce.
In addition, the Internet may not be accepted as a viable long-term
commercial marketplace for a number of reasons, including potentially
inadequate development of the necessary network infrastructure or delayed
development of enabling technologies and performance improvements. Our success
will depend, in large part, upon third parties maintaining the Internet
infrastructure to provide a reliable network backbone with the speed, data
capacity, security and hardware necessary for reliable Internet access and
services.
Further, the online market for drugstore products is in its infancy. The
market is significantly less developed than the online market for books,
auctions, music, software and numerous other consumer products. Even if use of
the Internet and electronic commerce continues to increase, the rate of
growth, if any, of the online drugstore market could be significantly less
than the online market for other products. Our rate of revenue growth could
therefore be significantly less than other online merchants.
Our Sales Could be Negatively Affected if We Are Required to Charge Taxes
on Sales
We do not collect sales or other similar taxes in respect of goods sold by
drugstore.com, except from purchasers located in the State of Washington.
However, one or more states or the federal government may seek to impose sales
tax collection obligations on out-of-state companies (such as drugstore.com)
that engage in or facilitate online commerce, and a number of proposals have
been made at the state and local level that would impose additional taxes on
the sale of goods and services through the Internet. Such proposals, if
adopted, could substantially impair the growth of electronic commerce, and
could adversely affect our opportunity to derive financial benefit from such
activities. Moreover, one or more states could begin to impose sales taxes on
sales of prescription products (which are not generally taxed at this time);
if so, customers who order prescriptions at our Web site and pick them up at a
local Rite Aid store would be required to pay state sales tax. A successful
assertion by one or more states or the federal government that we should
collect further sales or other taxes on the sales of products through
drugstore.com could negatively affect our revenues and business.
If We Do Not Respond to Rapid Technological Changes, Our Services Could
Become Obsolete and Our Business Would Be Seriously Harmed
As the Internet and online commerce industry evolve, we must license leading
technologies useful in our business, enhance our existing services, develop
new services and technology that address the increasingly
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sophisticated and varied needs of our prospective customers and respond to
technological advances and emerging industry standards and practices on a cost-
effective and timely basis. We may not be able to successfully implement new
technologies or adapt our Web store, proprietary technology and transaction-
processing systems to customer requirements or emerging industry standards. If
we are unable to do so, it could adversely impact our ability to build the
drugstore.com brand and attract and retain customers.
Governmental Regulation of the Internet and Data Transmission Over the
Internet Could Affect Our Business
Laws and regulations directly applicable to communications or commerce over
the Internet are becoming more prevalent. The most recent session of the U.S.
Congress resulted in Internet laws regarding children's privacy, copyrights,
taxation and the transmission of sexually explicit material. The European Union
recently enacted its own privacy regulations. In particular, many government
agencies and consumers are focused on the privacy and security of medical and
pharmaceutical records. The law of the Internet, however, remains largely
unsettled, even in areas where there has been some legislative action. It may
take years to determine whether and how existing laws such as those governing
privacy, libel and taxation apply to Internet stores such as ours. The rapid
growth and development of the market for online commerce may prompt calls for
more stringent consumer protection laws, both in the United States and abroad,
that may impose additional burdens on companies conducting business online and
in particular companies that fill prescriptions or maintain medical or
pharmaceutical records. The adoption or modification of laws or regulations
relating to Internet businesses could adversely affect our ability to attract
and serve customers.
Special Note Regarding Forward-Looking Statements
The foregoing discussion contains forward-looking statements that involve
risks and uncertainties. These statements relate to future events or our future
financial performance and include, but are not limited to, statements
concerning:
. The anticipated benefits and risks of our key strategic partnerships,
business relationships and acquisitions;
. Our ability to attract and retain customers;
. The anticipated benefits and risks associated with our business
strategy, including those relating to our distribution and fulfillment
strategy and our current and future product and service offerings;
. Our future operating results and the future value of our common stock;
. The anticipated size or trends of the market segments in which we
compete and the anticipated competition in those markets;
. Potential government regulation; and
. Our future capital requirements and our ability to satisfy our capital
needs.
Furthermore, in some cases, you can identify forward-looking statements by
terminology such as may, will, could, 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 specifically consider various factors, including the risks outlined
above. 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 to conform such statements to actual results or to changes in our
expectations.
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