UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended January 2, 2011
or
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
Commission File Number: 0-26137
drugstore.com, inc.
(Exact Name of Registrant as Specified in its
Charter)
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Delaware
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04-3416255
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(State or Other Jurisdiction of Incorporation or Organization)
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(I.R.S. Employer Identification No.)
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411 108
th
Avenue NE, Suite 1400
Bellevue, Washington 98004
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(425) 372-3200
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(Address of Principal Executive Offices)
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(Registrant’s telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class
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Name of Each Market on Which Listed
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Common Stock, par value $0.0001 per share
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NASDAQ Stock Market LLC
(NASDAQ Global Market)
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Securities registered pursuant
to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes
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No
x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes
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No
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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days. Yes
x
No
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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files). Yes
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No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-K or any amendment to this Form
10-K.
x
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
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Large Accelerated filer
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Accelerated filer
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Non-accelerated filer
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Smaller reporting company
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes
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No
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The aggregate market value of common stock held by non-affiliates of the registrant was $309,790,479 as of July 4, 2010, the last
business day of the registrant’s most recently completed second fiscal quarter.
As of March 4, 2011, the number of
shares of the registrant’s common stock outstanding was 105,911,293.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this annual report, to the extent not set forth in this annual report, is
incorporated by reference from the registrant’s definitive proxy statement relating to the registrant’s annual meeting of stockholders to be held on June 9, 2011, which definitive proxy statement will be filed with the Securities and
Exchange Commission within 120 days after the end of the fiscal year to which this annual report relates.
DRUGSTORE.COM, INC.
ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended January 2, 2011
Table of Contents
i
This Annual
Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements based on expectations, estimates, and projections as of the date of this filing. Actual results may differ materially from those expressed in
forward-looking statements. See item 1A of Part I—“Risk Factors.”
drugstore.com, inc. was incorporated in
April 1998 in the state of Delaware. We launched our web store at
www.drugstore.com
in February 1999 and completed our initial public offering in July 1999. Our common stock is listed on the NASDAQ Global Market under the symbol
“DSCM.” Our principal corporate offices are located in Bellevue, Washington. As used in this annual report, “drugstore.com,” “we,” “our,” and similar terms refer to drugstore.com, inc. and its subsidiaries,
unless the context indicates otherwise.
Business Strategy
Our business strategy is to offer our customers a wide selection of products at competitive prices and to provide a superior online shopping experience.
Convenience
. Our online stores are available to consumers 24 hours a day, seven days a week. All of our products are also
available for purchase by phone. We offer additional convenience to our customers through easy-to-use websites, robust search technology, and a variety of features such as:
Your List
, a personal shopping list of the customer’s previous
purchases that allows for quick and easy re-ordering, even without browsing the site;
Auto Delivery
, which enables customers to set up automatic shipments of frequently ordered products; the ability to schedule e-mail reminders about
previously purchased products that are scheduled to run out or are on sale; and an automated flexible spending account, or FSA, manager that keeps track of FSA-eligible purchases and provides customers with downloadable receipts to submit to their
FSA administrator.
Selection.
We are able to offer a significantly broader assortment of products, with greater depth
in each product category, because we do not have the shelf display space limitations of brick-and-mortar stores. With a single check-out, our customers are able to buy health, beauty and personal care products, prestige beauty brands, salon hair
care, natural products, and other specialty items. In addition, we offer contact lenses and customized nutritional supplement programs through our subsidiary websites.
Information
. We provide a broad array of interactive tools and information on our websites to help consumers make informed purchasing decisions. Our information services include detailed product
information pages; personalized product recommendations; customer reviews and other editorial content; the
eMedAlert
program, which alerts customers to safety issues such as FDA and product manufacturer recalls; and extensive health- and
pharmacy-related information, including a drug information database, a drug price index, information on generic drug alternatives, a drug interaction checker; and
Ask Your Pharmacist
, which is a database of over 800 frequently-asked questions
provided by pharmacists. Our customer care representatives are available to provide personal guidance and answer customers’ questions by phone, e-mail, and in some instances, instant chat while shopping our sites.
Privacy
. When shopping at a brick-and-mortar drugstore, many consumers may feel embarrassed or uncomfortable about buying items or
asking questions that may reveal personally sensitive aspects of their health or lifestyle to pharmacists, store personnel, or other shoppers. Our customers avoid these problems by shopping from the privacy of their home or office.
Value.
Our goal is to offer shoppers a broad assortment of health, beauty, clinical skincare, and vision products with competitive
pricing. We strive to improve our operating efficiencies and to leverage our fixed costs so that we can pass along the savings to our customers in the form of lower prices and exclusive deals. We also seek to inform customers of additional
cost-saving opportunities when they become available. For example, on our vision sites, we inform our customers of available rebates and volume purchase discounts.
1
Business Segments
In 2010, our over-the counter or OTC segment accounted for 84% of our net sales and our vision segment accounted for 16% of our net sales. See Note 13 of our consolidated financial statements included in
Part IV, Item 15 of this annual report. On July 30, 2010, we closed the sale of our mail-order pharmacy assets to BioScrip Pharmacy Services, Inc. (BioScrip) and entered into an agreement whereby BioScrip provides pharmacy services to
drugstore.com customers. Customers are able to continue to order and refill their prescriptions through the drugstore.com website, which are fulfilled by Bioscrip. All operations of our mail-order pharmacy segment have been presented as discontinued
operations for all periods presented.
OTC
We stock approximately 50,000 non-prescription health, beauty, personal care, household, and other products. We also offer approximately
20,000 products through our arrangements with drop-ship vendors. We offer OTC products in a variety of categories, including:
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• Personal Care
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• Diet and Fitness
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• Makeup and Accessories
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• Household
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• Hair Care
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• Pets
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• Skin Care
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• Baby and Mom
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• Men’s
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• Food and Snacks
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• Medicine and Health
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• FSA
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• Vitamins
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• Sexual Well-Being
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• Gifts
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• Toys and Games
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• Oral Care
• GNC
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• Beauty.com (prestige beauty products, also
accessible through
www.beauty.com
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• Green and Natural
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• SkinStore.com (clinical skincare and
beauty products, accessible through
www.SkinStore.com
and
spalook.com
)
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Through our
newly acquired subsidiary Salu Beauty, Inc. (Salu), we offer on
www.SkinStore.com
and through
www.spalook.com
, which we operate on behalf of a third party, over 200 premium brands of clinical skincare and beauty products typically
found only in luxury spas, fine stores, and dermatologists’ offices. Our beauty business, combined with the acquisition of Salu, is now one of the largest online beauty retailers offering mass and prestige brands, and clinical skincare
products.
We currently operate five microsites that we offer OTC products for sale, which allow us to better target specific
customers with tailored marketing programs by offering a larger assortment of niche-specific SKUs and product content. We also offer our OTC products for sale through various marketplaces and websites including Amazon.com and Buy.com, and in the
first quarter of 2011, we launched marketplaces on ShopRunner.com, Facebook.com and eBay.com.
In addition, we have partnered
with Medco Health Services, Inc. (Medco) and Rite Aid Corporation (Rite Aid) to provide technical development and operation services, consumer health products and OTC merchandising, fulfillment capabilities and customer care for the non-prescription
drug offerings on the Medco-branded and Rite Aid-branded online stores.
We also provide personalized nutrition services to
consumers in the form of an online assessment of an individual’s specific nutritional supplement needs, and deliver the personalized vitamins, minerals, herbs, and supplements in pharmaceutical-grade, daily dose packages. In addition, we act as
the exclusive fulfillment provider for customized nutritional supplements sold through
www.DrWeilVitaminAdvisor.com
,
www.DrWeil.com
, and other Dr. Weil-related websites.
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Vision
Through our subsidiary Vision Direct, we offer a broad assortment of contact lenses, in addition to reading glasses, contact lens cases,
and other contact lens supplies. We believe that we offer these products at a substantial price savings over eye care practitioners, national optical chains, and many online competitors.
In 2009, we entered into a strategic multi-year e-commerce partnership with Luxottica Group, S.p.A. (Luxottica), a global leader in the
design, manufacturing and distribution of fashion, luxury, and sport eyewear. Through this partnership, we will develop branded contact lens e-commerce sites for Luxottica’s North American businesses such as LensCrafters, Pearle Vision, and
Sears Optical. In January 2011, we launched two of the Luxottica-branded sites: www.lenscrafterscontacts.com and www.pearlevisioncontacts.com.
Our contact lens business is subject to the U.S. Fairness to Contact Lens Consumers Act, or FTCLCA, and the related regulations of the Federal Trade Commission, or FTC, which establish a national uniform
standard for eye care practitioners and direct marketers with respect to the sale of contact lenses, including verification of contact lens prescriptions. In accordance with these guidelines, we ask the patient’s eye care professional to verify
the prescription before we ship an order and allow eight business hours for the eye care professional to reply to our verification request. If the eye care professional approves the prescription, or does not respond to our verification request
within eight business hours, we ship the order to the customer as expressly permitted by the FTCLCA.
Marketing and Promotions
Our marketing and promotion strategy is designed to build brand recognition, increase customer traffic to our store, add
new customers, build strong customer loyalty, maximize repeat purchases, and develop incremental revenue opportunities. Our online advertising campaigns are focused on search engines, frequently visited Internet portals, health- and beauty-related
websites, and direct-to-consumer e-mail marketing programs. We further extend our online market presence through our affiliate program, through which we permit certain websites to make our products and services available to their audiences through
links to our websites.
We also employ a variety of marketing programs and promotions, such as discounted and free shipping
promotions, dollar off and percentage discounts, free gifts with purchase, and the drugstore.com dollars™ program, a loyalty program in which customers automatically earn a five percent rebate to be used for future non-prescription purchases.
Fulfillment and Customer Care
Order Fulfillment
We process most OTC orders from our primary
distribution center in Swedesboro, New Jersey, and in January 2010, we moved the processing of all vision orders from our distribution center in Ferndale, Washington to our primary distribution center in Swedesboro, New Jersey. We also process
drop-ship orders for certain OTC products and arrange for our drop-ship vendor partners to ship these products directly from the vendor’s warehouse. Due to the relatively short lead time required to fill orders for our products, usually 24 to
48 hours, order backlog is not material to our business.
We ship OTC products to U.S., U.S. Territory, and APO/FPO military
addresses. In addition, through an agreement with FiftyOne, Inc., we offer international shipment of select OTC health, beauty, and wellness products to 56 countries, and expect to expand to more countries over time. Vision Direct ships contact
lenses and other vision products worldwide, primarily to the United States and Canada.
We use third-party fulfillment
partners in Columbus, Ohio, and Australia to process and ship Salu orders.
3
Customer Care
Our customer care representatives operate from our call center in Halifax, Nova Scotia, Canada, from our headquarters in Bellevue,
Washington, and from our Sacramento, California office. Our customer care specialists are available 24 hours a day, seven days a week via e-mail or telephone to handle customer inquiries and assist customers in finding desired products. The
Help sections of our websites outline store policies and provide answers to customers’ frequently asked questions.
Technology
We have implemented a broad array of services and systems for site management, product searching, customer interaction,
transaction processing, and order fulfillment functions. These services and systems use a combination of our own proprietary technologies and commercially available, licensed technologies. We focus our internal development efforts on creating and
enhancing the specialized, proprietary software that is unique to our business. For example, our core merchandise catalog, customer interaction, order collection, fulfillment, and back-end systems are proprietary to drugstore.com. Our systems are
designed to provide real-time connectivity to the distribution center systems for both vision and OTC products. They include an inventory-tracking system, a real-time order tracking system, an executive information system, and an inventory
replenishment system.
We license database, operating system, and hardware components from third parties.
Competition
The market
for health, beauty, wellness, and vision products is intensely competitive and highly fragmented. Our competitors in the OTC segment include chain drugstores, mass market retailers, warehouse clubs, supermarkets, and, with respect to prestige
beauty, health, and spa products, specialty retailers and major department stores. Our competitors in the vision segment include other online providers of contact lenses, national optical chains, eye care professionals, and mass-market retailers and
warehouse clubs that provide prescription vision services. In addition, we compete with Internet portals and online service providers that feature shopping services and with other online or mail-order retailers that offer products within one or more
of our business segments.
During the recent economic conditions, we have seen and expect to see continued price competition
and elevated response rates to coupons and other promotional offers by increasingly price-conscious customers. That said, we have found that overall orders are less affected in periods of economic slowdown, due in part to our value-pricing and the
non-discretionary nature of many of our products.
We believe that the principal competitive factors in our market segments
include: brand awareness and preference, company credibility, product selection and availability, convenience, price, actual or perceived value, website features, functionality and performance, ease of purchasing, customer service, privacy, quality
and quantity of information supporting purchase decisions (such as product information and reviews), and reliability and speed of order shipment.
Intellectual Property
We regard our intellectual property as critical to
our future success; and we rely on a combination of patent, copyright, trademark, service mark, and trade secret laws, as well as contractual restrictions to establish and protect our proprietary rights in products and services. We own a number of
domain names, hold nine patents, have registered several trademarks, and have filed applications for the registration of a number of our other trademarks and service marks in the United States as well as several other countries. We have licensed in
the past, and expect to license in the future, some of our proprietary rights to third parties.
4
Seasonality
Our OTC business is subject to seasonal variations in demand. Historically, the fourth quarter of each year has been our strongest OTC sales quarter, primarily because of increased online shopping and our
greater marketing efforts during the holiday season as well as increased purchases by customers using funds from flexible spending accounts. We do not believe that our vision segment is substantially affected by seasonality.
Employees
As of
January 2, 2011, we had approximately 945 full-time employees. However, employment levels fluctuate due to seasonal variations in our OTC business, and we hire independent contractors and temporary employees as needed to address demand. None of
our employees is represented by a labor union, and we consider our employee relations to be good.
Available Information
We file with, and furnish to, the Securities and Exchange Commission, or SEC, periodic reports, proxy statements, and other information.
We make these documents available, free of charge, on our website at
www.investor.drugstore.com
as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC.
Directors and Officers
The following tables provide information regarding our directors and officers as of the date of this annual report:
Directors
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Name
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Age
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Position
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Dawn G. Lepore
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56
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President, Chief Executive Officer and Chairman of the Board, drugstore.com, inc.
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Richard W. Bennet III
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CEO, CCA Global Partners
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Geoffrey R. Entress
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47
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Venture Partner, Voyager Capital
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Jeffrey M. Killeen
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57
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Chairman and CEO, GlobalSpec, Inc.
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William D. Savoy
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Consultant
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Gregory S. Stanger
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46
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Chief Financial Officer, Chegg, Inc.
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Executive Officers
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Name
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Age
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Position
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Dawn G. Lepore
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56
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President, Chief Executive Officer, and Chairman of the Board
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Yukio Morikubo
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Vice President, Strategy, General Counsel and Secretary
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Robert Potter
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Vice President, Chief Accounting Officer
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Tracy Wright
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Vice President, Chief Finance Officer
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Dawn G. Lepore
has served as President, Chief Executive Officer and Chairman of the Board of drugstore.com since October 2004.
Ms. Lepore served as Vice Chairman—Active Trader, Technology, Operations, Administration and Business Strategy of The Charles Schwab Corporation, or CSC, from August 2003 to October 2004. CSC, through Charles Schwab & Co., Inc.,
or Schwab, and its other operating subsidiaries, is a financial services firm. Ms. Lepore served as Vice Chairman—Technology, Active Trader, Operations, and Administration of CSC and Schwab from May 2003 until August 2003, as Vice
Chairman—
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Technology, Operations and Administration of CSC and Schwab from July 2002 until May 2003, as Vice Chairman—Technology and Administration of CSC and Schwab from 2001 to 2002, as Vice
Chairman and Chief Information Officer of CSC and Schwab from 1999 to 2001 and as Executive Vice President and Chief Information Officer of CSC and Schwab from 1993 to 1999. She joined Schwab in 1983. Ms. Lepore serves as a director of
eBay Inc. and The New York Times Company.
Yukio Morikubo
has served as Vice President, General Counsel and Secretary
of drugstore.com since November 2006 and as Vice President, Strategy since April 2007. From April 2005 to September 2006, Mr. Morikubo was Vice President, General Counsel and Corporate Secretary of Advanced Digital Information Corporation, a
provider of intelligent data storage hardware and software solutions that was acquired in August 2006 by Quantum Corporation. He served as Chief Counsel, International of Cingular Wireless, LLC, formerly AT&T Wireless Services, Inc., a
wireless service provider, from 1996 to 1999 and again from 2000 until April 2005. Mr. Morikubo previously practiced with the law firm of Perkins Coie LLP and served as an auditor and tax consultant with KPMG LLP.
Robert Potter
has served as Vice President, Chief Accounting Officer of drugstore.com since May 2008, Chief Accountant since
December 2006, and as Senior Director and Corporate Controller for drugstore.com from 2004 to 2006. Prior to joining drugstore.com, he served as Corporate Controller for Midstream Technologies, Inc., a technology company, from 2000 to 2004.
Mr. Potter previously held senior positions with Mosaix, Inc., PHAMIS, Inc., Aldus Corporation and Ernst & Young LLP.
Tracy Wright
has served as Vice President, Chief Finance Officer of drugstore.com since May 2008, Vice President of Financial Planning and Analysis since August 2007, and as Senior Director of
Financial Planning and Analysis from 2003 to July 2007. Prior to joining drugstore.com, Ms. Wright held financial leadership roles at Western Wireless International, Freeinternet.com, and PriceWaterhouseCoopers LLP.
Non-Executive Officers
Jon Axelsson
has served as Vice President of Operations since June 2009. Mr. Axelsson joined drugstore.com in 2008. Prior to joining drugstore.com Mr. Axelsson held management positions with Wawa,
Inc., QVC, Inc., May Department Stores, and UPS.
Perry Evoniuk
has served as Vice President, Enterprise Architecture
since January 2009. Mr. Evoniuk joined drugstore.com in 1999 and has held several positions managing development and implementation of our web store infrastructure. Prior to joining drugstore.com, Mr. Evoniuk served in research and
development positions at Attachmate Corporation, a host connectivity provider, and at Hughes Aircraft, an aerospace and defense company.
Clifford Cancelosi
was appointed to Vice President and Chief Information Officer of drugstore.com in February 2011. Prior to joining drugstore.com, Mr. Cancelosi led the technology and
eCommerce strategy group for Alvarez & Marsal, and served senior leadership roles in the Operations and Merchant Technologies divisions of Amazon.com.
Julie Johnston
has served as Vice President, OTC Merchandising of drugstore.com since December 2006 and as the Senior Category Manager for Personal Care with drugstore.com from 2000 to 2006. From
1992 to 1999, Ms. Johnston served in a number of positions at Sears, Roebuck and Co., an international department store company, including Senior Buyer from 1996 to 1999.
Ronald E. Kelly
has served as Vice President, Customer Care and Logistics of drugstore.com since June 2006, and as Senior Director of Site Development and Customer Care and Logistics for
drugstore.com from 2003 to 2006. From 2001 to 2003, he served as Director of Customer Care with drugstore.com. From 1999 to 2001, Mr. Kelly served as a Senior Financial Analyst and later as Director of Procurement for drugstore.com.
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David Lonczak
has served as our Chief Marketing Officer since March 2007 and has
served as our Vice President, Marketing since December 2006. In early 2006, Mr. Lonczak began serving as Senior Director of Marketing in Pharmacy for drugstore.com, and served as General Manager of Vision for drugstore.com from 2005 to 2006.
From 2002 to 2005, Mr. Lonczak served in a number of positions with Cingular Wireless, LLC, formerly AT&T Wireless Services, Inc., a wireless service provider, including Vice President, eCommerce from 2004 to 2005.
Kathleen McNeill
has served as our Vice President of Beauty since December 2006. Ms. McNeill joined drugstore.com in June
2006 as our General Manager, Beauty. From 2005 to June 2006, Ms. McNeill served as Vice President of Flagship Stores with Bath and Body Works, a division of Limited Brands, Inc., a specialty retail company. From 2000 to 2005, Ms. McNeill
served in a number of positions, including Skincare Merchandise manager with Sephora, USA, Inc., the cosmetic retailer division of Moët Hennessy Louis Vuitton, an international luxury products retailer.
Stan Pavlovsky
has served as Vice President, Vision Direct, since January 2009. Mr. Pavlovsky joined drugstore.com in 2004,
in our financial planning and analysis group before moving over to our vision business. Prior to joining the company, Mr. Pavlovsky held positions in financial and business analysis at Microsoft Corporation, a software company, and The Boeing
Company, an aerospace company and aircraft manufacturer.
Jim Steeb
serves as our chief executive officer of Salu
Beauty, Inc., (Salu) a wholly-owned subsidiary of drugstore.com inc., acquired in 2010. Mr. Steeb has more than 25 years of experience in executive management, marketing, finance and IT. He joined Salu as CEO and president in 1999. Previously
he held leadership positions with Care Wise, Inc., Access Health, Inc., and Baxter Healthcare Corporation.
Ramer Holtan
was appointed to Vice President, Marketing in November 2010. Mr. Holtan joined drugstore.com in 2000 as a financial analyst and moved to marketing in 2001, where he has held management positions in the areas of retention marketing, pricing
strategy, and marketing analytics, as well as serving as general manager of Vision from 2004 to 2005. Prior to joining drugstore.com, Mr. Holtan spent five years working for Arthur Andersen LLP in the Economic and Financial Consulting group.
You
should carefully consider the following risks and uncertainties associated with our company and ownership of our securities. If any of the following risks actually occurs, our business, financial condition, or operating results could be materially
adversely affected. This could cause the trading price of our common stock to decline, and you could lose all or part of your investment. Some statements in this annual report (including some of the following risk factors) are forward-looking
statements. See the section entitled “Special Note Regarding Forward-Looking Statements” in Part I, Item 1 of this annual report.
We face significant competition from both traditional and online retailers.
The market segments in which we compete are rapidly evolving and intensely competitive, and we have many competitors in different industries, including both the retail and e-commerce services industries.
These competitors include chain drugstores, mass-market retailers, warehouse clubs, supermarkets, specialty retailers, major department stores, insurers and health care providers, national optical chains, eye care professionals, Internet portals and
online service providers that feature shopping services, and various online stores that offer products within one or more of our product categories. Many of our current and potential competitors have longer operating histories, larger customer
bases, greater brand recognition, and significantly greater financial, marketing, and other resources than we have. They may be able to secure merchandise from vendors on more favorable terms, operate with a lower cost structure, adopt more
aggressive pricing policies, or devote more
7
resources to technology development and marketing than we do. To the extent we can respond with more aggressive discounts, shipping rates, or other promotions, we cannot ensure that these will be
successful and in any event, our margins will be negatively affected. In addition, other companies in the retail and e-commerce service industries may enter into business combinations or alliances that would strengthen their competitive positions
and prevent them, their affiliated companies, or their strategic partners from entering into relationships with us.
As
various Internet market segments obtain large, loyal customer bases, participants in those segments may expand into the market segments in which we operate. In addition, new and expanded Web technologies may further intensify the competitive nature
of online retail and allow our competitors to duplicate many of the products, services, and content offered on our site. We believe that the Internet facilitates entry into the retail market and comparison shopping and renders it inherently more
competitive than conventional retailing formats. We expect competition in the e-commerce channel to intensify, and this increased competition may reduce our ability to grow and, as a result, reduce our revenue, increase our operating expenses, or
both, and harm our business.
Our revenue growth and profitability depends on the continued growth of demand for the products we offer.
Demand for many of our products, and, therefore, our business, is affected by changes in consumer preferences, general
economic and business conditions, and world events. For example, macro-economic trends in the United States and abroad, threatened or actual terrorist attacks or armed hostilities (or the resulting security concerns), or natural disasters could
create economic and consumer uncertainty and delays in and increased costs of product shipments to and from us, which may decrease demand. A softening of demand, for whatever reason, may result in decreased revenue or growth, which could prevent us
from achieving or sustaining profitability. Revenue growth or profitability may not be sustainable and our company-wide and by-segment percentage growth rates may decrease in the future.
Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors, including:
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our ability to retain and increase sales to existing customers, attract new customers, and satisfy our customers’ demands;
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the frequency and size of customer orders and the quantity and mix of products our customers purchase;
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changes in consumer acceptance and usage of the Internet, online services, and e-commerce;
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the price we charge for our products and for shipping those products, or changes in our pricing policies or the pricing policies of our competitors;
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the extent to which we offer our customers, and our customers take advantage of, free shipping or other promotional discounts;
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our ability to acquire merchandise, manage inventory, and fulfill orders;
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technical difficulties, system downtime, or interruptions;
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timing and costs of upgrades and developments in our systems and infrastructure;
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timing and costs of marketing and other investments;
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disruptions in service by shipping carriers;
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the introduction by our competitors of websites, products, or services;
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changes in the mix of products purchased by our customers (for example, if our OTC net sales do not grow as much as we anticipate or the proportion of
OTC net sales compared to net sales in vision segments is lower than we anticipate, our margins will be lower than we currently plan);
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the effects of strategic alliances, potential acquisitions, and other business combinations, and our ability to successfully and timely integrate them
into our business; and
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changes in government regulation.
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In addition, 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.
A portion of our revenues is also seasonal in
nature. Traditional retail seasonality affects our OTC business, resulting in higher revenues in the fourth quarter of each year as compared to other quarters. We may be unable to manage the increased sales effectively, and increases in inventory in
anticipation of holiday sales could negatively affect our cash flow. In addition, sales of some health and beauty products are driven, to some extent, by seasonal purchasing patterns and seasonal product changes, such as diet products, cold and flu
medications, and products with holiday-specific varieties. Consumer fads and other changes in consumer trends may also cause shifts in purchasing patterns, resulting in significant fluctuations in our operating results from one quarter to the next.
Our evolving business model and the unpredictability of our industry make it difficult for us to forecast accurately the
level or source of our revenues and our rate of growth. We believe that, because of these factors, historical trends and quarter-to-quarter comparisons of our operating results are not necessarily meaningful and should not be relied on as an
indicator of our future performance. In the past, our operating results have sometimes been, and it is likely that in some future quarter or quarters they will be, below the expectations of investors and securities analysts. In that event, the price
of our common stock may fall substantially, and stockholders may lose all or a part of their investment.
If our marketing efforts are
not effective at attracting and retaining customers at an acceptable cost, we will be unable to achieve consistent profitability.
If we do not maintain our brand and continue to increase awareness of our products and services, we may not build a critical mass of customers. Promoting and positioning our brand depends largely on the
success of our marketing efforts and our ability to provide consistent, high quality customer experiences. We believe that, because we are a small company with low public brand awareness in an increasingly competitive market, achieving significant
market awareness will require significant marketing expense. To promote our brand and our products and services, we have incurred and expect to continue to incur substantial expense in our marketing efforts both to attract and to retain customers.
Our promotional activities may not be effective at building our brand awareness and customer base to the extent necessary to generate sufficient revenue to become consistently profitable. Search engine and other online marketing initiatives comprise
a substantial part of our marketing efforts, and our success depends in part on our ability to manage costs associated with these initiatives, or to find other channels to acquire and retain customers cost-effectively. The demand for and cost of
online advertising has been increasing and may continue to increase. An inability to acquire and retain customers at a reasonable cost would increase our operating costs and prevent us from maintaining profitability.
If we fail to integrate, maintain or enhance our strategic relationships to help promote our website and expand our product offerings, our
development could be hindered.
We have entered, or expect to enter, into a number of strategic partnerships to build,
host, and market websites and to process and fulfill orders, most recently, with Rite Aid Corporation, Medco Health Solutions, Inc., Luxottica Group S.p.A., and BioScrip Pharmacy Services, Inc. We believe that our relationships with these and other
strategic partners, Internet portals, third-party distributors, and manufacturers are critical to attract customers, to facilitate broad market acceptance of our products and the drugstore.com brands, and to enhance our sales and marketing
capabilities. We expect to continue to evaluate and consider a wide array of potential strategic partnerships as part of our growth strategy. Any of these transactions could be material to our financial
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condition and results of operations. If we are unable to develop or maintain key relationships, our ability to attract customers would suffer and our business would be adversely affected. The
process of integrating and maintaining strategic partnerships may create unforeseen operating difficulties and expenditures and is itself risky. Such risks include a diversion of management time, as well as a shift of focus from operating the
businesses, to issues related to integration and administration of the strategic partnerships; partners’ having interests, strategies or goals inconsistent with ours; business decisions or other actions of our partners that may result in harm
to our reputation or adversely affect the value of our investment in the partnership. Such partnerships require a significant investment of time and resources, and we may not generate sufficient revenues to offset this investment. We may incur
additional operating losses and expenses as a result of the operations of the strategic partners or the partnerships. In addition, we are subject to many risks beyond our control that influence the success or failure of our strategic partners or
partnerships, including their ability to perform according to our partners’ and our expectations. Our business could be harmed if any of our strategic partners were to experience financial or operational difficulties or if other corporate
developments adversely affect their performance under their agreements with us.
Our future growth strategy may depend in part on our
ability to acquire complementary or strategic businesses. Any such acquisitions could result in dilution, operating difficulties, difficulties in integrating acquired businesses, and other harmful consequences.
We have acquired, and may in the future acquire, complementary or strategic businesses, technologies, services, and products as part of
our strategy to increase our net sales and customer base. The process of integrating acquisitions into our business and operations has resulted in, and may in the future result in:
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unforeseen operating difficulties and expenditures;
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disruption of our ongoing business, including loss of management focus on existing businesses and resources that would otherwise be available for
operation, ongoing development and expansion of our business;
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problems retaining key personnel of the businesses that we acquire;
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additional operating losses and expenses of the businesses we acquired or in which we invested;
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the potential impairment of tangible assets, such as inventory, and intangible assets and goodwill acquired in the acquisitions;
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the potential impairment of customer and other relationships of the business that we acquired or in which we invested or our own customers as a result
of any integration of operations;
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the difficulty of incorporating acquired technology and rights into our offerings and unanticipated expenses related to such integration;
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the difficulty of integrating a new company’s accounting, financial reporting, management, information, human resource and other administrative
systems to permit effective management, and the lack of control if such integration is delayed or not implemented; and
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the difficulty of implementing at companies we acquire the controls, procedures and policies appropriate for a larger public company.
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To the extent we miscalculate our ability to integrate and properly manage acquired businesses,
technologies, services, and products, or we depend on the continued service of acquired personnel who choose to leave, we may have difficulty in achieving our operating and strategic objectives. In addition, we may not realize the anticipated
benefits of any acquisition.
We may be subject to unanticipated problems and liabilities of acquired companies. While we
attempt in our acquisitions to determine the nature and extent of any pre-existing liabilities, and to obtain indemnification rights
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from the previous owners for acts or omissions arising prior to the date of acquisition, resolving issues of liability between the parties could involve a significant amount of time, manpower and
expense. If we or any of our subsidiaries were to be unsuccessful in a claim for indemnity from the seller of a business that we acquire, the liability imposed on us or our subsidiary could have a material adverse effect on us. We may not be able to
assimilate successfully the additional personnel, operations, acquired technology or products or services into our business. Further, the physical expansion in facilities that could occur as a result of any acquisition may result in disruptions that
could seriously impair our business. In addition, due to the recent disruptions in the global financial markets, valuations supporting our acquisitions could change rapidly, and we could determine that such valuations have experienced impairments
which could adversely impact our financial results.
We may be unable to identify suitable acquisition opportunities or to
negotiate and complete acquisitions on favorable terms, or at all. In addition, any future acquisitions may require substantial capital resources, and, to the extent it is available, we may need to obtain additional capital or financing, from time
to time, to fund these activities. This could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities, or amortization or impairment expenses related to goodwill and other intangible assets,
any of which could harm our business, financial condition, and results of operation. Sufficient capital or financing may not be available to us on satisfactory terms, or at all.
In connection with our acquisition of Salu, Inc., now Salu Beauty, Inc., we have entered a new line of business – clinical skincare and spa products – with greater targeted international
operations. We cannot assure you that our expansion into this business line will succeed.
We recently entered the
clinical skincare and spa products business with our acquisition of Salu, Inc., now Salu Beauty, Inc. We cannot assure that our expansion into these businesses will succeed. We have limited experience in the sale of clinical skincare and spa
products, particularly to targeted international markets. While we have operations in Canada, we have not previously had operations outside of North America. Our entry into this area will require us to devote substantial financial, technical,
managerial and other resources. As noted above, international expansion comes with substantial risks. We may not be able to successfully integrate the additional personnel, operations, acquired technology or products or services of Salu into our
business and there is no guarantee that key personnel of Salu will continue to work for us.
In addition, in connection with
the acquisition, certain senior management employees of Salu will be eligible to receive performance incentive payments in cash for each of the 2010 and 2011 fiscal years with an aggregate value of up to $2.5 million if certain financial performance
targets are achieved. These bonuses may limit our cash available to make future acquisitions and operate our business, and may affect our ability to obtain alternative financing. It is uncertain whether we will benefit financially from this
acquisition.
We are expanding into international markets, causing our business to be increasingly susceptible to international business
risks and challenges that could affect our profitability.
Through our contract with FiftyOne, Inc. and certain
operations of our newly acquired subsidiary, Salu, Inc., now Salu Beauty, Inc., we sell certain OTC products in international markets and expect to expand into international markets more aggressively in the future. To date, our international
business activities have been limited. Our lack of a track record outside the United States increases the risks described below. In addition, our experience in the United States may not be relevant to establishing a business outside the United
States. Accordingly, our international expansion strategy is subject to significant execution risk, and we cannot assure that our strategy will be successful. International sales are subject to inherent risks that could adversely affect our
operating results, including:
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the risk that our marketing strategies will not translate well to international markets and that we will need to expend resources to adapt those
strategies for a variety of new markets;
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the need to develop new supplier and manufacturer relationships;
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the need to comply with additional U.S. and foreign laws and regulations to the extent applicable, including but not limited to, restrictions on
advertising practices, regulations governing online services, restrictions on importation of specified or proscribed items, importation quotas, consumer protection laws, enforcement of intellectual property rights, laws dealing with consumer and
data protection, privacy, encryption, and restrictions on pricing or discounts;
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unexpected changes in international regulatory requirements and tariffs, and geopolitical events such as war and terrorist attacks;
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managing fluctuations in currency exchange rates;
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difficulties in staffing and managing foreign operations;
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greater difficulty in accounts receivable collection from overseas customers;
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potential adverse tax consequences in the U.S. and in foreign jurisdictions; and
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uncertain political and economic climates.
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To the extent we generate significant international sales, any negative impact on our international operations could negatively affect our revenues and operating results. In addition, it is costly to
establish, develop, and maintain international operations and websites that promote our brand internationally, which could further harm our revenues and operating results.
If the recent global economic crisis has a disproportionate impact on our business or that of our significant partners and suppliers, our business and results of operations would be harmed.
Deterioration in the U.S. and global credit markets and the financial services industry could negatively affect our
business or that of our significant partners and suppliers. Tightening of credit and the recent decline in the housing market has led to a lack of consumer confidence and a reduction in business activity generally, which could significantly harm our
revenues and operating results. In addition, our vendors could experience serious cash flow or other financial or operational problems due to the current economic conditions. As a result, our vendors may attempt to increase prices, alter payment
terms, or seek other relief in order to offset these problems. Vendors may further be forced to reduce production, shut down operations or file for bankruptcy protection, which in some cases could have a significant impact on our ability to serve
the market’s needs. In addition, access to credit from financial institutions may not be available. We do not expect the current economic conditions to improve significantly in the near future, and any continuation and/or worsening of the
economic environment could intensify the adverse affects of these difficult market conditions.
We may be unable to obtain the
additional capital we need in the future to support our growth.
Our available funds may 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. Due to the recent tightening of the credit and equity markets, any additional financing that we may
need may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our strategic flexibility or ability to develop and grow our business may be significantly limited. In March
2011, we entered into a loan and security agreement with our existing bank, which includes a revolving three-year line of credit allowing for borrowings up to $40.0 million, which accrue interest at LIBOR plus 2.5% – 3%, or prime plus
0% – 0.5%. This agreement replaced our two-year $25.0 million line of credit scheduled to mature in March 2011. As of January 2, 2011, $13.0 million was outstanding under the line of credit, which was refinanced under the new
three-year line of credit maturing in March 2014.
Advances available under the revolving line of credit are limited, based on
eligible inventory, accounts receivable, cash and investment balances, and balances outstanding under our line of credit. The agreement contains certain covenants that are customary in transactions of this nature, including a prohibition on other
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and liens, requirements regarding the payment of taxes, and certain restrictions on mergers and acquisitions, investments, and transactions with our affiliates, as well as certain financial
covenants. The agreement identifies certain events of default that are customary for transactions of this nature and subject to materiality provisions and grace periods where appropriate, including failure to pay any principal or interest under this
facility or other instruments when due, the occurrence of a material adverse change, violations of any covenants, a material cross-default to our other debt, or a change of control. In the event we are not in compliance with certain financial
covenants contained in the line of credit agreement, and are unable to obtain a waiver from the bank, borrowing available under the line of credit may be suspended until such time the covenant violations are remediated.
There are risks associated with our indebtedness.
At January 2, 2011, we had $14.6 million of debt obligations outstanding, as well as $26.5 million of available borrowing capacity under our existing three-year line of credit. We may incur
additional indebtedness in the future, including under our revolving line of credit, through additional capital leases, or through public or private offerings of debt securities. Our outstanding indebtedness and any additional indebtedness we incur
may have important consequences, including, without limitation, the following:
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we will be required to use cash to pay the principal of and interest on our indebtedness;
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our indebtedness and leverage may increase our vulnerability to adverse changes in general economic and industry conditions, as well as to competitive
pressure;
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our ability to obtain additional financing for working capital, capital expenditures and for general corporate and other purposes may be limited; and
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our flexibility in planning for, or reacting to, changes in our business and our industry may be limited.
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Our ability to make payments of principal of and interest on our indebtedness depends upon our future performance, which will be subject
to general economic conditions, industry cycles and financial, business and other factors affecting our consolidated operations, many of which are beyond our control. If we are unable to generate sufficient cash flow from operations in the future to
service our debt, we may be required to, among other things:
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seek additional financing in the debt or equity markets;
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refinance or restructure all or a portion of our indebtedness;
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reduce or delay planned capital expenditures; or
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reduce or delay planned operating expenditures.
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Such measures might not be sufficient to enable us to service our debt. In addition, any such financing, refinancing or sale of assets might not be available on economically favorable terms or at all.
If people or property are harmed by the products we sell, product liability claims could damage our business and reputation.
Some of the products we sell may expose us to product liability claims relating to personal injury, death, or property
damage caused by these products and may require us to take actions such as product recalls. Any such product liability claim or product recall may result in adverse publicity regarding us and the products we sell, which may harm our reputation. If
we are found liable under product liability claims, we could be required to pay substantial monetary damages. Further, even if we successfully defend ourselves against this type of claim, we could be forced to spend a substantial amount of money in
litigation expenses, our management could be required to spend valuable time in the defense against these claims, and our reputation could suffer, any of which could harm our business. Some of our vendors do not indemnify us against product
liability. Further, our liability
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insurance may not be adequate to protect us from all liability that may be imposed as a result of these claims, and we cannot be certain that insurance will continue to be available to us on
economically reasonable terms, or at all. Any imposition of product liability that is not covered by vendor indemnification or our insurance could harm our business, financial condition, and operating results.
Most of our fulfillment operations and owned inventory are located in a limited number of distribution facilities, and any significant disruption
of this center’s operations would hurt our ability to make timely delivery of our products.
We conduct most of
our fulfillment operations from our distribution facility in Swedesboro, New Jersey. Our distribution center in Swedesboro, our inventory storage facility in nearby Logan Township, New Jersey, and inventory held by a third-party fulfillment partner
in Columbus, Ohio house our entire owned product inventory other than a small amount held by Salu’s Australian subsidiary. In January 2010, we closed our Ferndale, Washington facility and transferred our vision inventory to our distribution
facility in Swedesboro, New Jersey. We recently entered into an agreement with GSI Commerce Solutions, Inc. (“GSI Commerce”) by which GSI Commerce will fulfill orders for us from a distribution center in the Western United States beginning
later in 2011. Additionally, BioScrip Pharmacy Services, Inc., fulfills all prescription orders through our website from its mail-order distribution center in Columbus, Ohio. A natural disaster or other catastrophic event, such as an earthquake,
fire, flood, severe storm, break-in, server or systems failure, terrorist attack, or other comparable event at our New Jersey facilities or our fulfillment partners’ Ohio facilities would cause interruptions or delays in our business and loss
of inventory and could render us unable to process or fulfill customer orders in a timely manner, or at all. Further, we have no formal disaster recovery plan, and our business interruption insurance may not adequately compensate us for losses that
may occur. In the event that a significant part of our New Jersey facilities or our fulfillment partners’ Ohio facilities were destroyed or our operations were interrupted for any extended period of time, our business, financial condition, and
operating results would be harmed.
We are dependent on a limited number of fulfillment and distribution partners. If we are unable to
obtain shipments of product from our vendors and deliver merchandise to our customers in a timely and cost-effective manner, our business and results of operations would be harmed.
We cannot control all of the various factors that might affect our timely and cost-effective procurement of products from our vendors and
delivery of products to our customers. We use a third-party fulfillment partner in Columbus, Ohio to fulfill Salu orders. We also rely on a limited number of third-party carriers for shipments of products to and from our distribution facilities and
those of our third-party fulfillment partners and to customers. We are therefore subject to the risks, including increased fuel costs, security concerns, labor disputes, union organizing activity, and inclement weather, associated with our
carriers’ ability to provide product fulfillment and delivery services to meet our distribution and shipping needs. Failure to procure and deliver merchandise, either to us or our fulfillment partners or to our customers, in a timely and
accurate manner would harm our reputation, the drugstore.com brands, our business, and our results of operations. In addition, any increase in fulfillment costs and expenses could adversely affect our business and operating results.
Our plans to automate our New Jersey distribution center, to have GSI Commerce to fulfill orders for us from a west coast distribution facility or
to expand to a third distribution center in the Midwest may be delayed or result in greater costs or business interruption than we anticipate, interfering with our ability to deliver merchandise to our customers in a timely and cost-effective
manner, and our business and results of operations would be harmed.
We have recently entered into an agreement with
GSI Commerce to fulfill orders for us from a distribution center in the Western United States. We have also begun the process of upgrading the automation of our New Jersey distribution center. In addition, we have recently begun to explore
strategies to expand our fulfillment operations to include a third distribution facility in the Midwestern United States. These initiatives will require significant capital resources as well as attention from our management team and may require us
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resources from the operation of our primary businesses. In addition, unexpected delays or increased costs of these initiatives could cause interruptions or delays in our business, and disruption
in our inventory processes while we build out these facilities could render us unable to process or fulfill customer orders in a timely manner, or at all and our business, financial condition, and operating results would be harmed.
If we are unable to optimize management of our distribution centers, we may be unable to meet customer demand.
Our ability to meet customer demand may be significantly limited if we do not successfully operate our distribution centers, including in
connection with any plans for new distribution centers or our plans to move our Salu fulfillment operations to our own distribution centers. Because it is difficult to predict sales volume, we may be unable to manage our facilities in an optimal
way, which may result in excess or insufficient inventory, warehousing, fulfillment, or distribution capacity. In addition, failure to control product damage and shrinkage effectively through security measures and inventory management practices
could adversely affect our operating margins. Our margins and revenues may also be affected if we are unable to obtain products from manufacturers and wholesalers timely and on favorable terms. In addition, if we need to increase our distribution
capacity sooner than anticipated, including in connection with any plans to move our Salu fulfillment operations, that expansion would require additional financing that may not be available to us on favorable terms when required, or at all.
Under our distribution agreement with GNC, and consignment arrangements with other partners, we maintain inventory of third
parties’ products in our primary distribution center, thereby increasing the complexity of tracking inventory in, and the operation of, our distribution center. Our failure to properly handle third party inventory that we hold would result in
unexpected costs and other harm to our business and reputation.
We need to manage changing and expanding operations.
Over the past several years, we have significantly expanded our operations, including through Salu, and we anticipate
that we will continue to expand. Our past growth has placed, and we expect that our anticipated future operations and expansion will continue to place, a significant strain on our managerial, operational, financial, and other resources. Some of the
administrative and operational challenges we have faced in the past as a result of our expansion and seasonal growth include the management of an expanded number of product offerings; the assimilation of systems and technologies of acquired
companies; increased pressure on our senior management; and increased demand on our systems and internal controls. Our ability to manage our operations and expansion effectively depends on the continued development and implementation of plans,
systems, and controls that meet our operational, financial, and management needs. If we are unable to develop or implement these plans, systems, or controls or otherwise manage our operations and growth effectively, we will be unable to increase
gross margins or achieve consistent profitability, and our business will be harmed.
The seasonality of our business places increased
strain on our operations.
We expect the largest amount of our net sales to occur during our fourth quarter. If we do
not stock or restock popular products in sufficient amounts such that we fail to meet customer demand, it could significantly affect our revenue and our future revenue. If we overstock products, we may be required to take significant inventory
markdowns or write-offs, which could reduce our gross margins. We may experience an increase in our shipping cost due to complimentary upgrades, split-shipments, and additional long-zone shipments necessary to ensure timely delivery for the holiday
season. If our systems and processes are not prepared to address peak volumes during high demand seasons, holidays, and events, we may experience system interruptions that make our websites unavailable or prevent us from efficiently fulfilling
orders, which may reduce the volume of goods we sell and the attractiveness of our products and services. In addition, we may be unable to staff our distribution centers adequately during these peak periods, and delivery companies may be unable to
meet the seasonal demand.
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A disruption in our operations could materially and adversely affect our business, results of
operations and financial condition.
Any disruption to our operations, including system, network, telecommunications,
software or hardware failures, and any damage to our physical locations, could materially and adversely affect our business, results of operations and financial condition.
Our operations are subject to the risk of damage or interruption from:
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fire, flood, earthquake or other natural disasters;
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power losses and interruptions;
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Internet, telecommunications or data network failures;
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physical and electronic break-ins or security breaches;
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If any of these events occur, it could result in interruptions, delays or cessations in service to customers of our partners’ e-commerce businesses and adversely impact our partners’ e-commerce
businesses. These events could also prevent us from fulfilling orders for our partners’ e-commerce businesses. Our partners might seek significant compensation from us for their losses. Even if unsuccessful, this type of claim likely would be
time-consuming and costly for us to address and damaging to our reputation.
Our primary data centers are located at the
facilities of a third-party hosting company. We do not control the security, maintenance or operation of these facilities, which are also susceptible to similar disasters and problems. Further, we have no formal disaster recovery plan, and our
insurance policies may not cover us for losses related to these events, and even if they do, they may not adequately compensate us for any losses that we or our partners’ may incur. Any system failure that causes an interruption of the
availability of our partners’ e-commerce businesses could reduce the attractiveness of our partners’ e-commerce businesses to consumers and result in reduced revenues, which could materially and adversely affect our business, results of
operations and financial condition.
We have significant inventory risk.
We must maintain sufficient inventory levels to operate our business successfully, including meeting the inventory needs of our strategic
partners and the expectations of our customers and those of our strategic partners that we will have the products they order in stock. However, we must also guard against the risk of accumulating excess inventory. This risk would be further
exacerbated by our proposed expansion to a second and third distribution center. We are exposed to significant inventory risks as a result of rapid changes in product cycles, changes in consumer tastes, uncertainty of success of product launches,
seasonality, manufacturer backorders, and other vendor-related problems. In order to be successful, we must accurately predict these trends and events, which we may be unable to do, and avoid over- or under-stocking products. Our ability to stock
products properly also depends on our strategic partners’ ability to predict and to keep us timely informed of these trends and events in their businesses. In addition, demand for products can change significantly between the time product
inventory is ordered and the time it is available for sale. When we begin selling a new product, it is particularly difficult to forecast product demand accurately. A failure to optimize inventory would increase our expenses if we have too much
inventory, and would harm our margins by requiring us to make split shipments for backordered items or pay for expedited delivery from the manufacturer if we had insufficient inventory. In addition, we may be unable to obtain certain products for
sale on our websites as a result of general shortages (for example, in the case of some medications), manufacturer policies (for example, in the case of some contact
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lenses and prestige beauty items), manufacturer or distributor problems, or popular demand. Failure to have inventory in stock when a customer orders it could cause us to lose that order or that
customer. The acquisition of some types of inventory, or inventory from some of our sources, may require significant lead time or prepayment, and this inventory may not be returnable. We carry a broad selection of products and significant inventory
levels of a substantial number of products, and we may be unable to sell this inventory in sufficient quantities or during the relevant selling seasons. The occurrence of one or more of these inventory risks may adversely affect our business and
operating results.
Our vendor relationships subject us to a number of risks.
We have significant vendors that are important to our sourcing of merchandise. We do not have long-term arrangements with most of our
vendors to guarantee availability of merchandise, particular payment terms, or extension of credit limits. If our current vendors were to stop selling merchandise to us on acceptable terms, we may not be able to acquire merchandise from other
vendors in a timely and efficient manner and on acceptable terms, or at all.
If we do not attract and retain qualified personnel, or if
our key employees fail to perform, our ability to execute our business strategy will be impaired.
We are dependent on
our key personnel, and our success depends in large part on our ability to attract and retain qualified personnel. All of our employees, including our executive officers, can terminate their employment with us at any time. If we experience
significant turnover or difficulty in recruiting new personnel, or if our key employees fail to perform as expected, our ability to execute our business strategy will be impaired.
Changes in our senior management may have an adverse effect on our ability to execute our business strategy.
Our success depends largely on the efforts and abilities of our senior management to execute our business plan. Changes in our senior management may be disruptive to our business and may adversely affect
our operations. For example, when we have changes in senior management positions, we may elect to adopt different business strategies or plans. Any new strategies or plans, if adopted, may not be successful and if any new strategies or plans do not
produce the desired results, our business may suffer.
Any errors in filling or packaging the contact lenses we dispense may expose us
to liability and negative publicity.
Errors relating to our contact lens dispensing process may result in liability
for us that our insurance may not cover. Because we distribute contact lenses directly to the consumer, we are one of the most visible participants in the distribution chain and therefore have increased exposure to liability claims. 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 liabilities that may be imposed if any such claims were to be successful.
Errors by either us or our competitors may also produce significant adverse publicity either for us or for the online vision industry in
general. Because of the significant amount of press coverage on Internet retailing, we believe that we are subject to a higher level of media scrutiny than other prescription product channels. The amount of negative publicity that we or the online
vision industry receives as a result of prescription processing errors could be disproportionate in relation to the negative publicity received by other eye care professionals making similar mistakes. We have no control over the practices of our
competitors, and we cannot ensure that our prescription processing operates completely without error. We believe customer acceptance of our online shopping experience is based in large part on consumer trust, and errors by us or our competitors and
related negative publicity could erode this trust or prevent it from growing. This could result in an immediate reduction in the amount of orders we receive, adversely affect our revenue growth, and harm our business and operating results.
17
Governmental regulation of our business could require significant expenditures, and failure to comply
with regulations could result in civil and criminal penalties.
Our business is subject to extensive federal, state and
local regulations. For example:
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•
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the sale, advertisement, and promotion of, among other things, contact lenses, OTC and homeopathic medications, dietary supplements, medical devices,
cosmetics, foods, and other consumer products that we sell are subject to regulation by the Food and Drug Administration, or FDA, the Federal Trade Commission, or FTC, the Consumer Product Safety Commission, and state regulatory authorities, as the
case may be; and
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•
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our vision business is also subject to the Fairness to Contact Lens Consumers Act and related regulations of the FTC, which requires all patients to
renew their contact lens prescriptions annually and requires third-party contact lens sellers, like Vision Direct, to verify these prescriptions in accordance with specified procedures.
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As we expand our product and service offerings and more non-pharmaceutical products become subject to FDA, FTC, and other regulation,
more of our products and services may become subject to regulation. In addition, regulatory requirements to which our business is subject may expand over time, and some of these requirements may have a disproportionately negative effect on Internet
retailers. For example, the federal government and a majority of states now regulate the retail sale of OTC products containing pseudoephedrine that might be used as precursors in the manufacture of illegal drugs. As a result, we are currently
unable to sell these products to customers residing in states that require retailers to obtain a physical form of identification or maintain a signature log. In addition to regulating the claims made for specific types of products, the FDA and the
FTC may attempt to regulate the content included on websites that market products to consumers. Complying with regulations is time-consuming, burdensome, and expensive and could delay our introduction of new products or services.
As our website is accessible over the Internet in multiple states and other countries, and if and when we expand our marketing strategies
to other countries, we may be subject to their laws and regulations or may be required to qualify to do business in those locations. Our failure to qualify in a state or country in which we are required to do so could subject us to taxes and
penalties and we could be subject to legal actions and liability in those jurisdictions. The restrictions or penalties imposed by, and costs of complying with, these laws and regulations could harm our business, operating results, and financial
condition. Our ability to enforce contracts and other obligations in states and countries in which we are not qualified to do business could be hampered, which could harm our business.
The laws and regulations applicable to our business often require subjective interpretation, and we cannot be certain that our efforts 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, any of which could harm our business, financial condition, or operating results. Compliance with new laws or regulations could increase our expenses or lead to delays as we adjust our websites and
operations.
Restrictions imposed by, and costs of complying with, governmental regulation of the Internet and data transmission over
the Internet could harm our business.
We are subject to the same federal, state, and local laws generally applicable
to businesses, as well as those directly applicable to companies conducting business online, including consumer protection laws, user privacy laws, and regulations prohibiting unfair and deceptive trade practices. Further, the growth of online
commerce could result in more stringent consumer protection laws that impose additional compliance burdens on us. Today there are an increasing number of laws specifically directed at the conduct of business on the Internet. Moreover, due to the
increasing use of the Internet, many additional laws and regulations relating to the Internet are being
18
debated at the state and federal levels. These laws and regulations could cover issues such as freedom of expression, pricing, user privacy, fraud, quality of products and services, taxation,
advertising, intellectual property rights, and information security. Applicability of existing laws to the Internet relating to issues such as property ownership, copyrights and other intellectual property issues, taxation, libel, obscenity, and
personal privacy could also harm our business. For example, U.S. and international laws regulate our ability to use customer information and to develop, buy, and sell mailing lists. The vast majority of these laws were adopted before the advent of
the Internet, and do not contemplate or address the unique issues raised by the Internet. Those laws that do reference the Internet, such as the Digital Millennium Copyright Act, are only beginning to be interpreted by the courts, and their
applicability and reach are therefore uncertain. The restrictions imposed by, and the costs of complying with, current and possible future laws and regulations related to businesses conducted on the Internet could harm our business, operating
results, and financial condition.
Healthcare reform measures and related changes in applicable federal and state laws could adversely
affect our business.
The efforts of governmental and third-party payers to contain or reduce the costs of healthcare
may adversely affect our business, operating results, and financial condition. Recently, there have been, and we expect that there will continue to be, a number of legislative and regulatory proposals aimed at changing the healthcare system,
including for example, restructuring the tax benefits available through flexible spending accounts and/or health savings accounts by limiting the eligibility of non-prescription products. If the laws or regulations are changed to limit further the
tax benefits through these accounts, such a change could have an adverse effect on our business by reducing revenues and eroding our margins.
We are subject to a number of risks related to payments we accept and process for third parties.
We accept payments by a variety of methods, including credit cards, gift certificates, and third-party payors such as Pay Pal, Google
Checkout, and Bill Me Later. In addition, we serve as a payment processing service provider for certain of our strategic partners. As we offer new payment options to our customers and processing services to our strategic partners, we may be subject
to additional regulations, compliance requirements, and fraud. For credit card payments and other third-party payors, we pay interchange and other fees, which may increase over time, raising our operating costs and lowering our profit margins. In
addition, we have additional contractual obligations to our strategic partners regarding the payment processing services we provide them, and conversely depend on our strategic partners to meet their obligations to us and to the third-party payors,
and any failure of us or our partners to meet those obligations could expose us to additional fees and expenses. We are also subject to payment card association operating rules and certification requirements, both as a merchant and as a service
provider, which could change or be reinterpreted to make compliance difficult or impractical. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit card
payments from our customers and those of our strategic partners or to facilitate other types of online payments, and our business and operating results could be adversely affected.
If we are required to collect sales and use taxes on the products we sell in additional jurisdictions, we may be subject to liability for past sales and our future sales may decrease.
Currently, decisions of the U.S. Supreme Court restrict the ability of states to collect state and local sales and use
taxes with respect to sales made by companies lacking a physical presence in the state. Based on this case law, we have historically only collected and remitted sales and use taxes in the states of Washington and New Jersey where our corporate
offices and distribution centers have been located. However, a number of states have passed or are considering passing initiatives that could test the Supreme Court’s position regarding sales and use taxes on Internet sales. The operation of
our distribution centers, the operations of any future distribution centers, our drop-shipping agreements with vendors, our arrangements with marketing affiliates, and other aspects of our evolving business, however, may result in additional sales
and use tax collection obligations. In addition, one or more other states may successfully assert that we should collect and remit sales and use or other taxes on the sale
19
of our products in that state. One or more states or the federal government may seek, either through unilateral action or through federal legislation, to impose sales or other tax collection
obligations on out-of-jurisdiction companies that engage in electronic commerce as we do.
Effective July 2008, New York
imposed such a sales tax obligation requirement on on-line retailers that use New York residents to directly or indirectly refer potential customers, via a link on an Internet Website or otherwise, to the online retailer. As a result, we began
collecting and remitting sales tax in New York in July 2008. Since then, other states have enacted legislation similar to New York’s, including Rhode Island in June 2009, North Carolina in August 2009, and Illinois in March 2011. In
response to recently imposed state sales tax requirements for online retailers, we have suspended certain marketing affiliate relationships with persons and entities residing in Rhode Island and North Carolina, which may cause our sales to decline.
Other states are considering similar laws, and if such laws become effective, we may have to change or limit our marketing activities in those states or face additional sales tax collection and remittance obligations, either of which could have a
negative effect on our sales.
Because our newly acquired subsidiary, Salu, is located in California and has distribution
activities in Ohio, we also collect sales tax in both California and Ohio on its sales. In conjunction with our fulfillment agreement with GSI Commerce, we will be required to collect sales tax in Nevada. If we proceed with our plans to open a
Midwest distribution center, we will likely be required to collect in the state where it is located as well.
In addition, one
or more states could begin to impose sales taxes on sales of prescription products, which are not generally taxed at this time. While we believe we are in compliance with existing laws and regulations, we could be subject to significant fines
or other payments for any unintentional past failure to comply with tax regulations. This could result in substantial tax liabilities for our past sales, decrease our ability to compete with traditional retailers, and otherwise harm our business,
financial condition, and operating results.
Pending an authoritative reconciliation of these initiatives with the common law,
and potentially for years into the future if any challenge to these initiatives resulted in a reversal by the courts of the long-standing restriction on states’ ability to tax out-of-state sellers, we could be required to collect and remit
sales and use taxes in states other than Washington, New York, New Jersey, California, Ohio, and Nevada. The imposition of additional tax obligations on our business by state and local governments could create significant administrative burdens for
us, decrease our future sales, and harm our cash flow and operating results.
We may be unable to increase the migration of consumers of
health, beauty, clinical skincare, and vision products from brick-and-mortar stores to our online solution, which would harm our revenues and prevent us from becoming profitable.
If we do not continue to attract and retain higher volumes of online customers to our Internet stores at a reasonable cost, we will not be
able to increase our revenues or achieve consistent profitability. Our success depends on our ability to continue to convert a large number of customers from traditional shopping methods to online shopping for health, beauty, wellness, vision, and
pharmacy products. Specific factors that could prevent widespread customer acceptance of our online solution include:
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shipping charges, which do not apply to purchases made at a brick-and-mortar store;
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•
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delivery time associated with Internet orders, as compared to the immediate receipt of products at a brick-and-mortar store;
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•
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delays in deliveries to customers;
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•
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lack of consumer awareness of our websites;
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•
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additional steps and delays in verifying prescriptions for prescription products;
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•
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regulatory restrictions or reform at the state and federal levels that could affect our ability to serve our customers;
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20
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•
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customer concerns about the security of online transactions, identity theft, or the privacy of their personal information;
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•
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product damage from shipping or shipments of wrong or expired products from us or other vendors, resulting in a failure to establish, or loss of,
customers’ trust in buying drugstore items online;
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•
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delays in responses to customer inquiries;
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•
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difficulties or delays in returning or exchanging orders; and
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•
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activity that diminishes a user’s online experience or subjects online shoppers to security risks, such as viruses, spam, spyware, phishing
(spoofing e-mails directed at Internet users), “denial of service” attacks directed at Internet service providers and online businesses, and breaches of data security.
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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 continue to expand the breadth and depth of our product and service offerings by promoting new or
complementary products or sales formats. Expansion of our offerings in this manner could require significant additional expenditures and could strain our management, financial, and operational resources. For example, we have launched our microsites
in an initiative to design separate web stores dedicated to specific categories of products and certain mobile platforms to expand the availability of our site to mobile telephone and other device users. Additionally, we may need to incur
significant marketing expenses, develop relationships with new fulfillment partners or manufacturers, or comply with new regulations. We may be unable to expand our product and service offerings or sales formats in a cost-effective or timely manner,
and any new offerings or formats may not generate satisfactory revenues to offset the costs involved. Furthermore, any new product or service offering or sales format that is not favorably received by consumers could damage the reputation of our
brand. A lack of market acceptance of our efforts or our inability to generate sufficient revenues to offset the cost of expanded offerings could harm our business.
Increasing concern about privacy, spam, and the use and security of customer information could restrict our marketing efforts and harm our business.
Internet retailers are also subject to increasing regulation and scrutiny relating to privacy, spam, and the use and security of personal
user information. These regulations, along with increased governmental or private enforcement (for example, by Internet service providers), may increase the cost of growing our business. Current and proposed regulations and enforcement efforts may
restrict our ability to collect and use demographic and personal information from users and send promotional e-mails, which could be costly or harm our marketing efforts. For example, if one or more Internet service providers were to block our
promotional e-mails to customers, our ability to generate orders and revenue could be harmed. Further, any violation of privacy, anti-spam, or data protection laws or regulations may subject us to fines, penalties, and damages and may otherwise have
a material adverse effect on our business, results of operations, and financial condition.
Our network and communications systems are
vulnerable to system interruption and damage, which could harm our operations and reputation.
Our ability to receive
and fulfill orders promptly and accurately is critical to our success and largely depends on the efficient and uninterrupted operation of our computer and communications hardware and software systems. We experience periodic system interruptions that
impair the performance of our transaction systems or make our websites inaccessible to our customers. These systems interruptions may prevent us from efficiently accepting and fulfilling orders, sending out promotional e-mails and other customer
communications in a timely manner, introducing new products and features on our website, promptly responding to customers, or providing services to third parties. Frequent or persistent interruptions in our services could cause current or potential
customers to believe that our systems are unreliable, which could cause them to avoid our websites,
21
drive them to our competitors, and harm our reputation. To minimize future system interruptions, we need to continue to add software and hardware and to improve our systems and network
infrastructure to accommodate increases in website traffic and sales volume, to replace aging hardware and software, and to make up for several years of underinvestment in technology. We may be unable to promptly and effectively upgrade and expand
our systems and integrate additional functionality into our existing systems. Any unscheduled interruption in our services, especially during the holiday shopping season, could result in fewer orders, additional operating expenses, or reduced
customer satisfaction, any of which would harm our revenues and operating results and could delay or prevent our becoming consistently profitable. In addition, the timing and cost of upgrades to our systems and infrastructure may substantially
affect our ability to maintain profitability.
Our systems and operations, and those of our suppliers and Internet service
providers, are vulnerable to damage or interruption from fire, flood, earthquakes, power loss, server failure, telecommunications and Internet service failure, acts of war or terrorism, computer viruses and denial-of-service attacks, physical or
electronic break-ins, sabotage, and similar events. Any of these events could lead to system interruptions, service delays, and loss of critical data for us, our suppliers, or our Internet service providers, and could prevent us from accepting and
fulfilling customer orders. Any significant interruption in the availability or functionality of our websites or our customer processing, distribution, or communications systems, for any reason, could seriously harm our business, financial
condition, and operating results. While we do have backup systems for some aspects of our operations, we do not have fully redundant backup systems or a formal disaster recovery plan. Our business interruption insurance may be inadequate to
compensate for all losses that may occur.
Security breaches could damage our reputation, expose us to liability, or otherwise harm our
business.
Although we have developed systems and processes that are designed to protect customer information and
prevent fraudulent transactions, data loss and other security breaches, failure to prevent or mitigate such breaches may adversely affect our operating results. To succeed, we must provide a secure transmission of confidential information over the
Internet and protect the confidential customer and patient information we retain, such as credit card numbers and prescription records. A third party who compromises or breaches the physical and electronic security measures we use to protect
transaction data and customer records could misappropriate proprietary information, cause interruptions in our operations, damage our computers or those of our customers, or otherwise harm our business. Any of these could harm our reputation and
expose us to a risk of loss or litigation and possible liability. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches, and our insurance may not be adequate to reimburse us for
losses caused by security breaches.
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 technologies
useful in our business, enhance our existing services, develop new services and technologies that address the increasingly 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 stores, proprietary technology, and transaction-processing systems to meet customer requirements or emerging
industry standards. Failure to successfully and timely do so could adversely affect our ability to build the drugstore.com brand and attract and retain customers.
We may be unable to protect our intellectual property, and we may be found to infringe proprietary rights of others, which could harm our business, brand, and reputation.
Our success depends in substantial part on our proprietary rights, including our technology, copyrights, trademarks, service marks, trade
dress, trade secrets, and similar intellectual property. We rely on a combination of patent, trademark, trade secret, and copyright law, as well as contractual restrictions to protect our proprietary
22
rights. Despite our efforts to protect our proprietary rights, however, unauthorized parties may attempt to copy, obtain, and use technology or information that we regard as proprietary, such as
our sales formats, the technology used to operate our website, our website content, and our trademarks. In addition, the laws of many countries do not protect our proprietary rights to the same extent as the laws of the United States.
We own a number of domain names, hold nine patents, and have registered several trademarks and filed applications for a number of other
trademarks in the United States and several other countries. We may be unable to secure the trademark registrations or patents for which we have applied, which could negatively affect our business. Our competitors or others may adopt marks or
service names similar to ours, which could impede our ability to build brand identity and lead to customer confusion, and owners of other registered trademarks or trademarks that incorporate variations of our marks could bring potential trade name
or trademark infringement claims against us. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective patent, copyright, trademark, and trade secret
protection may not be available in such jurisdictions. Our business could be harmed if we are unable to protect or preserve the value of our trademarks, patents, copyrights, trade secrets, or other proprietary rights for any reason, or if we are
subject to any claims or customer confusion related to our intellectual property or any failure or inability to protect our proprietary rights.
Litigation or proceedings before the U.S. Patent and Trademark Office or the World Intellectual Property Organization may be necessary in the future to enforce our intellectual property rights, to protect
our trade secrets and domain names, or to determine the validity and scope of the proprietary rights of others. Any litigation or adverse priority proceeding or other efforts to protect our intellectual property could result in substantial costs and
diversion of resources and could seriously harm our business and operating results. Third parties have in the past, and may in the future, also assert claims against us alleging infringement, misappropriation, or other violations of patent,
trademark, or other proprietary rights held by them, whether or not their claims have merit. For example, one of our subsidiaries was sued over alleged copyright and trademark violations based on use of “pop-up” advertising, although this
action was settled in June 2004 without any material adverse effects to us. 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 claims, whether they are with or without merit or are determined in our favor, could be time-consuming, result in costly litigation, divert the attention of our management, cause service upgrade delays, and harm our business or operating
results. Furthermore, as a result of infringement claims we may be required to enter into costly royalty or licensing agreements, which may not be available on terms that are acceptable to us, or at all. If a third party successfully asserts an
infringement claim against us and we are required to pay monetary damages or royalties or we are unable to obtain suitable non-infringing alternatives or license the infringed or similar intellectual property on reasonable terms on a timely basis,
our business could be adversely affected.
The third-party licenses on which we rely may not continue to be available to us on
commercially reasonable terms. The loss of such licenses could require us to incur greater cost or change our business plans, either of which could harm our business.
We have a history of generating significant losses, and may not be able to sustain profitability.
We have an accumulated deficit of $774.8 million through January 2, 2011. To date, we have had only four profitable quarters, and we may never achieve profitability on a full-year or consistent
basis. As a result, our stock price may decline and stockholders may lose all or a part of their investment in our common stock.
Our
stock price is likely to continue to fluctuate, which could result in substantial losses for stockholders.
The market
price of our common stock has been, and is likely to continue to be, extremely volatile. Our stock price could be subject to wide fluctuations in response to a number of factors, including those described in this annual report, some of which are
beyond our control, and these fluctuations could result in substantial losses for stockholders.
23
In the past, securities class action and derivative litigation has often been brought
against a company following periods of volatility in the market price of its securities. We have been named in such lawsuits in the past, including certain putative class action and derivative suits filed against us and certain of our current and
former officers and directors in 2004. Although the courts dismissed these lawsuits, we may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and
resources, which could seriously harm our business and operating results and cause the trading price of our stock to decline.
Certain
stockholders own a significant amount of our common stock, which could discourage an acquisition of drugstore.com or make removal of incumbent management more difficult.
Amazon.com beneficially owns approximately 12% of our outstanding stock, and is entitled to designate a director to serve on our board of
directors, currently Geoffrey R. Entress. Kleiner Perkins Caufield and Byers, or KPCB, owns approximately 9% of our outstanding stock, Samana Capital, L.P. (formerly Ziff Asset Management, L.P.), or Samana, owns approximately 8% of our
outstanding stock, Discovery Group I, LLC owns approximately 9% of our outstanding stock, and T. Rowe Price Associates, Inc. owns approximately 7% of our outstanding stock. Because each owns a significant percentage of our capital stock, any of
these stockholders, or more than one of them, could significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. Furthermore,
because of these substantial equity stakes in drugstore.com, competitors of these stockholders, or other potential acquirers could decide not to merge with, or acquire, us. In addition, in the case of a potential acquisition of drugstore.com by
another party, a substantial equity stake in drugstore.com could prevent the tax-free treatment of an acquisition, making drugstore.com a less attractive acquisition candidate. In addition, if any of our significant stockholders were to sell a
substantial quantity of their holdings in a short period of time, our stock price could decline.
At January 2, 2011, we
had approximately $626.9 million of federal net operating loss carry-forwards that will expire beginning in 2018. Internal Revenue Code Section 382 imposes limitations on our ability to utilize net operating losses if we experience an ownership
change. An ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percentage points over a three-year period. The value of the stock at the time of an ownership
change is multiplied by the applicable long-term tax exempt interest rate to calculate the annual limitation. Any unused annual limitation may be carried over to later years. Based upon our cumulative historic ownership activity, it likely results
in a significant limitation on the utilization of our net operating loss carryforwards. Also, if we were to have an extraordinary amount of shares acquired, for example more than 40.0 million from a new or existing 5% shareholder or if we were
to be acquired, then based on our current fair value and the low long-term tax exempt interest rate, utilization of a significant amount of our net operating losses could be further limited.
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ITEM 1B.
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UNRESOLVED STAFF COMMENTS
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None.
Our principal
executive offices are located in Bellevue, Washington, where we lease approximately 53,000 square feet under a lease that expires in July 2013, with two separate five-year renewal options that, if exercised, would extend the lease expiration to July
2023. Our primary distribution facility for our OTC and vision segments is located in Swedesboro, New Jersey, where we lease approximately 270,000 square feet under a lease that expires in December 2020, with options to renew for two additional
five-year periods. We also lease an inventory storage facility in Logan Township, New Jersey for 85,000 square feet through February 2013. We lease approximately 11,500 square feet under a lease that expires in March 2016 for our principal customer
care center, which is located in Halifax, Nova Scotia, Canada.
24
Our subsidiary Salu leases approximately 10,000 square feet under a lease that expires in
June 2016 for its principal corporate offices located in Gold River, California. Skincarestore Australia Pty Ltd., a subsidiary of Salu, leases approximately 2,000 square feet in Roselle, New South Wales, Australia, under a sublease that expires in
November 2014, for retail space used for a salon and spa and related business purposes.
We continue to make improvements to
our existing New Jersey distribution center to improve capacity and increase efficiency. Our overall goal is to leverage our existing distribution center as much as possible, and in 2011 we plan to make technology investments in supply chain
infrastructure to support fulfillment capabilities from multiple distribution centers. We have recently entered into an agreement with GSI Commerce by which GSI Commerce will fulfill orders for us from a distribution center in the Western United
States. Also, in December 2010 we made purchase commitments for approximately $5.0 million of software and hardware to automate our New Jersey distribution center. In addition, we have recently begun to explore strategies to expand our fulfillment
operations to include a third distribution facility in the Midwestern United States. Management regularly reviews our anticipated requirements for all of our facilities and the costs and benefits associated with new facilities, and, based on that
review, may adjust other of our facilities needs, as well.
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ITEM 3.
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LEGAL PROCEEDINGS
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See
Note 9 of our consolidated financial statements,
“Commitments and Contingencies—Legal Proceedings,”
included in Part IV, Item 15 of this annual report.
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PART II
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ITEM 5.
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MARKET FO
R REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
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Market Information
Our common stock is traded on the NASDAQ Global Market under the symbol “DSCM.” The following table sets forth, for the periods indicated, the high and low sales prices of our common stock, as
reported by the NASDAQ Global Market.
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High
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Low
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Fiscal Year Ended January 2, 2011
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First Quarter
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$
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3.95
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$
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2.60
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Second Quarter
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$
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3.95
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$
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2.92
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Third Quarter
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$
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3.21
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$
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1.48
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Fourth Quarter
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$
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2.34
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$
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1.55
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High
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Low
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Fiscal Year Ended January 3, 2010
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First Quarter
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$
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1.47
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$
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0.65
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Second Quarter
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$
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2.09
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$
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1.07
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Third Quarter
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$
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2.72
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$
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1.54
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Fourth Quarter
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$
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3.59
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$
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2.19
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Holders of Record
As of March 4, 2011, there were approximately 822 holders of record of our common stock, and a much larger number of beneficial
owners.
Dividends
We have never declared or paid cash or stock dividends on our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our
business and do not anticipate paying any dividends in the foreseeable future.
Recent Sales of Unregistered Securities
None.
Issuer Purchases of
Equity Securities
The following table sets forth all purchases of our capital stock made by or on behalf of drugstore.com
or any affiliated purchasers during the fourth quarter of 2010. The shares represent shares of restricted stock that we withheld from shares otherwise due to be released to certain of our employees under the terms of restricted stock award
agreements in settlement of our tax withholding obligations with respect to such employees.
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Period
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Total no.
of shares
purchased
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Average price
paid per share(1)
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October 2, 2010
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6,496
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$
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1.84
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October 3, 2010
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98,197
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$
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1.84
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Total
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104,693
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(1)
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Price paid reflects the value of shares withheld based on the closing price of our common stock on Monday, October 4, 2010.
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In addition, for the majority of restricted stock units we grant, the number of shares
issued on the date the restricted stock units vest is net of the minimum statutory withholding requirements that we pay in cash to the appropriate taxing authorities on behalf of our employees. We have not included these withheld shares in the
common stock repurchase totals in the table above.
We presently have no publicly announced repurchase plan or program, but
intend to continue to allow participants to satisfy statutory minimum tax withholding obligations in connection with the vesting of outstanding restricted stock and restricted stock units through the withholding of shares.
Stock Performance Graph
The graph below shows the relative investment performance of our common stock, the NASDAQ Stock Market Index and the Morgan Stanley
High-Technology Index for the last five years. The following graph is presented pursuant to SEC rules and is not meant to be an indication of our future performance.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1/1/2006
|
|
|
12/31/2006
|
|
|
12/30/2007
|
|
|
12/28/2008
|
|
|
1/3/2010
|
|
|
1/2/2011
|
|
|
drugstore.com
|
|
$
|
100.00
|
|
|
$
|
128.42
|
|
|
$
|
115.09
|
|
|
$
|
40.35
|
|
|
$
|
108.42
|
|
|
$
|
77.54
|
|
|
NASDAQ Stock Market (U.S.) Index
|
|
$
|
100.00
|
|
|
$
|
109.52
|
|
|
$
|
121.27
|
|
|
$
|
69.39
|
|
|
$
|
102.89
|
|
|
$
|
120.29
|
|
|
Morgan Stanley High Tech Index
|
|
$
|
100.00
|
|
|
$
|
108.81
|
|
|
$
|
120.51
|
|
|
$
|
63.30
|
|
|
$
|
110.70
|
|
|
$
|
127.19
|
|
27
|
ITEM
|
6. SELECTED FINANCIAL DATA
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
|
2010
|
|
|
2009(2)
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
|
(in thousands, except share and per share data)
|
|
|
Consolidated Statements of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
456,507
|
|
|
$
|
375,574
|
|
|
$
|
322,214
|
|
|
$
|
289,188
|
|
|
$
|
247,744
|
|
|
Loss from continuing operations
|
|
|
(9,614
|
)
|
|
|
(9,854
|
)
|
|
|
(18,907
|
)
|
|
|
(19,110
|
)
|
|
|
(20,136
|
)
|
|
Gain from discontinued operations, net of tax (1)
|
|
|
6,064
|
|
|
|
8,477
|
|
|
|
10,620
|
|
|
|
7,599
|
|
|
|
5,380
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,550
|
)
|
|
$
|
(1,377
|
)
|
|
$
|
(8,287
|
)
|
|
$
|
(11,511
|
)
|
|
$
|
(13,026
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss from continuing operations per share
|
|
$
|
(0.09
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.20
|
)
|
|
Basic and diluted gain from discontinued operations per share
|
|
$
|
0.06
|
|
|
$
|
0.09
|
|
|
$
|
0.11
|
|
|
$
|
0.08
|
|
|
$
|
0.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per share
|
|
$
|
(0.03
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.14
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
102,217,033
|
|
|
|
96,950,189
|
|
|
|
96,481,787
|
|
|
|
95,350,046
|
|
|
|
93,405,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and marketable securities
|
|
$
|
33,531
|
|
|
$
|
36,853
|
|
|
$
|
38,194
|
|
|
$
|
36,249
|
|
|
$
|
40,639
|
|
|
Cash dividends declared per common share
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Working capital
|
|
|
42,506
|
|
|
|
42,986
|
|
|
|
34,463
|
|
|
|
35,529
|
|
|
|
41,125
|
|
|
Total assets
|
|
|
200,372
|
|
|
|
154,529
|
|
|
|
152,549
|
|
|
|
175,408
|
|
|
|
168,322
|
|
|
Long-term debt obligations, less current portion
|
|
|
13,985
|
|
|
|
3,011
|
|
|
|
2,567
|
|
|
|
1,221
|
|
|
|
1,839
|
|
|
Total stockholders’ equity
|
|
$
|
121,329
|
|
|
$
|
97,666
|
|
|
$
|
94,200
|
|
|
$
|
94,368
|
|
|
$
|
92,678
|
|
|
(1)
|
The results of operations of our mail-order pharmacy and local pick-up pharmacy segments have been classified as discontinued operations in all periods presented.
|
|
(2)
|
Fiscal year 2009 was a 53-week year, all other fiscal years presented were 52-week years.
|
28
|
ITEM 7.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Forward-Looking Statements
This annual report on Form 10-K and the
documents incorporated into this annual report by reference contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 based on our expectations, estimates and projections as of the date of this
filing. Actual results may differ materially from those expressed in forward-looking statements. All statements made in this annual report other than statements of historical fact, including statements regarding our future financial and operational
performance, sources of liquidity and future liquidity needs, are forward-looking, including statements regarding:
|
|
•
|
|
our beliefs regarding the impact of recently issued standards that are not yet effective will have on our consolidated financial statements upon
adoption;
|
|
|
•
|
|
the potential of any legal proceedings or claims to have, individually or in the aggregate, a material adverse effect on our business prospects,
financial condition, or operating results;
|
|
|
•
|
|
the affects of leveraging our capabilities in Internet marketing, merchandising, fulfillment, and customer care in the health, beauty, and wellness
arena, including through our strategic partnerships and our microsite strategy, on future growth in our OTC segment;
|
|
|
•
|
|
our beliefs regarding the adequacy of our liquidity in light of our operations and anticipated capital expenditures;
|
|
|
•
|
|
whether the internal controls of Salu have materially affected, or will likely materially affect, our internal controls over financial reporting;
|
|
|
•
|
|
our expectation that we will continue to evaluate and consider a wide array of potential strategic partnerships as part of our growth strategy;
|
|
|
•
|
|
the future impact of, or the parties’ performance under, our agreements with BioScrip and BioScrip Pharmacy Services, including our expected gain
on the sale over fiscal 2011 and the impact on our net income (loss);
|
|
|
•
|
|
our expectations regarding our continued marketing and merchandising strategies, including the expansion of our product offerings and the continuation
of our shipping or other promotions;
|
|
|
•
|
|
our expectations and assumptions underlying our valuation of our equity awards;
|
|
|
•
|
|
the future launch of new or improved technology or additional websites, including for our strategic partners and in conjunction with our microsite
strategy; and
|
|
|
•
|
|
management’s outlook on our net sales, net income (loss), adjusted EBITDA, ongoing adjusted EBITDA and other financial results for the first
quarter and full year of 2011.
|
Forward-looking statements are based on current expectations, and are not
guarantees of future performance and involve assumptions, risks, and uncertainties. Actual performance may differ materially from those contained or implied in such forward-looking statements. Risks and uncertainties that could cause our actual
results to differ significantly from management’s expectations are discussed further in the section entitled “Risk Factors” in Part I, Item 1A of this annual report. You should not rely on a forward-looking statement as
representing our views as of any date other than the date on which we made the statement. We expressly disclaim any intent or obligation to update any forward-looking statement after the date on which we make it.
The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in
Part IV, Item 15 of this annual report.
29
Overview
drugstore.com, inc. is a leading online retailer of health, beauty, clinical skincare, and vision products. We provide a convenient, private, and informative shopping experience while offering a wide
assortment of products through our web stores located on the Internet as follows:
|
|
|
|
|
Health, Beauty & Pharmacy
|
|
OTC Partnerships
|
|
www.drugstore.com
|
|
www.medcohealthstore.com
|
|
www.Beauty.com
|
|
www.riteaidonlinestore.com
|
|
www.SkinStore.com
(1)
|
|
www.spalook.com
(1)
|
|
www.DrWeilVitaminAdvisor.com
(3)
|
|
|
|
|
|
|
Microsites
|
|
Vision and Vision Partnerships
|
|
www.thenaturalstore.com
|
|
www.VisionDirect.com
|
|
www.athisbest.com
|
|
www.LensMart.com
|
|
www.sexualwellbeing.com
|
|
www.Lensworld.com
|
|
www.allergysuperstore.com
|
|
www.LensQuest.com
|
|
www.vitaminemporium.com
|
|
www.pearlevisioncontacts.com
(2)
|
|
|
|
www.lenscrafterscontacts.com
(2)
|
|
(1)
|
On February 19, 2010, we completed the acquisition of Salu, Inc., now Salu Beauty, Inc. (Salu), owner of SkinStore.com and operator and fulfillment partner for the
spalook.com web store. See Note 2 of our consolidated financial statements.
|
|
(2)
|
In January 2011, we launched two of our partnership sites with Luxottica Group, S.p.A. (Luxottica), a global leader in the design, manufacturing and distribution of
fashion, luxury, and sport eyewear.
|
|
(3)
|
We act as the exclusive fulfillment provider for customized nutritional supplements sold through
www.DrWeilVitaminAdvisor.com, www.DrWeil.com
, and other
Dr. Weil-related websites.
|
Business Segments; Growth Strategies
We operate our business in two business segments: over-the-counter or OTC and vision.
|
|
•
|
|
OTC
. Our OTC segment includes all non-prescription products sold online through our health and beauty web stores, microsites, and our
partnership web stores. We source our OTC products from various manufacturers and distributors. We also sell advertising on our primary OTC site
www.drugstore.com
. Our business strategy is to offer our customers a wide selection of health,
beauty, and wellness products at competitive prices and provide a superior online shopping experience. We are able to offer a significantly broader assortment of products, with greater depth in each product category, than brick-and-mortar drugstores
and provide a broad array of interactive tools and information on our websites to help consumers make informed purchasing decisions.
|
Key drivers of our OTC growth strategy for our OTC segment include expanding into new marketing channels and enhanced use of mobile and social media, continued ramp up of microsites, growth in
partnerships, international expansion, and overall increased customer conversion from site improvements and enhancements. We will continue to enter into new marketing channels, such as Buy.com, which we launched in the fourth quarter of 2010, and
ShopRunner.com and eBay.com, which we launched in the first quarter of 2011. In addition, we will continue to make investments in social media advertising and increasing our fan following population. We also recently launched new device agnostic
mobile stores and plan on launching a variety of applications, or apps, in 2011. We expect continued growth from our microsites, both from the five microsites we have launched to date as well as additional microsites we plan to launch in 2011.
Microsites allow us to better target specific customers with tailored marketing programs, by offering a larger assortment of niche specific SKUs and product content. We anticipate continued growth from our partnerships with Medco Health Services,
Inc. (Medco), which we recently extended the agreement with Medco through 2018, and Rite
30
Aid Corporation (Rite Aid) as they continue to attract new customers to the websites and generate more orders from site visitors. Finally, we plan to make improvements to site navigation and look
and feel of our sites to improve customer conversion. With these initiatives, we will continue to capitalize on our leadership position in health and beauty online, and continue to expand our categories and employ our strategy of being the
“when, where, and how” of health, beauty, and wellness.
|
|
•
|
|
Vision
. Our vision segment includes contact lenses and eye accessories sold through our vision web stores. We purchase our contact lens
inventory directly from various manufacturers and other distributors. We have a strategic multi-year e-commerce partnership with Luxottica, a global leader in the design, manufacturing and distribution of fashion, luxury, and sport eyewear. Through
this partnership, we will develop branded contact lens e-commerce sites for Luxottica’s North American businesses such as LensCrafters, Pearle Vision, and Sears Optical. In January 2011, we launched two Luxottica branded sites,
www.lenscrafterscontacts.com
and
www.pearlevisioncontacts.com
. In 2011, we plan to continue to drive new customer growth through promotional offers on our owned vision sites and launch additional Luxottica branded sites.
|
Business Acquisition
On February 19, 2010, we acquired Salu. The acquisition was made pursuant to an Agreement and Plan of Merger, dated as of December 27, 2009, by and among drugstore.com, Silk Acquisition
Corporation, a Delaware corporation and a wholly owned subsidiary of drugstore.com, Salu, certain stockholders of Salu, and a representative of all stockholders of Salu. As consideration for their shares of Salu, the stockholders of Salu received
$19.4 million in cash (less approximately $1.9 million of Salu’s transaction expenses and the repayment of Salu’s outstanding debt obligation of $2.6 million paid out of the merger consideration) and 5,425,678 shares of drugstore.com
common stock with a fair value of $17.3 million. Of this initial consideration, drugstore.com paid approximately $2.7 million in cash and 816,450 shares of our common stock into escrow to secure post-closing indemnification obligations of
Salu’s stockholders. Additionally, certain employees of Salu are eligible to receive a performance incentive payment payable in cash over a two-year period commencing in fiscal year 2010 with an aggregate value of $2.5 million if the surviving
entity achieves certain financial and other performance targets.
On the acquisition date, we recorded a liability of $0.5
million which represented the fair value of the portion of the performance incentive payment that will be accounted for as additional consideration. Any adjustments to the fair value of our initial estimate of the performance incentive payment may
affect our consolidated statements of operations and could have a material impact on our financial results. In 2010, approximately $0.2 million of the initial purchase price, equal parts of cash and stock, was reimbursed and $0.2 million was due
from escrow in connection with adjustments allowed for under the Agreement and Plan of Merger. Also in 2010, we reduced the performance incentive liability to $0.3 million and recorded a benefit to the statement of operations of $0.2 million.
We financed a portion of the cash payable at the closing of the acquisition described above by borrowing $10.0 million under
our revolving two-year line of credit pursuant to our March 2009 loan and security agreement with our existing bank. In conjunction with the acquisition, we also paid $1.4 million in transaction fees in the first quarter of 2010. In 2010, we also
incurred integration costs and purchase accounting adjustments of approximately $0.7 million, which are recorded in general and administrative expenses and cost of sales ($0.1 million) in our statements of operations. Salu’s results of
operations are included in the consolidated statements of operations beginning February 20, 2010, and generated net sales of $42.3 million, and net income of $2.3 million, excluding integration costs and purchase accounting adjustments of $0.3
million.
Discontinued Operations
On July 29, 2010, drugstore.com and DS Pharmacy, Inc., our wholly owned subsidiary, entered into a second amendment to the asset purchase agreement dated May 5, 2010, as amended July 14,
2010, with
31
BioScrip, Inc., and BioScrip Pharmacy Services, Inc., its wholly owned subsidiary (BioScrip), of which the sale closed on July 30, 2010. Under the terms of the agreement, BioScrip Pharmacy
Services purchased substantially all of the assets of DS Pharmacy for a purchase price of $10.5 million, subject to adjustment for changes in gross profit of the business. Of this initial consideration, BioScrip paid $5.0 million in connection with
closing, with $0.5 million accounting for the purchase of inventory and $4.5 million accounting for the purchase of other assets. BioScrip will pay the remaining $5.5 million of the consideration into escrow in installments, based on the monthly
profitability of the business, over the 12 months following the closing. The final amount paid out of escrow will be determined after the 12-month period based on the profitability of the prescription pharmacy business during that period. For the
year ended January 2, 2011, we recognized $1.6 million of the contingent consideration and will continue to earn all or a portion of the remaining consideration of $3.9 million over the remaining contract period in 2011. Additionally, the
parties entered into a 5-year marketing agreement allowing drugstore.com pharmacy customers to continue to order as they always have through the drugstore.com web store. Under the agreement, 12 months following the closing of July 30, 2010,
BioScrip will pay drugstore.com a fee to continue to market the drugstore.com pharmacy, which will be served by BioScrip. We consider the marketing service fees to be indirect cash inflows of our discontinued mail-order pharmacy segment, as the fees
earned are not a significant source of ongoing future revenue.
On September 3, 2008, we entered into an amended and
restated main agreement with Rite Aid whereby we transferred to Rite Aid the rights to our local pick-up pharmacy business (LPU), which included prescription refills sold online through the drugstore.com web store or the Rite Aid online store and
picked up by customers at Rite Aid stores, in exchange for $9.9 million, paid in ten monthly installments beginning in September 2008. We recorded the purchase price as a deferred gain that we recognized over the ten-month contractual payment period
ended June 2009. Additionally, Rite Aid paid drugstore.com ongoing marketing service fees for the continued marketing of Rite Aid’s LPU offering on the drugstore.com site during the term of the agreement, which terminated in May 2010. In
addition the pharmacy agreement terminated as of July 2010.
We have classified the results of operations of our mail-order
pharmacy and LPU business segments as discontinued operations in the accompanying consolidated financial statements for all periods presented.
We operate using a 52/53-week retail calendar year with each of the fiscal quarters in a 52-week year representing a 13-week period. Fiscal year 2010 was a 52-week year, fiscal year 2009 was a 53-week
year, with the fourth quarter of 2009 representing a 14-week period, and fiscal year 2008 was a 52-week year. To make results comparable on a 52-week basis for the purpose of presenting normalized growth rates, net sales growth rate comparisons for
2010 and 2009 below have been multiplied by a fraction of 52/53.
Results of Operations
Customer and Order Data
We define new and repeat customer orders as orders generated through our health and beauty web stores, microsites, and our vision web stores, excluding our partnership orders with Medco, Rite Aid and
Spalook and orders generated through Dr. Weil-related web stores. We define total orders as all orders fulfilled through our distribution centers. Mixed orders across one or more of our business segments are reported to each individual segment,
but are included only as one order in the number of total customer orders shipped. Orders from new customers increased year-over-year in 2010 by 16% to 1.9 million orders and increased year-over-year in 2009 by 17% to 1.6 million orders.
These increases are primarily the result of expansion into new marketing channels, and in 2010, 128,000 new orders generated from our acquisition of Salu. Orders from repeat customers as a percentage of total orders decreased year-over-year to 65%
in 2010 compared to 68% in 2009 and 72% in 2008 as a result of our partnership orders becoming an increasing proportion of our total orders. Our partnership orders, as defined above, totaled 576,000 in 2010 and 268,000 in 2009.
32
Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
(in thousands, except per order data)
|
|
|
Total net sales
|
|
$
|
456,507
|
|
|
|
21.5
|
%
|
|
$
|
375,574
|
|
|
|
16.6
|
%
|
|
$
|
322,214
|
|
|
Total customer orders shipped
|
|
|
7,078
|
|
|
|
19.2
|
%
|
|
|
5,938
|
|
|
|
12.0
|
%
|
|
|
5,300
|
|
|
Total average net sales per order
|
|
$
|
65
|
|
|
|
3.2
|
%
|
|
$
|
63
|
|
|
|
3.3
|
%
|
|
$
|
61
|
|
Net sales include
gross revenues from sales of product, shipping fees, service fees, and advertising revenues, net of discounts, provision for sales returns, and other allowances. Net sales also include consignment service fees earned from our arrangements with
certain partners, under which we do not take title to the inventory and do not establish pricing. We record on a net basis consignment service fees, which constitute approximately 1% of total net sales in each period presented.
Total net sales increased approximately 22% year-over-year in 2010 as a result of the acquisition of Salu on February 19, 2010,
which generated $42.3 million of net sales in 2010, and increases in order volume and net sales per order. Normalized to exclude the extra week in 2009, net sales increased 24% year-over-year in 2010. Order volumes increased year-over-year in 2010,
primarily reflecting a 21% increase in orders in our OTC segment. Net sales per order increased year-over-year in 2010 as a result of an increase in net sales per order in both our OTC and vision segments.
Total net sales increased 17% year-over-year in 2009 as a result of an increase in order volume, the 53-week year in 2009 compared to the
52-week year in 2008, and an increase in the average net sales per order. Normalized to exclude the extra week in 2009, net sales increased 14% year-over-year in 2009. Order volumes increased year-over-year in 2009, reflecting a 19% and 6% increase
in orders in our OTC and vision segments, respectively. Net sales per order increased year-over-year in 2009 as a result of an increase in net sales per order in our vision segment, partially offset by a decrease in net sales per order in our OTC
segment. Revenues from repeat customers, excluding partnerships, were 72%, 74% and 76% in 2010, 2009, and 2008 respectively.
OTC Net
Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
(in thousands, except per order data)
|
|
|
OTC net sales
|
|
$
|
385,234
|
|
|
|
25.5
|
%
|
|
$
|
306,854
|
|
|
|
17.7
|
%
|
|
$
|
260,794
|
|
|
Percentage of total net sales from OTC
|
|
|
84.4
|
%
|
|
|
|
|
|
|
81.7
|
%
|
|
|
|
|
|
|
80.9
|
%
|
|
OTC customer orders shipped
|
|
|
6,490
|
|
|
|
21.1
|
%
|
|
|
5,358
|
|
|
|
19.1
|
%
|
|
|
4,498
|
|
|
OTC average net sales per order
|
|
$
|
59
|
|
|
|
3.5
|
%
|
|
$
|
57
|
|
|
|
-1.7
|
%
|
|
$
|
58
|
|
Net sales in our OTC
segment increased approximately 26% year-over-year in 2010 as a result of an increase in order volume and average net sales per order. Normalized to exclude the extra week in 2009, net sales in our OTC segment increased 28% year-over-year in 2010.
The number of orders in our OTC segment grew year-over-year by 21% in 2010. Orders from both new and repeat customers increased as a result of: (a) orders generated from our acquisition of Salu on February 19, 2010, (b) orders driven
by our partnerships with Medco and Rite Aid, and (c) orders through new and existing marketing channels. The year-over-year increase in the average net sales per order in our OTC segment in 2010 resulted primarily from a shift in mix to higher
priced items, primarily driven by the acquisition of Salu, which has higher average net sales per order. Net sales generated by our acquisition of Salu in 2010 were $42.3 million, and net sales generated by our partnerships with Medco and Rite Aid
in 2010 were $19.0 million compared to $8.9 million in 2009.
33
Net sales in our OTC segment increased 18% year-over-year in 2009 as a
result of an increase in order volume and the 53-week year in 2009 compared to the 52-week year in 2008, partially offset by a decrease in average net sales per order. OTC net sales, normalized to exclude the 53
rd
week in the year, increased 15% year-over-year in 2009. The number
of orders in our OTC segment grew year-over-year by 19% in 2009 driven by increased orders from both new and repeat customers as a result of our increasing active customer base and our continued efforts to improve customer retention and conversion
by adding website enhancements and offering a broader selection of basic necessity items and hard-to-find specialty items through the addition of new SKUs, which encourages customers to return to our websites and make repeat, replenishment, and
impulse purchases, and to a lesser extent, orders driven by our partnerships with Rite Aid and Medco. The slight year-over-year decrease in average net sales per order in 2009 resulted from a decrease in shipping revenue as customers took advantage
of free shipping offers and choose not to use expedited shipping methods, increased discounts driven by promotional activity, and a slight decrease in the number of units per order, partially offset by a shift in product mix to higher priced items.
Vision Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
(in thousands, except per order data)
|
|
|
Vision net sales
|
|
$
|
71,273
|
|
|
|
3.7
|
%
|
|
$
|
68,720
|
|
|
|
11.9
|
%
|
|
$
|
61,420
|
|
|
Percentage of total net sales from vision
|
|
|
15.6
|
%
|
|
|
|
|
|
|
18.3
|
%
|
|
|
|
|
|
|
19.1
|
%
|
|
Vision customer orders shipped
|
|
|
591
|
|
|
|
0.5
|
%
|
|
|
588
|
|
|
|
6.3
|
%
|
|
|
553
|
|
|
Vision average net sales per order
|
|
$
|
121
|
|
|
|
3.4
|
%
|
|
$
|
117
|
|
|
|
5.4
|
%
|
|
$
|
111
|
|
Net sales in our vision segment increased 4% year-over-year in 2010 as a result of an increase in orders and net
sales per order. Normalized to exclude the extra week in 2009, net sales in our vision segment increased 6% year-over-year in 2010. Net sales in our vision segment increased 12% year-over-year in 2009 as a result of an increase in order volume, an
increase in average net sales per order, and the 53-week year in 2009 compared to the 52-week year in 2008. Vision net sales normalized to exclude the 53
rd
week in the year, increased 10% year-over-year in 2009. The year-over-year increase in average net sales per order in
2010 and 2009 was driven primarily by customers making larger quantity purchases, price increases for certain SKUs (none of which were individually material), and sales of higher-priced newer technology contact lenses, partially offset by increased
use of discount and promotional offers by our customers. Orders in our vision segment in 2010 were consistent and orders increased year-over-year in 2009, primarily as a result of increased new customer orders driven by promotional offers.
Cost of Sales and Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Total cost of sales
|
|
$
|
322,011
|
|
|
|
22.3
|
%
|
|
$
|
263,350
|
|
|
|
15.7
|
%
|
|
$
|
227,531
|
|
|
Total gross profit dollars
|
|
$
|
134,496
|
|
|
|
19.8
|
%
|
|
$
|
112,224
|
|
|
|
18.5
|
%
|
|
$
|
94,683
|
|
|
Total gross margin percentage
|
|
|
29.5
|
%
|
|
|
|
|
|
|
29.9
|
%
|
|
|
|
|
|
|
29.4
|
%
|
Cost of sales consists
primarily of the cost of products sold to our customers, including allowances for shrinkage and damaged, slow-moving, and expired inventory; outbound and inbound shipping costs; and expenses related to promotional inventory included in shipments to
customers. We net against cost of sales payments that we receive from vendors in connection with volume purchases or rebate allowances and payment discount terms.
Total cost of sales increased year-over-year in absolute dollars in 2010 and 2009 as a result of growth in order volume and net sales in our OTC and vision segments. Total gross margin percentage
decreased year-over-year in
34
2010 primarily as a result of a decrease in our OTC segment margin due to increased new customer promotions, downward marketplace pricing pressures, and lower advertising revenue. Gross margin
percentage increased year-over-year in 2009 primarily as a result of a fifty basis point improvement in our OTC segment margin.
Shipping
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Shipping activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shipping revenue
|
|
$
|
15,018
|
|
|
|
10.7
|
%
|
|
$
|
13,567
|
|
|
|
-1.7
|
%
|
|
$
|
13,804
|
|
|
Shipping costs
|
|
|
34,744
|
|
|
|
22.4
|
%
|
|
|
28,379
|
|
|
|
9.5
|
%
|
|
|
25,911
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net shipping loss
|
|
$
|
19,726
|
|
|
|
33.2
|
%
|
|
$
|
14,812
|
|
|
|
22.3
|
%
|
|
$
|
12,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shipping revenue
|
|
|
3.3
|
%
|
|
|
|
|
|
|
3.6
|
%
|
|
|
|
|
|
|
4.3
|
%
|
|
Shipping costs
|
|
|
7.6
|
%
|
|
|
|
|
|
|
7.6
|
%
|
|
|
|
|
|
|
8.0
|
%
|
|
Net shipping loss
|
|
|
4.3
|
%
|
|
|
|
|
|
|
3.9
|
%
|
|
|
|
|
|
|
3.8
|
%
|
We include in net sales
our revenues from shipping charges to customers, and we include in cost of sales outbound shipping costs. Our net shipping loss increased year-over-year in absolute dollars and as a percentage of net sales in 2010 and 2009, primarily as a result of
a decrease in shipping revenue resulting from an increase in the number of customers using free shipping offers, a reduced number of customers choosing expedited shipping methods for their orders, and the elimination of surcharges for APO/FPO and
Alaska and Hawaii orders in the fourth quarter of 2008, combined with a greater proportion of OTC orders, which have a higher shipping cost than orders in our vision segment. We expect to continue to subsidize a portion of customers’ shipping
costs for the foreseeable future, through certain free shipping promotions, as a strategy to attract and retain customers.
OTC Cost of
Sales and Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
OTC cost of sales
|
|
$
|
267,681
|
|
|
|
27.2
|
%
|
|
$
|
210,456
|
|
|
|
16.8
|
%
|
|
$
|
180,252
|
|
|
OTC gross profit dollars
|
|
$
|
117,553
|
|
|
|
21.9
|
%
|
|
$
|
96,398
|
|
|
|
19.7
|
%
|
|
$
|
80,542
|
|
|
OTC gross margin percentage
|
|
|
30.5
|
%
|
|
|
|
|
|
|
31.4
|
%
|
|
|
|
|
|
|
30.9
|
%
|
Cost of sales in our OTC
segment increased year-over-year in absolute dollars in 2010, as a result of growth in order volumes and net sales generated from the acquisition of Salu, growth in net sales from our partnerships with Medco and Rite Aid, and growth in net sales
generated through existing and new marketing channels. Our gross margin percentage decreased year-over-year in 2010 as a result of increased promotional activity, softness in discretionary consumer spending, declining advertising revenue as a result
of changes in our marketing services agreement, manufacturer out of stocks and discontinued product lines, and lower margin growth from our Medco and Rite Aid partnerships, partially offset by net sales generated by Salu, which has historically
higher margins, and reduced OTC product costs and increased vendor subsidies.
Cost of sales in our OTC segment increased
year-over-year in absolute dollars in 2009, as a result of growth in order volume and net sales. The year-over-year increase in gross margin percentage in this segment in 2009 resulted primarily from improvements in product margins in a majority of
our product categories as a result of our ongoing pricing and sourcing initiatives and better targeted promotional efforts, partially offset by higher customer use of discount offers.
35
Vision Cost of Sales and Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Vision cost of sales
|
|
$
|
54,330
|
|
|
|
2.7
|
%
|
|
$
|
52,894
|
|
|
|
11.9
|
%
|
|
$
|
47,279
|
|
|
Vision gross profit dollars
|
|
$
|
16,943
|
|
|
|
7.1
|
%
|
|
$
|
15,826
|
|
|
|
11.9
|
%
|
|
$
|
14,141
|
|
|
Vision gross margin percentage
|
|
|
23.8
|
%
|
|
|
|
|
|
|
23.0
|
%
|
|
|
|
|
|
|
23.0
|
%
|
Cost of sales in our
vision segment increased year-over-year in absolute dollars in 2010 and 2009, as a result of an increase in net sales. Gross margin percentage in 2010 benefited year-over-year by lower product costs through our joint sourcing agreement with
Luxottica, partially offset by increased discounts and promotional offers. Additionally, cost of sales increased due to a greater mix of higher priced inventory related to the build-up of inventory to support the move in the first quarter of 2010 of
our vision fulfillment operations from Ferndale, Washington to our distribution center in Swedesboro, New Jersey, and a one-time inventory shrinkage charge related to the migration of inventory to a new perpetual inventory system. Gross margin
percentage in 2009 remained consistent year-over-year.
Fulfillment and Order Processing Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Fulfillment and order processing expense
|
|
$
|
49,604
|
|
|
|
18.4
|
%
|
|
$
|
41,891
|
|
|
|
7.7
|
%
|
|
$
|
38,896
|
|
|
Percentage of net sales
|
|
|
10.9
|
%
|
|
|
|
|
|
|
11.2
|
%
|
|
|
|
|
|
|
12.1
|
%
|
|
Fixed and variable cost information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable costs
|
|
$
|
36,194
|
|
|
|
21.9
|
%
|
|
$
|
29,700
|
|
|
|
12.9
|
%
|
|
$
|
26,307
|
|
|
Fixed costs
|
|
$
|
13,410
|
|
|
|
10.0
|
%
|
|
$
|
12,191
|
|
|
|
-3.2
|
%
|
|
$
|
12,589
|
|
Fulfillment and order
processing expenses include payroll and related expenses for personnel engaged in purchasing, fulfillment, distribution, and customer care activities (including warehouse and vision prescription verification personnel), distribution center equipment
and packaging supplies, credit card processing fees, and bad debt expenses. These expenses also include rent and depreciation related to equipment and fixtures in our distribution centers and call center facility. Variable fulfillment costs
represent the incremental costs of fulfilling, processing, and delivering the orders that are variable based on sales volume.
Variable fulfillment and order processing expenses increased year-over-year in absolute dollars in 2010 primarily as a result of a 21%
increase in order volume in our OTC segment, and to a lesser extent, a higher fulfillment cost for Salu, which is provided by a third party fulfillment partner. Fixed fulfillment and order processing expenses increased year-over-year in 2010,
primarily due to the addition of Salu’s fulfillment costs of $1.3 million, an increase in stock-based compensation expense of $0.4 million as a result of stock awards approved at our stockholder meeting on June 10, 2010, partially offset
by a reduction in depreciation expense of $0.4 million related to equipment and software purchases being fully depreciated in prior periods. Fulfillment and order processing expenses as a percentage of net sales improved year-over-year in 2010, due
to cost containment efforts and the fact that our fixed fulfillment costs were spread across a higher revenue base.
Variable
fulfillment and order processing expenses increased year-over-year in absolute dollars in 2009 primarily as a result of a 19% increase in order volume in our OTC segment, partially offset by a reduction in labor fulfillment costs resulting from
process improvements made in our primary distribution center and efficiencies gained as a result of increased order volume. Fixed fulfillment and order processing expenses decreased year-over-year by $0.4 million in 2009 primarily as a result of a
decrease in consulting fees of approximately $0.9 million related to process improvement projects, partially offset by increased depreciation expense of $0.3 million related to equipment and software purchases, and increased operating expenses of
36
$0.2 million. Fulfillment and order processing expenses as a percentage of net sales decreased in 2009 as a result of a 30 basis point improvement in variable costs as a percentage of net sales,
due to increased efficiencies in our primary distribution facility, and a 70 basis improvement in fixed costs as a percentage of sales, due to fixed costs spread across a higher revenue base, and to a lesser extent, a reduction in consulting
expenses.
Marketing and Sales Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Marketing and sales expense
|
|
$
|
46,550
|
|
|
|
23.4
|
%
|
|
$
|
37,727
|
|
|
|
16.2
|
%
|
|
$
|
32,464
|
|
|
Percentage of net sales
|
|
|
10.2
|
%
|
|
|
|
|
|
|
10.0
|
%
|
|
|
|
|
|
|
10.1
|
%
|
Marketing and sales
expenses include advertising expenses, promotional expenditures, web analytic tools, web design, and payroll and related expenses for personnel engaged in marketing and merchandising activities. Advertising expenses include our obligations under
various advertising contracts. Advertising and other promotional costs, which consist primarily of online advertising, and to a lesser extent, royalty and public relations expenditures, are expensed as incurred, and were $34.2 million in 2010,
$27.3 million in 2009, and $22.8 million in 2008.
Marketing and sales expenses increased year-over-year in absolute
dollars and as a percentage of net sales in 2010 primarily as a result of an increase of $6.9 million in paid search, affiliate, and portal costs, driven by order volume, growth in new customer orders, the addition of Salu’s online marketing
costs, and growth in partnership marketing costs; increased stock-based compensation of $0.6 million as a result of stock awards approved at our stockholder meeting on June 10, 2010; and an increase of $1.2 million from the addition of
Salu’s other marketing costs.
Marketing and sales expenses increased year-over year in absolute dollars but decreased as
a percentage of net sales in 2009 primarily from an increase of $4.5 million in paid search, affiliate, and portal costs, driven primarily by order volume, growth in new customer orders, and growth in partnership marketing costs, and a $0.8 million
increase in employee related costs.
Marketing and sales expense per new customer, excluding partnership marketing costs and
orders, was $24 in 2010, $22 in 2009 and $23 in 2008. The year-over-year increase in 2010 marketing cost per new customer is primarily due to a higher mix of new customer orders, which have a higher acquisition cost, and an increase in marketing
investments associated with our microsites and international initiatives as well as a shift in marketing channel mix related to social networks and marketplaces. The year-over-year decrease in 2009 marketing cost per new customer, excluding
partnerships, is primarily due to the acquisition of new customers in lower cost marketing channels.
Technology and Content Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Technology and content expense
|
|
$
|
27,303
|
|
|
|
9.8
|
%
|
|
$
|
24,864
|
|
|
|
8.1
|
%
|
|
$
|
22,995
|
|
|
Percentage of net sales
|
|
|
6.0
|
%
|
|
|
|
|
|
|
6.6
|
%
|
|
|
|
|
|
|
7.1
|
%
|
Technology and content
expenses consist primarily of payroll and related expenses for personnel engaged in developing, maintaining, and making routine upgrades and improvements to our websites. Technology and content expenses also include Internet access and hosting
charges, depreciation on hardware, and IT structures, utilities, and website content and design expenses.
37
Technology and content expenses increased year-over-year in absolute dollars but decreased
as a percentage of net sales in 2010 primarily from: the addition of $1.6 million of Salu’s technology costs; an increase in depreciation expense of $1.1 million related to the completion of internally developed software projects and the
acquisition of software and computer equipment to enhance our websites and IT infrastructure; an increase in stock-based compensation expense of $0.5 million as a result of stock awards approved at our stockholder meeting on June 10, 2010;
partially offset by a decrease in employee-related costs of approximately $0.9 million related to reduced employee compensation. Technology and content expenses increased year-over-year in absolute dollars but decreased as a percentage of net sales
in 2009 primarily from: increases in depreciation costs of $1.5 million related to the completion of internally developed software projects and the acquisition of software and computer equipment to enhance our websites and IT infrastructure; and an
increase in employee related expenses of $0.4 million, primarily driven by a slight increase in headcount and other compensation, partially offset by a reduction in stock compensation expense.
Technology and content expenses as a percentage of net sales decreased in 2010 and 2009 as a result of fixed costs being spread across a
higher revenue base.
General and Administrative Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
General and administrative expense
|
|
$
|
20,221
|
|
|
|
14.6
|
%
|
|
$
|
17,642
|
|
|
|
-11.2
|
%
|
|
$
|
19,866
|
|
|
Percentage of net sales
|
|
|
4.4
|
%
|
|
|
|
|
|
|
4.7
|
%
|
|
|
|
|
|
|
6.2
|
%
|
General and administrative
expenses consist of payroll and related expenses for executive and administrative personnel, corporate facility expenses, including depreciation on equipment and leasehold improvements, professional service expenses, intangible asset amortization,
and other general corporate expenses.
General and administrative expenses increased year-over-year in absolute dollars by
$2.6 million, but decreased as a percentage of net sales in 2010. Of the increase, $1.3 million relates to stock compensation as a result of stock awards approved at our stockholder meeting on June 10, 2010, $1.9 million related to the addition
of Salu’s general and administrative costs, and a $1.2 million benefit realized in 2009 from the resolution of our New Jersey sales tax case. Partially offsetting these increases is a reduction in professional fees of approximately $1.0 million
related to consulting projects focused on our profitability initiatives in 2009, a reduction in employee related expenses of $0.7 million, and a decrease of approximately $0.3 million related to increased purchase card program incentives and general
cost reductions. Additionally, 2010 included a $1.4 million transaction fee related to the acquisition of Salu and the issuance of a fully vested warrant with a fair value of $0.7 million issued in exchange for three years of advisory services,
partially offset by the absence of 2009 expenses of $1.0 million for an advisory fee related to our strategic alliance with Luxottica, $0.4 million of expenses related to the Salu acquisition, and a charge of $0.5 million related to a legal
settlement.
General and administrative expenses decreased in both absolute dollars and as a percentage of net sales in 2009
compared to the prior year. The year-over-year decrease of $2.2 million resulted primarily from: a decrease in stock-based compensation of $1.9 million primarily due to option grants becoming fully vested in 2008; a decrease in professional fees of
$1.6 million primarily related to pricing and sourcing initiatives that were incurred in the prior year; a $0.4 million decrease in amortization as a result of certain intangible assets being fully amortized; and to a lesser extent, in the first
half of 2009, a decrease of $1.6 million related to the settlement of our New Jersey sales tax case, and reduced insurance costs of $0.4 million. These decreases were partially offset by the a legal settlement of $0.5 million, a $1.0 million
advisory fee related to our strategic alliance with Luxottica, increased employee related expenses of $1.5 million, and $0.4 million of expenses related to our acquisition of Salu.
38
General and administrative expenses as a percentage of net sales decreased in 2010 and 2009
as a result of fixed costs spread across a higher revenue base.
Interest Income and Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
Fiscal Year
2009
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Interest (expense) income, net
|
|
$
|
(432
|
)
|
|
$
|
46
|
|
|
$
|
631
|
|
Interest income
consists of earnings on our cash, cash equivalents, and marketable securities, and interest expense consists primarily of interest associated with debt obligations. The year-over-year increase in net interest expense in 2010 was primarily from an
increase in interest expense resulting from higher borrowings on our line of credit primarily due to the acquisition of Salu and receiving lower returns on a year-over-year lower average balance of cash, cash equivalents, and marketable securities.
The year-over-year decrease in net interest income in 2009 was primarily a result of receiving lower returns on cash, cash equivalents, and marketable securities balances, partially offset by a decrease in interest expense as we decreased our
outstanding debt obligations.
Gain from Discontinued Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
2010
|
|
|
% Change
|
|
|
Fiscal Year
2009
|
|
|
% Change
|
|
|
Fiscal Year
2008
|
|
|
|
|
($ in thousands)
|
|
|
Gain from discontinued operations
|
|
$
|
6,064
|
|
|
|
-28.5
|
%
|
|
$
|
8,477
|
|
|
|
-20.2
|
%
|
|
$
|
10,620
|
|
The gain from
discontinued operations in 2010 represents the gain on the sale and the operations of our discontinued mail-order pharmacy segment as a result of our sale of our mail-order pharmacy assets to BioScrip, which closed on July 30, 2010. See Note 3
of our consolidated financial statements, “
Discontinued Operations
,” included in Part IV, Item 15 of this annual report. The gain from discontinued operations in 2009 represents the operations of both our discontinued
mail-order pharmacy segment of $2.5 million and $5.9 million received from Rite Aid related to the sale of our local pick-up pharmacy (LPU) business. The gain from discontinued operations in 2008 also represents the operations of both our
discontinued mail-order pharmacy segment of $2.5 million and $5.7 million generated by discontinued operations prior to the sale of the LPU business to Rite Aid in September 2008, and a net $2.3 million from the sale of discontinued operations
related to LPU, comprised of $4.0 million payment, a $0.3 million gain from the sale of inventory, partially offset by the acceleration amortization of $1.9 million of prepaid marketing costs.
Non-GAAP Measures
Adjusted EBITDA
and Ongoing Adjusted EBITDA
The following table provides information regarding our adjusted EBITDA, including a
reconciliation of net loss to adjusted EBITDA, for the last three fiscal years (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
Net loss
|
|
$
|
(3,550
|
)
|
|
$
|
(1,377
|
)
|
|
$
|
(8,287
|
)
|
|
Amortization of intangible assets
|
|
|
434
|
|
|
|
477
|
|
|
|
867
|
|
|
Amortization of non-cash marketing
|
|
|
—
|
|
|
|
—
|
|
|
|
3,435
|
|
|
Stock-based compensation
|
|
|
8,949
|
|
|
|
5,400
|
|
|
|
7,564
|
|
|
Depreciation
|
|
|
13,733
|
|
|
|
12,682
|
|
|
|
10,912
|
|
|
Interest income, net
|
|
|
432
|
|
|
|
(46
|
)
|
|
|
(631
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
$
|
19,998
|
|
|
$
|
17,136
|
|
|
$
|
13,860
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
39
The following table provides information regarding our ongoing adjusted EBITDA, including a
reconciliation of adjusted EBITDA to ongoing adjusted EBITDA, for the last three fiscal years (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
Adjusted EBITDA
|
|
$
|
19,998
|
|
|
$
|
17,136
|
|
|
$
|
13,860
|
|
|
Less: Proceeds from the sale of LPU
|
|
|
—
|
|
|
|
(5,946
|
)
|
|
|
(11,515
|
)
|
|
Less: Discontinued mail-order pharmacy operations
|
|
|
(6,437
|
)
|
|
|
(2,603
|
)
|
|
|
(2,610
|
)
|
|
Less: Litigation related settlements
|
|
|
—
|
|
|
|
(725
|
)
|
|
|
—
|
|
|
Add: Vision migration charges
|
|
|
650
|
|
|
|
—
|
|
|
|
—
|
|
|
Add: Salu and Luxottica transaction and integration related costs
|
|
|
2,130
|
|
|
|
1,400
|
|
|
|
—
|
|
|
Add: New Jersey sales tax and interest
|
|
|
—
|
|
|
|
—
|
|
|
|
380
|
|
|
Add: DC process improvement and profitability initiatives consulting
|
|
|
—
|
|
|
|
—
|
|
|
|
2,339
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ongoing Adjusted EBITDA
|
|
$
|
16,341
|
|
|
$
|
9,262
|
|
|
$
|
2,454
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
To supplement the consolidated financial statements presented in accordance with U.S. generally accepted
accounting principles (GAAP), we use the non-GAAP measure of adjusted EBITDA, defined as earnings before interest, taxes, depreciation, and amortization of intangible assets, adjusted to exclude the impact of stock-based compensation expense. We
also use the non-GAAP measure of ongoing adjusted EBITDA, defined as adjusted EBITDA excluding the impact of expenses or income from discontinued operations, certain legal actions, settlements and related costs outside our normal course of business,
restructuring and severance costs, impairment charges, and certain other one-time charges and credits specifically identified in the non-GAAP reconciliation financial schedules included in this annual report. These non-GAAP measures are provided to
enhance the user’s overall understanding of our current financial performance. Management believes that adjusted EBITDA and ongoing adjusted EBITDA, as defined, provides useful information to us and to investors by excluding certain items that
may not be indicative of our core operating results. In addition, because we have historically provided adjusted EBITDA and have recently begun to provide ongoing adjusted EBITDA measures to investors, management believes that including adjusted
EBITDA and ongoing adjusted EBITDA measures provides consistency in the our financial reporting. However, adjusted EBITDA and ongoing adjusted EBITDA should not be considered in isolation, or as a substitute for, or as superior to, net income/loss,
cash flows, or other consolidated income/loss or cash flow data prepared in accordance with GAAP, or as a measure of our profitability or liquidity. Although adjusted EBITDA and ongoing adjusted EBITDA are frequently used as measures of operating
performance, they are not necessarily comparable to other similarly titled captions of other companies due to differences in methods of calculation. Net income/loss is the closest financial measure prepared by us in accordance with GAAP in terms of
comparability to adjusted EBITDA and ongoing adjusted EBITDA.
Adjusted EBITDA and ongoing adjusted EBITDA have increased
year-over-year in 2010 and 2009, primarily as a result of a year-over-year increase in gross profit dollars of $22.3 million and $17.5 million in 2010 and 2009, respectively, driven primarily by increased sales volume. Additionally, fixed costs as a
percentage of revenue have decreased year-over-year in 2010 and 2009 as a result of costs being spread across a higher revenue base.
Significant Accounting Judgments
The preparation of financial statements in conformity with GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related
disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The Securities and Exchange Commission has defined a company’s critical accounting policies as the ones that are most important to
the portrayal of the company’s financial condition and results of operations and that require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently
uncertain. Significant accounting policies are included in Note 1 of our consolidated financial
40
statements included in Part IV, Item 15 of this annual report. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based on information presently
available. Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions. In addition, any significant unanticipated changes in any of our assumptions could have a material adverse effect on our
business, financial condition, and results of operations.
Revenue Recognition
We recognize revenue from product sales or services rendered (including advertising revenues), net of sales tax, when the following
revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the selling price or fee earned is fixed or determinable; and (4) collection of
the resulting receivable is reasonably assured. Revenue arrangements with multiple deliverables are divided into separate units and revenue is allocated using estimated selling prices if we do not have vendor-specific objective evidence or
third-party evidence of the selling prices of the deliverables.
Revenues are recorded when the products are shipped and title
passes to customers, net of promotional discounts, cancellations, rebates, and returns allowances. We generally require payment by credit card at the point of sale. We estimate return allowances, which reduce product sales by our estimate of
expected product returns, based on our historical experience. Historically, product returns have not been significant and have not differed significantly from our estimates. We evaluate whether it is appropriate to record the gross amount of product
sales and related costs or the net amounts earned. Generally, when we are the primary party obligated in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these
indicators, we record revenue on a gross basis. In addition, when we report revenue from fulfillment partnerships, we include in revenues, the costs of the products sold and our variable fulfillment costs to fulfill each order that are received from
our fulfillment partners.
From time to time, we provide incentive offers to our customers to encourage purchases. Such offers
include discounts on specific current purchases, or future rebates based on a percentage of the current purchase, as well as other offers. We treat discounts, when our customers accept them, as a reduction in the sales price of the related
transaction and we present them as a net amount in net sales. We treat rebates as a reduction in the sales price based on estimated redemption rates. We estimate redemption rates using our historical experience for similar offers. Historically, our
redemption rates have not differed materially from our estimates, which we adjust quarterly.
Inventories
We value our inventories at the lower of cost (using the weighted-average cost method) or the current estimated market
value. We regularly review inventory quantities on hand and adjust our inventories for shrinkage and slow-moving, damaged, and expired inventory, which we record as the difference between the cost of the inventory and the estimated market value
based on management’s assumptions about future demand for the products we offer and market conditions. We use a variety of methods to reduce the quantity of slow-moving inventory, including reducing sales prices on our websites, negotiating
returns to vendors, and liquidating inventory through third parties. If our estimates of future product demand or our assumptions about market conditions are inaccurate, we could understate or overstate the write down required for excess and
obsolete inventory. Historically, inventory write downs have not differed materially from our estimates.
These assumptions
about future write-downs of inventory are inherently uncertain. As a measure of sensitivity, for every 1% of additional inventory allowance at January 2, 2011 we would have recorded an additional cost of sales of approximately $0.5 million.
41
Goodwill, Indefinite lived and Other Intangible Assets
We test for impairment of goodwill during the fourth quarter of each year and whenever indicators of impairment occur. The first phase of
the test screens for impairment, while the second phase of the test (if necessary) measures the amount of impairment. The first phase is performed by comparing the fair value of the applicable reporting unit to its carrying value. Fair value is
determined using either a discounted cash flow methodology or methodology based on comparable market prices. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that
goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.
During fiscal 2010, 2009 and 2008 we estimated the fair value of our reporting units by preparing a discounted cash flow analysis using
forward looking projections of our estimated future operating results. Based on the results of the discounted cash flow analysis each year, we concluded that the fair value of our reporting units exceeded the carrying value, and therefore goodwill
was not impaired. We also considered as an indicator of market value the market value of our common stock during the fourth quarter of the respective fiscal years.
The significant assumptions used in our discounted cash flow analysis included: projected operating results, the discount rate used to present value future cash flows, and capital expenditures. Projected
operating results assumptions include sales growth assumptions which are based on historical trends, and to a lesser extent, future sales growth from new strategic partnerships or initiatives. Also included in projected operating results are gross
margin and operating cost growth assumptions which are based on the historical relationship of those measures compared to sales. Our discount rate is a “market participant” weighted average cost of capital (WACC). Financial and credit
markets directly impact our fair value measurement through our weighted average cost of capital that we use to determine our discount rate. Our capital expenditure assumptions are based on our planned capital expenditures for existing and new
projects. Sensitivity tests were performed on our significant assumptions and determined that a reasonable, negative change in assumptions would not impact our conclusions.
We review the carrying values of our amortized long-lived assets, including definite-lived intangible assets, whenever an indicator of impairment exists. When facts and circumstances indicate that the
carrying values of long-lived assets may be impaired, we perform an evaluation of recoverability. The determination of whether the asset is recoverable is based on any excess of the carrying value over the expected future cash flows, as estimated
through undiscounted cash flows, excluding interest charges. If it is not recoverable, any resulting impairment charge would be measured based on the difference between the carrying value of the asset and its fair value, as estimated through
expected future discounted cash flows, discounted at a rate of return for an alternate investment.
We review our
indefinite-lived intangible assets, other than goodwill, for impairment annually during the fourth quarter or when an indicator of impairment exists. We compare the carrying value of the asset to its estimated fair value based upon a discounted cash
flow analysis and record an impairment charge when the carrying value of the asset exceeds the estimated fair value. Based upon our review, we recorded no impairment for amortized or unamortized long-lived assets in fiscal 2010, 2009, or 2008.
Stock-Based Compensation
We measure compensation cost for all stock-based awards at fair value on the date of grant and recognize compensation cost over the service period for awards expected to vest. We calculate the fair value
of our stock options and stock appreciation rights granted to employees using the Black-Scholes option pricing model using the single-option approach. The fair value of restricted stock is determined based on the number of shares granted and the
quoted price of our common stock. The fair value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method. We base our computation of expected volatility on our
42
historical volatility, adjusted for changes in capital structure and corporate changes, information available that may indicate future volatility, and observable mean reversion tendencies of
historical volatility. Our expected term estimates are based on a comprehensive weighted average life (WAL) analysis. The WAL analysis provides a historical based platform for use in developing expected term estimates for the future based on the
historically observed time periods from grant date through post-vesting activities, such as exercise and cancellation. We base the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with an
equivalent remaining term. Where the expected term of our stock-based awards does not correspond with the terms for which interest rates are quoted, we average the rates quoted for the closest available term maturities. A dividend yield of 0% is
considered appropriate as we have not issued and do not anticipate issuing any dividends in the near future. When estimating forfeitures, we consider historical voluntary termination behavior in addition to actual option forfeitures. In conjunction
with this analysis, we identified distinct subgroups: non-management employees, management employees, our chief executive officer, board members, and other non-employees. We apply an estimated forfeiture rate to employee subgroups, based on the
weighted average termination behavior of those subgroups. If our estimated forfeiture rate changes, we retrospectively increase or decrease stock-based compensation in the period of change. Any such revisions to the estimates we use to calculate the
fair value of our stock-based awards could have a material impact on our results of operations and financial position. Our estimated forfeiture rates at in 2010 and 2009 were both 15% for restricted stock awards and units and 35% for stock options
and stock appreciation rights. A 1% change in our estimated forfeiture rates combined would have had an approximate $0.1 million impact on our 2010 net loss. See Note 12 of our consolidated financial statements, “
Employee Benefit
Plans
,” included in Part IV, Item 15 of this annual report.
Recent Accounting Pronouncements
See Note 1 of our consolidated financial statements, “
The Company and Summary of Significant Accounting Policies—New
Accounting Pronouncements
,” included in Part IV, Item 15 of this annual report.
Liquidity and Capital Resources
We have an accumulated deficit of $774.8 million through January 2, 2011. To date, we have had only four profitable
quarters, and we may never achieve profitability on a full-year or consistent basis. We expect to incur a net loss in the first quarter of 2011 and possibly longer.
Our primary source of cash is sales made through our websites, for which we collect cash from our customers and payments received from our fulfillment partners. Our primary uses of cash are purchases of
inventory, salaries, marketing expenses, and overhead and fixed costs. Any projections of our future cash needs and cash flows are subject to substantial uncertainty for the reasons discussed in this section and in the sections entitled
“
Risk Factors
,” in Part I, Item 1A of this annual report.
Our principal sources of liquidity are our
cash, cash equivalents, and marketable securities. Historically, our principal liquidity requirements have been to meet our working capital and capital expenditure needs. Until required for other purposes, our cash and cash equivalents are
maintained in deposit accounts or highly liquid investments with remaining maturities of 90 days or less at the time of purchase. Our marketable securities, which include commercial paper, U.S. government agency obligations, and corporate notes and
bonds, are considered short-term as they are available to fund current operations. In addition, in March 2011, we entered into a new three-year line of credit agreement with our existing bank, which replaced our existing two-year $25.0 million line
of credit, allowing for borrowings of up to $40.0 million in the aggregate through March 2014, which is available to fund operations, capital expenditures, or finance acquisitions, as needed. As of January 2, 2011, the available borrowings
under the two-year line of credit were approximately $11.5 million, and in March 2011, the available borrowings under the three-year line of credit were approximately $26.5 million. In the event we are not in compliance with certain financial
covenants contained in the line of credit agreement, and are unable to obtain a waiver from the bank, borrowing available under the line of credit may be temporarily suspended until such time the covenant violations are remediated.
43
As of January 2, 2011, our cash and money market funds include $5.0 million that
serves as collateral on a contract. The contract is cancelable with 30-days written notice and therefore the cash equivalent is considered readily available within 30-days.
On February 19, 2010, we completed our acquisition of Salu. See Note 2 of our consolidated financial statements, “
Acquisition of Salu
” included in Part VI, Item 15 of this
annual report. In connection with this acquisition, we financed a portion of the cash payable at the closing of the acquisition by borrowing $10.0 million under our previous two-year revolving line of credit, which accrued interest at the higher of
the prime rate plus 0.50% (3.75% at January 2, 2011). The balance outstanding under the line of credit was $13.0 million as of January 2, 2011 and was refinanced under the new three-year revolving line of credit entered into in March 2011.
We believe that our cash and marketable securities on hand plus our sources of cash will be sufficient to fund our operations
and anticipated capital expenditures. However, any projections about our future cash needs and cash flows are subject to substantial uncertainty. As a result, we may need to raise additional monies to fund our operating activities or for strategic
flexibility (if, for example, we decide to pursue business or technology acquisitions or invest in additional distribution centers) or if our expectations regarding our operations and anticipated capital expenditures change. We have assessed in the
past, and will continue to assess, opportunities for raising additional funds by selling equity, equity-related or debt securities, obtaining additional credit facilities, or obtaining other means of financing for strategic reasons or to further
strengthen our financial position. We cannot be certain that additional financing will be available to us on acceptable terms when required, or at all. Furthermore, if we were to raise additional funds through the issuance of 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.
Discussion of Cash Flows
The following table provides information
regarding our cash flows for the last three fiscal years (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
Net cash provided by (used in):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operating activities
|
|
$
|
15,960
|
|
|
$
|
2,380
|
|
|
$
|
319
|
|
|
Discontinued operating activities
|
|
$
|
(2,394
|
)
|
|
$
|
1,420
|
|
|
$
|
9,594
|
|
|
Continuing investing activities
|
|
$
|
(24,538
|
)
|
|
$
|
(4,302
|
)
|
|
$
|
(4,454
|
)
|
|
Discontinued investing activities
|
|
$
|
(1,073
|
)
|
|
|
—
|
|
|
|
—
|
|
|
Financing activities
|
|
$
|
10,307
|
|
|
$
|
(2,520
|
)
|
|
$
|
1,166
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
$
|
(1,738
|
)
|
|
$
|
(3,022
|
)
|
|
$
|
6,625
|
|
Cash provided by
(used in) operating activities
. Our operating cash flows result primarily from cash received from our customers, fulfillment partners, and advertising and other service revenue, offset by cash payments we make for products and services, employee
compensation, payment processing and related transaction costs, and interest payments on our debt obligations. Cash received from customers and other activities generally corresponds to our net sales, and because our customers primarily use credit
cards to buy from us, our receivables from customers settle quickly. Working capital at any specific point in time is subject to many variables, including seasonality, inventory management and category expansion, the timing of cash receipts and
payments, vendor payment terms, and valuation of cash equivalents and marketable securities.
Net cash provided by continuing
operations in 2010 reflects non-cash expenses of $23.2 million, cash provided by working capital of $2.4 million, which includes a $7.9 million increase in accounts payable due to the timing of vendor payments and cash used of $5.2 million to
purchase inventory, partially offset by a loss from continuing operations of $9.6 million. Net cash provided by continuing operations in 2009 reflects non-cash
44
expenses of $18.5 million, partially offset by a loss from continuing operations of $9.9 million, and uses of working capital of $6.3 million, which includes $7.7 million to purchase inventory
and a $5.4 million increase in accounts receivable. In 2008, net cash provided by continuing operations reflects non-cash expenses of $19.3 million, offset by a loss from continuing operations of $18.9 million.
Net cash provided by continuing operations increased year-over-year in 2010 by $13.6 million, primarily from an increase in cash provided
from working capital of $8.7 million due primarily to collections on accounts receivable and a decrease in cash used to purchase inventory, and a $4.7 million increase in non-cash expenses, primarily from a $3.5 million increase in stock
compensation as a result of stock awards approved at our stockholder meeting on June 10, 2010 and a $1.0 million increase in depreciation expense. Net cash provided by continuing operations increased year-over-year in 2009 by $2.3 million,
primarily from a $9.0 million decrease in the loss from continuing operations, partially offset by an increase of $6.3 million in cash used for working capital purposes and lower non-cash expenses of $0.8 million resulting from lower stock-based
compensation, partially offset by higher depreciation expense.
Net cash used in discontinued operations increased
year-over-year in 2010 by $3.8 million, primarily from a $2.4 million decrease in the gain from discontinued operations and an increase of $1.4 million used to settle assets and liabilities of our mail-order pharmacy business. Net cash provided by
discontinued operations decreased year-over-year in 2009 by $8.1 million, primarily from a $2.1 million decrease in the gain from discontinued operations and a decrease of $6.0 million used primarily for the final settlement of assets and
liabilities held by our discontinued LPU business in 2008 upon the sale to Rite Aid.
Cash provided by (used in) investing
activities
. Our net cash flows used in investing activities include the purchase of marketable securities, the acquisition of fixed assets and intangible assets, and the acquisition of Salu, partially offset by the net proceeds received from the
sales and maturities of marketable securities and proceeds from the sale of discontinued operations.
Net cash used in
continuing investing activities in 2010 reflects $18.0 million of cash used to acquire Salu, net of $1.4 million of cash acquired, $13.1 million used to purchase fixed assets and intangible assets, and $22.4 million used to purchase marketable
securities, partially offset by $5.0 million of proceeds received for the sale of certain assets of our mail-order pharmacy, and $23.9 million from sales and maturities of marketable securities. Net cash used in investing activities in 2009 reflects
the purchase of marketable securities of $15.9 million and the purchase of fixed assets and intangible assets of $8.5 million, partially offset by the $5.9 million of cash proceeds received from the sale of the LPU business and $14.1 million from
sales and maturities of marketable securities. Net cash used in investing activities in 2008 reflects the purchase of marketable securities of $46.9 million and the purchase of fixed assets of $13.2 million, partially offset by the $4.0 million of
cash proceeds received from the sale of the LPU business and $51.7 million from sales and maturities of marketable securities.
Net cash used in continuing investing activities increased year-over-year in 2010 by $20.2 million, primarily as a result of the
acquisition of Salu and increased purchases of fixed assets. Net cash used in investing activities decreased year-over-year in 2009, primarily as a result of a decrease in the purchase of fixed assets and intangible assets, offset by the proceeds
received from the sale of discontinued operations.
Net cash used in discontinued investing activities in 2010 represents the
software development costs incurred related to the systems integration between our mail-order pharmacy and BioScrip.
Cash
provided by (used in) financing activities.
Our net cash flows from financing activities represent cash provided from borrowings under our revolving bank line of credit to fund capital expenditures, acquisitions, and operations, and the exercise
of options and shares purchased under our employee stock purchase plan, which terminated in the second quarter of 2009, partially offset by payments on our debt obligations.
Net cash provided by financing activities in 2010 represents $10.0 million of proceeds received from the line of credit for the Salu acquisition and $0.8 million received from the exercise of stock
options, partially offset by
45
$0.5 million used to pay debt obligations and purchase treasury stock. Net cash used in financing activities in 2009 represents $3.0 million of proceeds received from the line of credit,
partially offset by $5.6 million used to pay debt obligations. Net cash provided by financing activities in 2008 represents $5.0 million of proceeds received from the line of credit and $0.5 million received from the exercise of stock options,
partially offset by $4.4 million used to pay debt obligations. Net cash provided by financing activities increased year-over-year in 2010 by $12.8 million primarily due to the proceeds received from the line of credit, which were used to acquire
Salu, and lower payments on debt obligations. Net cash used in financing activities increased year-over-year in 2009 by $3.7 million, primarily due to a decrease in proceeds received from borrowings under our revolving line of credit, an increase in
payments on debt obligations, and a decrease in proceeds received from the exercise of stock options and employee stock purchase plan primarily due to the expiring of the employee stock purchase plan in June 2009.
Contractual Obligations and Commitments
In March 2011, we entered into a loan and security agreement with our existing bank, which includes a revolving three-year line of credit allowing for borrowings up to $40.0 million, which accrue interest
at LIBOR plus 2.5%-3%, or prime plus 0%-0.5%. This agreement replaces our two-year $25.0 million line of credit originally scheduled to mature in March 2011. As of January 2, 2011, $13.0 million was outstanding under the line of credit, which
was refinanced under the new three-year line of credit maturing in March 2014. Availability under the line of credit was also reduced by a $541,000 letter of credit we provided to our corporate headquarters landlord. As of January 2, 2011, the
available borrowings under the two-year line of credit were approximately $11.5 million and in March 2011, the available borrowings under the three-year line of credit were approximately $26.5 million. Advances available under the revolving line of
credit are limited, based on eligible inventory, accounts receivable, cash and investment balances, and balances outstanding under our line of credit. The agreement contains certain covenants that are customary in transactions of this nature,
including a prohibition on other debt and liens, requirements regarding the payment of taxes, and certain restrictions on mergers and acquisitions, investments, and transactions with our affiliates, as well as certain financial covenants. As of
January 2, 2011, we exceeded our capital expenditure covenant of $14.0 million by $0.1 million, and as of January 30, 2011 we failed our adjusted quick ratio covenant, which were both waived in conjunction with the March 2011 loan and
security agreement renewal. In our new agreement, the adjusted quick ratio definition was redefined to reduce the possibility of non-compliance in the future. The agreement identifies certain events of default that are customary for transactions of
this nature and subject to materiality provisions and grace periods where appropriate, including failure to pay any principal or interest under this facility or other instruments when due, the occurrence of a material adverse change, violations of
any covenants, a material cross-default to our other debt, or a change of control. As of January 2, 2011, none of these events had occurred.
We also lease equipment and software under non-cancelable capital leases. Capital lease obligations bear interest ranging from 3% to 8% and mature 24- 36 months from the date of funding. We secured
additional funds of $1.7 million during 2010 and $0.2 million during 2009, through capital lease financing agreements. We are in compliance with all covenants required by these agreements.
Our principal executive offices are located in Bellevue, Washington, where we lease approximately 53,000 square feet under a lease that
expires in July 2013, with two separate five-year renewal options that, if exercised, would extend the lease expiration to July 2023. Our primary distribution facility for our OTC and vision segments is located in Swedesboro, New Jersey, where we
lease approximately 270,000 square feet under a lease that expires in December 2020, with options to renew for two additional five-year periods. We also lease an inventory storage facility in Logan Township, New Jersey for 85,000 square feet through
February 2013. We lease approximately 11,500 square feet under a lease that expires in March 2016 for our principal customer care center, which is located in Halifax, Nova Scotia, Canada. Our subsidiary Salu leases approximately 10,000 square feet
under a lease that expires in June 2016 for its principal corporate offices located in Gold River, California. Skincarestore Australia Pty Ltd., a subsidiary of Salu, leases approximately 2,000 square feet in Roselle, New South Wales, Australia,
under a sublease that expires in November 2014, for retail space used for a salon and spa and related business purposes.
46
As of January 2, 2011, our principal commitments consisted of obligations outstanding
under capital and operating leases, our line of credit, and purchase commitments as follows (in thousands):
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payment Due by Period
|
|
|
|
|
Total
|
|
|
< 1 year
|
|
|
1-3 years
|
|
|
3-5 years
|
|
|
> 5 years
|
|
|
Capital leases (1)
|
|
$
|
1,657
|
|
|
$
|
625
|
|
|
$
|
1,032
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Line of credit (2)
|
|
|
16,359
|
|
|
|
1,009
|
|
|
|
15,350
|
|
|
|
—
|
|
|
|
—
|
|
|
Operating leases (3)
|
|
|
17,823
|
|
|
|
3,120
|
|
|
|
7,092
|
|
|
|
4,002
|
|
|
|
3,609
|
|
|
Purchase commitment (4)
|
|
|
4,980
|
|
|
|
4,980
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
40,819
|
|
|
$
|
9,734
|
|
|
$
|
23,474
|
|
|
$
|
4,002
|
|
|
$
|
3,609
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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(1)
|
Capital lease obligations consist primarily of technology and operations assets.
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(2)
|
Line of credit includes our borrowings on our line of credit with our bank, which was refinanced in March 2011, with a maturity date of March 2014 and respective
interest payments
|
|
(3)
|
Operating lease obligations consist of office building, distribution center, and call center leases.
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(4)
|
In December 2010, we entered into an agreement to purchase approximately $5.0 million of hardware and software to automate our primary distribution center.
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Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements.
Management Outlook
For the first quarter of fiscal year 2011, we are targeting net sales in the range of $123.0 million to $126.0 million. We anticipate net
loss for the first quarter in the range of $0.7 million to $2.5 million, adjusted EBITDA in the range of $2.7 million to $4.3 million and ongoing adjusted EBITDA in the range of $2.0 million and $3.5 million.
For fiscal 2011, we are targeting net sales in the range of $515.0 million to $530.0 million, net income in the range of $200,000 to $2.5
million, adjusted EBITDA in the range of $18.3 million to $22.7 million and ongoing adjusted EBITDA in the range of $16.0 million to $20.0 million. We are also projecting total gross margins for 2011 of 28.2-28.7%, reflecting gross margins in OTC of
29-29.5% and vision of 24-24.5%.
The following table provides information regarding our guidance for adjusted EBITDA and
ongoing adjusted EBITDA, including a reconciliation of net income (loss) to adjusted EBITDA and ongoing adjusted EBITDA (in thousands):
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|
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Three Months Ended
April 3, 2011
|
|
|
Twelve Months Ended
January 1, 2012
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|
|
|
|
Range High
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|
|
Range Low
|
|
|
Range High
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|
|
Range Low
|
|
|
Net income (loss)
|
|
$
|
(700
|
)
|
|
$
|
(2,500
|
)
|
|
$
|
2,500
|
|
|
$
|
200
|
|
|
Amortization of intangible assets
|
|
|
135
|
|
|
|
135
|
|
|
|
525
|
|
|
|
525
|
|
|
Stock-based compensation
|
|
|
1,500
|
|
|
|
1,600
|
|
|
|
7,000
|
|
|
|
6,000
|
|
|
Depreciation
|
|
|
3,200
|
|
|
|
3,300
|
|
|
|
12,000
|
|
|
|
11,000
|
|
|
Interest expense, net
|
|
|
165
|
|
|
|
165
|
|
|
|
650
|
|
|
|
550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
$
|
4,300
|
|
|
$
|
2,700
|
|
|
$
|
22,675
|
|
|
$
|
18,275
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Discontinued Rx mail operations
|
|
|
(800
|
)
|
|
|
(700
|
)
|
|
|
(2,675
|
)
|
|
|
(2,275
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ongoing Adjusted EBITDA
|
|
$
|
3,500
|
|
|
$
|
2,000
|
|
|
$
|
20,000
|
|
|
$
|
16,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
These projections are subject to substantial uncertainty. See “
Risk Factors,
” in Part I,
Item 1A of this annual report and “
Special Note Regarding Forward-Looking Statements
” above.
47
|
ITEM 7A.
|
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
|
We have assessed our vulnerability to certain market risks, including interest rate risk associated with marketable securities, accounts receivable, accounts payable, capital lease obligations, and cash
and cash equivalents. 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 is not material to
us.
Our financing facilities expose our net earnings to changes in short-term interest rates because interest rates on the
underlying obligations are variable. Borrowings outstanding under the variable interest-bearing financing facilities totaled $13.0 million at January 2, 2011 and the highest interest rate attributable to this outstanding balance was 4.5% at
January 2, 2011. A change in net earnings resulting from a hypothetical 10% increase or decrease in interest rates would not be material.
We have investment risk exposure arising from our investments in marketable securities due to volatility of the bond market in general, company-specific circumstances, and changes in general economic
conditions. As of January 2, 2011, we had $13.1 million of securities classified as “marketable securities.” We regularly review the carrying value of our investments and identify and record losses when events and circumstances
indicate that declines in the fair value of such assets below our accounting basis are other-than-temporary.
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ITEM 8.
|
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|
The financial statements required pursuant to this item are filed under Part IV, Item 15(a)(1) of this annual report. The financial statement schedule required under Regulation S-X is filed under
Part IV, Item 15(a)(2) of this annual report.
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ITEM 9.
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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|
None.
|
ITEM 9A.
|
CONTROLS AND PROCEDURES
|
Evaluation of
Disclosure Controls and Procedures
Under the supervision of and with the participation of our management, including our
chief executive officer, chief accounting officer, and general counsel, we performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as amended, or the Exchange Act). Based on that evaluation, our management, including our chief executive officer, chief accounting officer, and general counsel, concluded that, as of January 2, 2011, our disclosure controls and procedures were
effective to provide reasonable assurance that all material information required to be disclosed in reports filed or submitted by us under the Exchange Act is made known to management in a timely fashion.
The certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 are filed as exhibits 31.1 and 31.2, respectively, in
this Form 10-K.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f)) under the Exchange Act). Management evaluated the effectiveness of our internal control over financial reporting based on criteria established in Internal
48
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Management’s assessment of and conclusion on the effectiveness of
internal control over financial reporting did not include the internal controls of Salu, Inc. which is included in the 2010 consolidated financial statements of drugstore.com, inc. and constituted $45.6 million and $36.6 million of total and net
assets, respectively, as of January 2, 2011 and $42.3 million and $2.0 million of net sales and net income, respectively, for the year then ended. Based on its evaluation, management concluded that, as of January 2, 2011, our system of
internal control over financial reporting was effective. Ernst & Young LLP, an independent registered public accounting firm, has issued an attestation report on the effectiveness of our internal control over financial reporting as of
January 2, 2011, which is included below.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Limitations on
Controls
Management does not expect that our disclosure controls and procedures or our internal control over financial
reporting will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based on certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. In
addition, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within drugstore.com have been detected.
49
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
drugstore.com, inc.
We have
audited drugstore.com, inc.’s internal control over financial reporting as of January 2, 2011, based on criteria established in
Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of
the Treadway Commission (the COSO criteria). drugstore.com, inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s
internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions
and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting, management’s assessment of
and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Salu, Inc. which is included in the 2010 consolidated financial statements of drugstore.com, inc. and constituted $45.6 million
and $36.6 million of total and net assets, respectively, as of January 2, 2011 and $42.3 million and $2.0 million of net sales and net income, respectively, for the year then ended. Our audit of internal control over financial reporting of
drugstore.com, inc. also did not include an evaluation of the internal control over financial reporting of Salu, Inc.
In our
opinion, drugstore.com, inc. maintained, in all material respects, effective internal control over financial reporting as of January 2, 2011, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of drugstore.com, inc. as of January 2, 2011
and January 3, 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended January 2, 2011 of drugstore.com, inc., and our report dated
March 18, 2011 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Seattle, Washington
March 18, 2011
50
|
ITEM 9B.
|
OTHER INFORMATION
|
2011 Bonus Plan
In February 2011, the compensation committee approved an incentive bonus plan under which our executive officers are eligible to receive cash bonuses for fiscal year 2011, based on a two-pronged
assessment: (i) company performance, as demonstrated by our achievement of certain net revenue and adjusted EBITDA objectives; and (ii) the individual’s performance.
Each executive officer is assigned an initial target bonus percentage based on his or her position and responsibilities. Initial target
bonuses as a percentage of base salary for each named executive officer remained unchanged from 2010 levels. Ms. Lepore is eligible to receive an initial target bonus of up to 150% of her 2011 salary, Mr. Morikubo is eligible to receive an
initial target bonus of up to 40% of his 2011 salary, and each of Mr. Potter and Ms. Wright is eligible to receive an initial target bonus of up to 35% of his or her 2011 salary.
Under the company performance component of the 2011 bonus plan, if we achieve specific graduated net revenue and adjusted EBITDA
thresholds, each named executive officer could be eligible to receive anywhere from 0% of his or her initial target bonus amount, if we fail to meet certain minimum net revenue and adjusted EBITDA thresholds, to 40% to 55% if we perform within the
range we have targeted for the year to 130%, if we vastly exceed our guidance for the year. The compensation committee reserved the right to exercise discretion in determining the final amounts to be paid under the bonus plan.
The individual performance component of each named executive officer’s actual bonus is a function of (i) his or her initial
target bonus and (ii) an individual performance adjustment. Under this component of the bonus plan, a named executive officer’s ultimate bonus amount, that is, his or her initial target bonus amount multiplied by the company performance
payout factor, is then adjusted again by a multiplier of 0% to 130%, based on his or her individual job performance. As under the company performance component of the bonus plan, the compensation committee reserved the right to exercise discretion
in determining the final amounts to be paid under the bonus plan.
Executive Officer Change-in-Control Agreements
Each of Robert Potter, Vice President, Chief Accounting Officer, Yukio Morikubo, Vice President, Strategy, General Counsel and Secretary,
and Tracy Wright, Vice President, Chief Finance Officer, was previously party to a change in control agreement that our compensation committee approved in January 2009. On January 28, 2011, our compensation committee, recognizing that the earlier
agreements were not entirely consistent with the committee’s intent, approved, and in February 2011, the Company and the individuals entered into, change in control agreements that replaced the earlier agreements.
All provisions of the 2011 agreements are the same as the prior agreements with one exception. Under the earlier agreements, any
acceleration of vesting of equity in connection with a change of control or termination of employment was governed by the 2008 equity incentive plan and/or the applicable form of equity award agreement. The 2011 change in control agreements provide
that in the event that the executive officer’s employment is terminated without cause or he or she terminates his or her employment for good reason upon or within one year of a change in control of drugstore.com, all of the officer’s then
outstanding and unvested equity awards will vest as of the date of any such termination whether or not they would have otherwise vested under the 2008 equity incentive plan and/or the applicable form of equity award agreement.
As under the earlier agreements, in the event of a termination without cause or a voluntary termination of employment for good reason in
connection with a change of control (as earlier described), we will pay the officer a lump sum severance payment equal to one year of his or annual salary in effect immediately prior to the change in control or as of the end of the previous calendar
year, whichever is greater, plus one year of target bonus for the year of the change in control, and he or she will be entitled to receive company-paid premiums for health care
51
coverage pursuant to the Consolidated Omnibus Reconciliation Act of 1985, as amended (COBRA) for a period of up to twelve months.
Also, in the event that the benefits provided to an executive officer under these change in control agreements constitute
“
parachute payments
” within the meaning of Section 280G of the Internal Revenue Code and may subject such benefits to the excise tax imposed by Section 4999 of the Internal Revenue Code, the benefits will be (1) paid in full, or (2)
reduced so the executive is not subject to excise taxation, whichever results in the named executive officer’s receipt of the greatest after-tax amount.
Each executive officer’s receipt of these benefits will be subject to his or her compliance with our confidentiality agreement and his or her execution of a release of claims in the form customarily
used by us in connection with the termination of an executive officer’s employment.
For purposes of the change in
control agreements, “change in control” has the definition provided in our 2008 Plan and means:
|
|
•
|
|
A change in the ownership of the Company where any person or affiliated group acquires stock constituting more than 50% of the total voting power of
the stock of the Company;
|
|
|
•
|
|
A change in the effective control of the Company where a majority of members of the board of directors is replaced during any twelve (12) month period
by directors whose appointment or election is not endorsed by a majority of the members of the board of directors prior to the appointment or election; or
|
|
|
•
|
|
A change in the ownership of a substantial portion of the Company’s assets where any person or affiliated group acquires (or has acquired during
the previous twelve (12) month period) assets from the Company that have a value equal to or more than 50% of the value of all of the assets of the Company immediately prior to such acquisition(s).
|
For purposes of the change in control agreements, “cause” means:
|
|
•
|
|
any act of personal dishonesty in connection with his or her responsibilities as an employee intended to result in substantial personal enrichment of
the executive;
|
|
|
•
|
|
the executive’s conviction of, or plea of nolo contendere to, a felony;
|
|
|
•
|
|
the executive’s gross misconduct; or
|
|
|
•
|
|
the executive’s continued failure to perform the duties and responsibilities of his or her position after notice and the lapse of a two week cure
period during which the failure remained uncured.
|
For purposes of the change in control agreements,
“good reason” means any of the following uncured events:
|
|
•
|
|
a material reduction of the officer’s authority, duties or responsibilities;
|
|
|
•
|
|
a material reduction in the officer’s base compensation; or
|
|
|
•
|
|
a material change in the geographic location where the officer must perform his or her services; provided that no relocation of fifty (50) miles or
less will be deemed material for purposes of the change in control agreements.
|
Before an executive may
resign for good reason under the change in control agreements, he or she must provide the company with written notice within ninety (90) days of the initial event constituting good reason and a period of at least thirty (30) days must have lapsed
during which the event remained uncured.
The foregoing description is not complete and is qualified by reference to the full
text of the form of change in control agreement filed herewith as Exhibit 10.29.
52
PART III
|
ITEM 10.
|
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
|
Directors and Executive Officers
Information regarding our executive
officers required by Part III, Item 10 is set forth in the section entitled “
Business—Directors and Officers,
” in Part I, Item 1 of this annual report. Information regarding our directors required by Part III,
Item 10 is incorporated into this annual report by reference to the section entitled “
Proposal No. 1—Election of Directors
” in our proxy statement for our annual meeting of stockholders to be held on June 9,
2011, or the 2011 Proxy Statement.
Information relating to compliance with Section 16(a) of the Securities Exchange Act
of 1934, as amended, required by Part III, Item 10 is incorporated into this annual report by reference to the section entitled “
Section 16 Beneficial Ownership Reporting Compliance
” in the 2011 Proxy Statement.
Code of Business Conduct and Ethics
Our board of directors has adopted a code of business conduct and ethics, or Code, applicable to all directors, officers and employees of drugstore.com, including our chief executive officer, chief
finance officer, chief accounting officer, and controller. You may obtain a copy of the Code, without charge, on written request to Investor Relations, drugstore.com, inc., 411 108
th
Avenue NE, Suite 1400, Bellevue, Washington 98004, or by calling (425) 372-3200.
|
ITEM 11.
|
EXECUTIVE COMPENSATION
|
Information regarding executive compensation required by Part III, Item 11 is incorporated into this annual report by reference to
the section entitled “
Executive Compensation
” in the 2011 Proxy Statement.
|
ITEM 12.
|
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|
Information regarding our equity compensation plans required by Part III, Item 12 is incorporated into this annual report by
reference to in the section entitled “
Securities Authorized for Issuance under Equity Compensation Plan
” in the 2011 Proxy Statement.
Information regarding security ownership of certain beneficial owners and management and related stockholder matters required by Part III, Item 12 is incorporated into this annual report by reference
to the section entitled “
Security Ownership of Certain Beneficial Owners and Management
” in the 2011 Proxy Statement.
|
ITEM 13.
|
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|
Information regarding certain relationships and related transactions required by Part III, Item 13 is incorporated into this annual report by reference to the section entitled “
Transactions
with Related Persons
” in the 2011 Proxy Statement.
|
ITEM 14.
|
PRINCIPAL ACCOUNTANT FEES AND SERVICES
|
Information regarding principal accountant fees and services required by Part III, Item 14 is incorporated into this annual report by reference to the section entitled “
Proposal
No. 3—Ratification of Appointment of Independent Public Accounting Firm
” in the 2011 Proxy Statement.
53
PART IV
|
ITEM 15.
|
EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES.
|
|
|
(a)
|
The following documents are filed as a part of this annual report on Form 10-K:
|
1.
Index to Consolidated Financial Statements:
2.
Index to Financial Statement Schedules:
All other schedules
have been omitted because the required information is shown in the consolidated financial statements or the accompanying notes, or is not applicable or required.
3.
Index of Exhibits:
|
|
|
|
|
Exhibit
No.
|
|
Exhibit Description
|
|
2.1
|
|
Definitive Agreement and Plan of Merger with Salu, Inc. (incorporated by reference to Exhibit 2.1 to drugstore.com, inc.’s Current Report on Form 8-K dated February 19, 2010
(SEC File No. 000-26137)).
|
|
|
|
|
2.2
|
|
Asset Purchase Agreement by and among DS Pharmacy, Inc., drugstore.com, inc. BioScrip, inc. and BioScrip Pharmacy Services, Inc., dated May 5, 2010 (incorporated by reference to
Exhibit 2.1 to drugstore.com, inc.’s Current Report on Form 8-K dated May 14, 2010 (SEC File No. 000-26137)).
|
|
|
|
|
2.3
|
|
First Amendment to Asset Purchase Agreement between drugstore.com, inc. and BioScrip, Inc., dated July 14, 2010 (incorporated by reference to Exhibit 10.1 to drugstore.com,
inc.’s Current Report on Form 8-K dated July 19, 2010 (SEC File No. 000-26137)).
|
|
|
|
|
2.4
|
|
Second Amendment to Asset Purchase Agreement between drugstore.com, inc. and BioScrip, Inc., dated July 29, 2010 (incorporated by reference to Exhibit 2.1 to drugstore.com,
inc.’s Current Report on Form 8-K dated August 2, 2010 (SEC File No. 000-26137)).
|
|
|
|
|
3.1
|
|
Amended and Restated Certificate of Incorporation of drugstore.com, inc. (incorporated by reference to Exhibit 3.2 to drugstore.com, inc.’s Registration Statement on Form S-1
filed February 9, 2000 (Registration No. 333-96441)).
|
|
|
|
|
3.1a
|
|
Certificate of Designation of Series 1 Preferred Stock of drugstore.com, inc. (incorporated by reference to Exhibit 3.1a to drugstore.com, inc.’s Quarterly Report on Form 10-Q
for the Quarter Ended July 2, 2000 (SEC File No. 000-26137)).
|
|
|
|
|
3.2
|
|
Amended and Restated Bylaws of drugstore.com, inc. dated January 26, 2009 (incorporated by reference to Exhibit 3.1 to drugstore.com inc.’s Current Report on Form 8-K dated
January 26, 2009 (SEC File No. 000-26137)).
|
|
|
|
|
4.1
|
|
Warrant issued to Lehman Brothers, Inc. on November 16, 2006, on the cancellation of the warrant issued to Heidrick & Struggles, Inc. on February 14, 2005 (incorporated by
reference to Exhibit 4.2 to drugstore.com inc.’s Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2006 (SEC File No. 000-26137)).
|
54
|
|
|
|
|
Exhibit
No.
|
|
Exhibit Description
|
|
4.2
|
|
Form of Warrant (incorporated by reference to Exhibit 4.1 to drugstore.com inc.’s Quarterly Report on Form 10-Q for the Quarter Ended July 1, 2007 (SEC File No.
000-26137)).
|
|
|
|
|
4.3
|
|
Form of Warrant (incorporated by reference to Exhibit 4.1 to drugstore.com inc.’s Quarterly Report on Form 10-Q for the Quarter Ended September 30, 2007 (SEC File No.
000-26137)).
|
|
|
|
|
4.4
|
|
1998 Stock Plan, as amended June 21, 2000 (incorporated by reference to Exhibit 10.2 to drugstore.com, inc.’s Quarterly Report on Form 10-Q for the Quarter Ended July 2, 2000)
(SEC File No. 000-26137)).
|
|
|
|
|
4.5
|
|
2008 Equity Incentive Plan (incorporated by reference to Appendix A to the registrant’s proxy statement dated February 23, 2009).
|
|
|
|
|
4.6
|
|
Restricted Stock Agreement between the Company and Dawn G. Lepore dated October 3, 2008 (incorporated by reference to Exhibit 10.1 to drugstore.com, inc.’s Current Report
on Form 8-K dated October 2, 2008 (SEC File No. 000-26137)).
|
|
|
|
|
4.7
|
|
Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.2 to drugstore.com, inc.’s Current Report on Form 8-K dated October 2, 2008 (SEC File No.
000-26137)).
|
|
|
|
|
4.8
|
|
Form of Stock Option Agreement (incorporated by reference to Exhibit 10.3 to drugstore.com, inc.’s Current Report on Form 8-K dated October 2, 2008 (SEC File No.
000-26137))
|
|
|
|
|
4.9
|
|
Form of Stock-Settled Stock Appreciation Right Agreement (incorporated by reference to Exhibit 10.1 to drugstore.com, inc.’s Quarterly Report on Form 10-Q for the quarter
ended September 27, 2009 (Registration No. 000-26137)).
|
|
|
|
|
4.10
|
|
Form of Stock-Settled Stock Appreciation Right Agreement between the Company and Dawn Lepore (incorporated by reference to Exhibit 10.2 to drugstore.com, inc.’s Quarterly
Report on Form 10-Q for the quarter ended September 27, 2009 (Registration No. 000-26137)).
|
|
|
|
|
4.11
|
|
Form of Restricted Stock Unit Agreement
|
|
|
|
|
4.12
|
|
Form of Restricted Stock Unit Agreement between the Company and Dawn Lepore
|
|
|
|
|
10.1
|
|
Form of Indemnification Agreement between drugstore.com, inc. and each of its officers and directors (incorporated by reference to Exhibit 10.1 to drugstore.com, inc.’s
Registration Statement on Form S-1 filed May 19, 1999 (Registration No. 333-78813)).
|
|
|
|
|
10.2
|
|
Fourth Amended and Restated Investors’ Rights Agreement dated May 19, 1999, among drugstore.com, inc. and certain investors (incorporated by reference to Exhibit 10.12 to
drugstore.com, inc.’s Registration Statement on Form S-1/A filed July 8, 1999 (Registration No. 333-78813)).
|
|
|
|
|
10.3
|
|
Addendum dated June 17, 1999, to Fourth Amended and Restated Investors’ Rights Agreement dated May 19, 1999, among drugstore.com, inc. and certain investors
(incorporated by reference to Exhibit 10.25 to drugstore.com, inc.’s Registration Statement on Form S-1/A filed June 28, 1999 (Registration No. 333-78813)).
|
|
|
|
|
10.4
|
|
Form of Second Addendum to Fourth Amended and Restated Investors’ Rights Agreement dated May 19, 1999, among drugstore.com, inc. and certain investors (incorporated by
reference to Exhibit 10.32 to drugstore.com, inc.’s Registration Statement on Form S-1/A filed July 20, 1999 (Registration No. 333-78813)).
|
|
|
|
|
10.5
|
|
Third Addendum dated January 24, 2000, to Fourth Amended and Restated Investors’ Rights Agreement dated May 19, 1999, among drugstore.com, inc. and certain investors
(incorporated by reference to Exhibit 10.38 to drugstore.com, inc.’s Registration Statement on Form S-1 filed February 9, 2000 (Registration No. 333-96441)).
|
55
|
|
|
|
|
Exhibit
No.
|
|
Exhibit Description
|
|
10.6
|
|
Fourth Addendum dated September 29, 2000, to Fourth Amended and Restated Investors’ Rights Agreement dated May 19, 1999, among drugstore.com, inc. and certain
investors (incorporated by reference to Exhibit 10.7 to drugstore.com, inc.’s Registration Statement on Form S-3/A filed October 2, 2000 (Registration No. 333-45266)).
|
|
|
|
|
10.7
|
|
Fifth Amended and Restated Voting Agreement dated December 23, 1999, among drugstore.com, inc. and certain founders and investors (incorporated by reference to Exhibit 10.20 to
drugstore.com, inc.’s Registration Statement on Form S-1 filed February 9, 2000 (Registration No. 333-96441)).
|
|
|
|
|
10.8
|
|
Governance Agreement dated June 17, 1999, among drugstore.com, inc., General Nutrition Corporation and General Nutrition Investment Company (incorporated by reference to
Exhibit 10.30 to drugstore.com, inc.’s Registration Statement on Form S-1/A filed June 28, 1999 (Registration No. 333-78813)).
|
|
|
|
|
10.9
|
|
Registration Rights Agreement dated as of December 8, 2003 by and among drugstore.com, inc. and the other signatories thereto (incorporated by reference to Exhibit 10.1 to
drugstore.com, inc.’s Current Report on Form 8-K filed December 23, 2003 (SEC File No. 000-26137)).
|
|
|
|
|
10.10
|
|
Lease Agreement dated August 30, 1999, between DS Distribution, Inc. and the Northwestern Mutual Life Insurance Company (incorporated by reference to Exhibit 10.1 to
drugstore.com, inc.’s Quarterly Report on Form 10-Q for the quarter ended October 3, 1999 (SEC File No. 000-26137)).
|
|
|
|
|
10.11
|
|
Amendment No. 1 to Lease Agreement dated December 10, 2003, between DS Distribution, Inc. and Liberty Vendor I, L.P (as successor in interest to the Northwestern Mutual
Life Insurance Company) (incorporated by reference to Exhibit 10.23 to drugstore.com inc.’s Annual Report on Form 10-K for the Fiscal Year Ended December 28, 2003 (SEC File No. 000-26137)).
|
|
|
|
|
10.12
|
|
Amendment No. 2 to Lease Agreement dated December 1, 2009, between DS Distribution, Inc. and Liberty Vendor I, L.P (as successor in interest to the Northwestern Mutual
Life Insurance Company).
|
|
|
|
|
10.13
|
|
Lease of Office Space dated December 23, 2010 between Crombie Developments Ltd and DS Distribution Canada Ltd.
|
|
|
|
|
10.14
|
|
Industrial Building Lease dated June 20, 2007 between DS Distribution, Inc. and U.S. Industrial REIT II (incorporated by reference to Exhibit 10.17 to drugstore.com,
inc.’s Annual Report on Form 10-K for the Fiscal Year Ended December 28, 2008 (SEC File No. 000-26137)).
|
|
|
|
|
10.15
|
|
First Amendment to Industrial Building Lease dated October 10, 2007 between DS Distribution, Inc. and U.S. Industrial REIT II (incorporated by reference to Exhibit 10.18 to
drugstore.com, inc.’s Annual Report on Form 10-K for the Fiscal Year Ended December 28, 2008 (SEC File No. 000-26137)).
|
|
|
|
|
10.16
|
|
Second Amendment to Industrial Building Lease dated November 18, 2010 between drugstore.com, inc. and U.S. Industrial REIT II
|
|
|
|
|
10.17
|
|
Sublease effective as of June 1, 2003 between Nova Scotia Power Incorporated and International Vision Direct Ltd. (incorporated by reference to Exhibit 10.25 to drugstore.com
inc.’s Annual Report on Form 10-K for the Fiscal Year Ended December 28, 2003 (SEC File No. 000-26137)).
|
|
|
|
|
10.18
|
|
Office Lease Agreement dated August 16, 2004, between EOP-Northwest Properties, L.L.C. and drugstore.com, inc. (incorporated by reference to Exhibit 10.2 to drugstore.com,
inc.’s Quarterly Report on Form 10-Q for the quarter ended September 26, 2004 (SEC File No. 000-26137)).
|
|
|
|
|
10.19
|
|
Loan and Security Agreement dated March 5, 2009 (incorporated by reference to Exhibit 10.24 to drugstore.com, inc.’s Annual Report on Form 10-K for the fiscal year ended
December 28, 2008 (SEC File No. 000-26137)).
|
56
|
|
|
|
|
Exhibit
No.
|
|
Exhibit Description
|
|
10.20
|
|
Settlement Agreement dated May 8, 2009 (incorporated by reference to Exhibit 10.1 to drugstore.com, inc.’s Quarterly Report on Form 10-Q for the quarter ended
June 28, 2009 (SEC File No. 000-26137)).
|
|
|
|
|
10.21
|
|
Offer letter of Dawn Lepore dated September 21, 2004 (incorporated by reference to Exhibit 10.1 to drugstore.com, inc.’s Current Report on Form 8-K/A filed
November 3, 2004 (SEC File No. 000-26137)).
|
|
|
|
|
10.22
|
|
Letter agreement with Dawn Lepore dated December 28, 2006 (incorporated by reference to Exhibit 10.1 to drugstore.com, inc.’s Current Report on Form 8-K filed
December 29, 2006 (SEC File No. 000-26137)).
|
|
|
|
|
10.23
|
|
Letter agreement with Dawn Lepore dated December 31, 2008 (incorporated by reference to Exhibit 10.27 to drugstore.com, inc.’s Annual Report on Form 10-K for the
Fiscal Year Ended December 28, 2008 (SEC File No. 000-26137)).
|
|
|
|
|
10.24
|
|
Letter agreement with Dawn Lepore, dated January 26, 2009 (incorporated by reference to Exhibit 10.1 to drugstore.com, inc.’s Current Report on Form 8-K dated
January 26, 2009)(SEC File No. 000-26137)).
|
|
|
|
|
10.25
|
|
Amendment dated December 31, 2010 to Letter Agreement with Dawn Lepore
|
|
|
|
|
10.26
|
|
Offer letter of Yukio Morikubo dated November 10, 2006 (incorporated by reference to Exhibit 10.2 to drugstore.com, inc.’s Current Report on Form 8-K filed December 4,
2006 (SEC File
No. 000-26137)).
|
|
|
|
|
10.27
|
|
Offer letter of Robert Potter, dated May 23, 2008
|
|
|
|
|
10.28
|
|
Offer letter of Tracy Wright, dated May 23, 2008
|
|
|
|
|
10.29
|
|
Form of Change in Control Agreement with Executive Officers
|
|
|
|
|
21.1
|
|
List of Subsidiaries.
|
|
|
|
|
23.1
|
|
Consent of Independent Registered Public Accounting Firm.
|
|
|
|
|
24.1
|
|
Powers of Attorney (included on the signature page of this Annual Report on Form 10-K).
|
|
|
|
|
31.1
|
|
Certification of Dawn G. Lepore, Chairman of Board, President and Chief Executive Officer of drugstore.com, inc., pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
|
|
|
31.2
|
|
Certification of Robert P. Potter, Vice President, Chief Accounting Officer of drugstore.com, inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
32.1
|
|
Certification of Dawn G. Lepore, Chairman of Board, President and Chief Executive Officer of drugstore.com, inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
32.2
|
|
Certification of Robert P. Potter, Vice President, Chief Accounting Officer of drugstore.com, inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
57
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
drugstore.com, inc.
We have audited the accompanying consolidated balance sheets
of drugstore.com, inc. as of January 2, 2011 and January 3, 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended January 2, 2011. Our
audits also included the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial
statements referred to above present fairly, in all material respects, the consolidated financial position of drugstore.com, inc. at January 2, 2011 and January 3, 2010, and the consolidated results of its operations and its cash flows for
each of the three years in the period ended January 2, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As
discussed in Note 1 to the consolidated financial statements, in 2009, the Company changed its method of accounting for instruments indexed to an entity’s own stock
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), drugstore.com, inc.’s internal control over financial reporting as of
January 2, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 18, 2011 expressed an unqualified
opinion thereon.
/s/ Ernst & Young LLP
Seattle, Washington
March 18, 2011
F-1
DRUGSTORE.COM, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
20,437
|
|
|
$
|
22,175
|
|
|
Marketable securities
|
|
|
13,094
|
|
|
|
14,678
|
|
|
Accounts receivable, net of allowances
|
|
|
13,916
|
|
|
|
13,275
|
|
|
Inventories
|
|
|
48,977
|
|
|
|
39,300
|
|
|
Other current assets
|
|
|
3,701
|
|
|
|
2,406
|
|
|
Assets of discontinued operations
|
|
|
2,440
|
|
|
|
2,832
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
102,565
|
|
|
|
94,666
|
|
|
Fixed assets, net
|
|
|
25,181
|
|
|
|
24,104
|
|
|
Other intangible assets, net
|
|
|
14,503
|
|
|
|
3,398
|
|
|
Goodwill
|
|
|
57,593
|
|
|
|
32,202
|
|
|
Other long-term assets
|
|
|
530
|
|
|
|
159
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
200,372
|
|
|
$
|
154,529
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
49,540
|
|
|
$
|
34,408
|
|
|
Accrued compensation
|
|
|
3,433
|
|
|
|
5,707
|
|
|
Accrued marketing expenses
|
|
|
4,108
|
|
|
|
5,247
|
|
|
Other current liabilities
|
|
|
2,397
|
|
|
|
1,542
|
|
|
Current portion of long-term debt obligations
|
|
|
581
|
|
|
|
195
|
|
|
Liabilities of discontinued operations
|
|
|
—
|
|
|
|
4,581
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
60,059
|
|
|
|
51,680
|
|
|
Long-term debt obligations, less current portion
|
|
|
13,985
|
|
|
|
3,011
|
|
|
Deferred income taxes
|
|
|
4,079
|
|
|
|
959
|
|
|
Other long-term liabilities
|
|
|
920
|
|
|
|
1,213
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
|
Preferred stock, $.0001 par value, 10,000,000 shares authorized, no shares issued and outstanding
|
|
|
—
|
|
|
|
—
|
|
|
Common stock, $.0001 par value, stated at amounts paid in: 250,000,000 shares authorized, 106,108,096 and 100,362,285 shares
issued, and 105,897,847 and 100,256,729 shares outstanding
|
|
|
896,378
|
|
|
|
869,146
|
|
|
Treasury stock, at cost, 210,249 and 105,556 shares
|
|
|
(344
|
)
|
|
|
(151
|
)
|
|
Accumulated other comprehensive income (loss)
|
|
|
76
|
|
|
|
(98
|
)
|
|
Accumulated deficit
|
|
|
(774,781
|
)
|
|
|
(771,231
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders’ equity
|
|
|
121,329
|
|
|
|
97,666
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity
|
|
$
|
200,372
|
|
|
$
|
154,529
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-2
DRUGSTORE.COM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2008
|
|
|
Net sales
|
|
$
|
456,507
|
|
|
$
|
375,574
|
|
|
$
|
322,214
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
322,011
|
|
|
|
263,350
|
|
|
|
227,531
|
|
|
Fulfillment and order processing
|
|
|
49,604
|
|
|
|
41,891
|
|
|
|
38,896
|
|
|
Marketing and sales
|
|
|
46,550
|
|
|
|
37,727
|
|
|
|
32,464
|
|
|
Technology and content
|
|
|
27,303
|
|
|
|
24,864
|
|
|
|
22,995
|
|
|
General and administrative
|
|
|
20,221
|
|
|
|
17,642
|
|
|
|
19,866
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
465,689
|
|
|
|
385,474
|
|
|
|
341,752
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(9,182
|
)
|
|
|
(9,900
|
)
|
|
|
(19,538
|
)
|
|
Interest (expense) income, net
|
|
|
(432
|
)
|
|
|
46
|
|
|
|
631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
(9,614
|
)
|
|
|
(9,854
|
)
|
|
|
(18,907
|
)
|
|
Gain from discontinued operations, net of tax
|
|
|
6,064
|
|
|
|
8,477
|
|
|
|
10,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,550
|
)
|
|
$
|
(1,377
|
)
|
|
$
|
(8,287
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss from continuing operations per share
|
|
$
|
(0.09
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.20
|
)
|
|
Basic and diluted gain from discontinued operations per share
|
|
$
|
0.06
|
|
|
$
|
0.09
|
|
|
$
|
0.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per share
|
|
$
|
(0.03
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.09
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
102,217,033
|
|
|
|
96,950,189
|
|
|
|
96,481,787
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to
consolidated financial statements.
F-3
DRUGSTORE.COM, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Treasury Stock
|
|
|
Accumulated
other
comprehensive
income (loss)
|
|
|
Accumulated
deficit
|
|
|
Total
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
|
|
|
Balance at December 30, 2007
|
|
|
96,296,687
|
|
|
$
|
856,193
|
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
27
|
|
|
$
|
(761,852
|
)
|
|
$
|
94,368
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise of stock options and warrants
|
|
|
158,345
|
|
|
|
336
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
336
|
|
|
Employee stock purchase plan
|
|
|
92,047
|
|
|
|
189
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
189
|
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
7,564
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
7,564
|
|
|
Net loss and comprehensive loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
30
|
|
|
|
(8,287
|
)
|
|
|
(8,257
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 28, 2008
|
|
|
96,547,079
|
|
|
|
864,282
|
|
|
|
—
|
|
|
|
—
|
|
|
|
57
|
|
|
|
(770,139
|
)
|
|
|
94,200
|
|
|
Exercise of stock options and warrants
|
|
|
55,546
|
|
|
|
122
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
122
|
|
|
Employee stock purchase plan
|
|
|
106,500
|
|
|
|
94
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
94
|
|
|
Restricted stock issued, net of 5,262 cancelled shares
|
|
|
3,547,604
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Treasury stock purchases
|
|
|
—
|
|
|
|
—
|
|
|
|
105,556
|
|
|
|
(151
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(151
|
)
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
5,055
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
5,055
|
|
|
Cumulative effect of change in accounting principle
|
|
|
—
|
|
|
|
(407
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
285
|
|
|
|
(122
|
)
|
|
Net loss and comprehensive loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(155
|
)
|
|
|
(1,377
|
)
|
|
|
(1,532
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at January 3, 2010
|
|
|
100,256,729
|
|
|
|
869,146
|
|
|
|
105,556
|
|
|
|
(151
|
)
|
|
|
(98
|
)
|
|
|
(771,231
|
)
|
|
|
97,666
|
|
|
Exercise of stock options
|
|
|
355,650
|
|
|
|
820
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
820
|
|
|
Common stock issued for acquisition of Salu
|
|
|
5,425,678
|
|
|
|
17,271
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
17,271
|
|
|
Stock and restricted stock issued, net of 88,668 cancelled shares
|
|
|
(35,517
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Treasury stock purchases
|
|
|
(104,693
|
)
|
|
|
—
|
|
|
|
104,693
|
|
|
|
(193
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(193
|
)
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
9,141
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
9,141
|
|
|
Net loss and comprehensive loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
174
|
|
|
|
(3,550
|
)
|
|
|
(3,376
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at January 2, 2011
|
|
|
105,897,847
|
|
|
$
|
896,378
|
|
|
|
210,249
|
|
|
$
|
(344
|
)
|
|
$
|
76
|
|
|
$
|
(774,781
|
)
|
|
$
|
121,329
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-4
DRUGSTORE.COM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2008
|
|
|
Operating Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,550
|
)
|
|
$
|
(1,377
|
)
|
|
$
|
(8,287
|
)
|
|
Less gain from discontinued operations
|
|
|
6,064
|
|
|
|
8,477
|
|
|
|
10,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
(9,614
|
)
|
|
|
(9,854
|
)
|
|
|
(18,907
|
)
|
|
Adjustments to reconcile loss from continuing operations to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
13,733
|
|
|
|
12,682
|
|
|
|
10,912
|
|
|
Amortization of intangible assets
|
|
|
434
|
|
|
|
477
|
|
|
|
867
|
|
|
Stock-based compensation
|
|
|
8,949
|
|
|
|
5,400
|
|
|
|
7,564
|
|
|
Other
|
|
|
57
|
|
|
|
(33
|
)
|
|
|
(59
|
)
|
|
Changes in, net of amounts acquired:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
445
|
|
|
|
(5,448
|
)
|
|
|
(444
|
)
|
|
Inventories
|
|
|
(5,157
|
)
|
|
|
(7,733
|
)
|
|
|
(1,743
|
)
|
|
Other assets
|
|
|
(784
|
)
|
|
|
(348
|
)
|
|
|
1,425
|
|
|
Accounts payable, accrued expenses and other liabilities
|
|
|
7,897
|
|
|
|
7,237
|
|
|
|
704
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by continuing operations
|
|
|
15,960
|
|
|
|
2,380
|
|
|
|
319
|
|
|
Net cash provided by (used in) discontinued operations
|
|
|
(2,394
|
)
|
|
|
1,420
|
|
|
|
9,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
13,566
|
|
|
|
3,800
|
|
|
|
9,913
|
|
|
|
|
|
|
|
Investing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of marketable securities
|
|
|
(22,358
|
)
|
|
|
(15,910
|
)
|
|
|
(46,926
|
)
|
|
Sales and maturities of marketable securities
|
|
|
23,911
|
|
|
|
14,130
|
|
|
|
51,705
|
|
|
Purchases of fixed assets
|
|
|
(13,019
|
)
|
|
|
(8,323
|
)
|
|
|
(13,197
|
)
|
|
Proceeds from the sale of discontinued operations
|
|
|
4,969
|
|
|
|
5,946
|
|
|
|
3,964
|
|
|
Purchase of Salu, less cash acquired
|
|
|
(17,977
|
)
|
|
|
—
|
|
|
|
—
|
|
|
Purchases of intangible assets
|
|
|
(64
|
)
|
|
|
(145
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in continuing investing activities
|
|
|
(24,538
|
)
|
|
|
(4,302
|
)
|
|
|
(4,454
|
)
|
|
Net cash used in discontinued investing activities
|
|
|
(1,073
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(25,611
|
)
|
|
|
(4,302
|
)
|
|
|
(4,454
|
)
|
|
|
|
|
|
|
Financing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from exercise of stock options, warrants, and employee stock purchase plan
|
|
|
820
|
|
|
|
216
|
|
|
|
525
|
|
|
Proceeds from line of credit and term loan
|
|
|
10,000
|
|
|
|
2,986
|
|
|
|
5,000
|
|
|
Principal payments on capital leases, line of credit and term loan obligations
|
|
|
(320
|
)
|
|
|
(5,571
|
)
|
|
|
(4,359
|
)
|
|
Purchase of treasury stock
|
|
|
(193
|
)
|
|
|
(151
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
10,307
|
|
|
|
(2,520
|
)
|
|
|
1,166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(1,738
|
)
|
|
|
(3,022
|
)
|
|
|
6,625
|
|
|
Cash and cash equivalents at beginning of year
|
|
|
22,175
|
|
|
|
25,197
|
|
|
|
18,572
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year
|
|
$
|
20,437
|
|
|
$
|
22,175
|
|
|
$
|
25,197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Cash Flow Information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
520
|
|
|
$
|
215
|
|
|
$
|
360
|
|
|
Common stock issued for purchase of Salu
|
|
$
|
17,271
|
|
|
|
—
|
|
|
|
—
|
|
|
Equipment acquired in capital lease agreements
|
|
$
|
1,012
|
|
|
$
|
226
|
|
|
$
|
524
|
|
See accompanying notes
to consolidated financial statements.
F-5
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Accounting Policies
Description of
Business
drugstore.com, inc. is a leading online retailer of health, beauty, clinical skincare, and vision products.
We provide a convenient, private, and informative shopping experience while offering a wide assortment of products through our web stores located on the Internet as follows:
|
|
|
|
|
Health, Beauty & Pharmacy
|
|
OTC Partnerships
|
|
www.drugstore.com
|
|
www.medcohealthstore.com
|
|
www.Beauty.com
|
|
www.riteaidonlinestore.com
|
|
www.SkinStore.com (1)
|
|
www.spalook.com (1)
|
|
www.DrWeilVitaminAdvisor.com (3)
|
|
|
|
|
|
|
|
Microsites
|
|
Vision and Vision Partnerships
|
|
www.thenaturalstore.com
|
|
www.VisionDirect.com
|
|
www.athisbest.com
|
|
www.LensMart.com
|
|
www.sexualwellbeing.com
|
|
www.Lensworld.com
|
|
www.allergysuperstore.com
|
|
www.LensQuest.com
|
|
www.vitaminemporium.com
|
|
www.pearlevisioncontacts.com (2)
|
|
|
|
www.lenscrafterscontacts.com (2)
|
|
(1)
|
On February 19, 2010, we completed the acquisition of Salu, Inc., now Salu Beauty, Inc. (Salu), owner of SkinStore.com and operator and fulfillment partner for the
spalook.com web store. See Note 2 of our consolidated financial statements.
|
|
(2)
|
In January 2011, we launched two sites under our partnership with Luxottica Group, S.p.A. (Luxottica), a global leader in the design, manufacturing and distribution of
fashion, luxury, and sport eyewear.
|
|
(3)
|
We act as the exclusive fulfillment provider for customized nutritional supplements sold through
www.DrWeilVitaminAdvisor.com, www.DrWeil.com
, and other
Dr. Weil-related websites.
|
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include those of drugstore.com, inc. and our subsidiaries. All material intercompany
transactions and balances have been eliminated.
We operate using a 52/53-week retail calendar year with each of the fiscal
quarters in a 52-week year representing a 13-week period. Fiscal year 2010 is a 52-week year, fiscal year 2009 is a 53-week year, with the fourth quarter of 2009 representing a 14-week period, and fiscal year 2008 is a 52-week year.
Estimates and Assumptions
The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts of assets and
liabilities, revenues and expenses, and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates include, but are not limited to, revenue recognition, inventories, goodwill and intangible assets,
stock-based compensation, deferred taxes, and commitments and contingencies. Actual results could differ from our estimates, and these differences could be material.
Cash Equivalents
We consider all highly liquid investments with a
maturity of three months or less from the date of purchase to be cash equivalents. Cash equivalents include money market funds and commercial paper.
F-6
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Marketable Securities
Management determines the appropriate classification of marketable securities at the time of purchase and reevaluates such designation as
of each balance sheet date. The evaluation includes our view that our investments in debt securities are available to support current operations and therefore classified as a current asset. At January 2, 2011 and January 3, 2010,
marketable securities, which are considered available-for-sale and carried at fair value with unrealized gains or losses included in accumulated other comprehensive income in stockholders’ equity and consisted primarily of U.S. government
agency obligations, corporate notes, and commercial paper. Cost of securities sold is determined using the specific identification method.
We regularly monitor and evaluate the realizable value of our marketable securities. When assessing marketable securities for other-than-temporary declines in value, we consider such factors as, among
other things, how significant the decline in value is as a percentage of the amortized cost, how long the market value of the investment has been less than its amortized cost, the performance of the issuer’s price in relation to the price of
its competitors within the industry and the market in general, analyst recommendations, any news that has been released specific to the issuer, and the outlook for the overall industry in which the issuer operates. If events and circumstances
indicate that a decline in the value of these assets has occurred and is other than temporary, we record a charge against net earnings. No such charges have been recorded in fiscal years 2010, 2009, and 2008.
Fair Value
GAAP has established a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical
assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels
of inputs used to measure fair value are as follows:
Level 1—Valuations based on quoted prices for
identical assets and liabilities in active markets.
Level 2—Valuations based on observable inputs other
than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or inputs that are observable or can be
corroborated by observable market data.
Level 3—Valuations based on observable inputs reflecting
our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.
See Note 5 for a summary of our assets and liabilities that we measure at fair value.
Concentration of Credit Risk
Financial instruments, which
potentially subject us to concentrations of credit risk, consist principally of our holdings of cash, cash equivalents, marketable securities, and accounts receivable. Our credit risk is managed by investing our cash equivalents and marketable
securities in high-quality money market instruments and securities of the U.S. government agencies, and high-quality corporate issuers. We manage our credit risk through monitoring the stability of the United States-based financial institutions we
use and the diversification of our financial resources by limiting the investment in any one issuer of not more than 10% of the total portfolio at the time of purchase, except for investments in U.S. treasuries and agencies and investment
advisors’ money market funds.
F-7
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Accounts Receivable
Accounts receivable includes amounts due primarily from customers from the sales of products and vendors from promotional funding and
rebates. At January 2, 2011 and January 3, 2010, vendor receivables, net, were $7.2 million and $7.3 million, respectively, and customer receivables, net, were $6.7 million and $6.0 million, respectively. We record accounts receivable net
of allowances for doubtful accounts, which were $55,000 as of January 2, 2011 and $69,000 as January 3, 2010. We determine our allowance for doubtful accounts by considering a number of factors, including the length of time receivables are
past due, previous loss history, our ability to offset our obligations, and the customer’s ability to pay its obligation. We write off accounts receivable when they become uncollectible, and any payments subsequently received are applied to the
allowance for doubtful accounts.
Inventories
Inventories consist of finished goods and are stated at the lower of cost (using the weighted average cost method) or the current
estimated market value and adjusted for shrinkage, slow moving, damaged, and expired inventory.
Fixed Assets
Fixed assets are stated at cost less accumulated depreciation and amortization, which includes the depreciation of
assets recorded under capital leases. We determine depreciation and amortization using the straight-line method over the estimated useful lives of the related assets, which range from two to ten years. Fixed assets purchased under capital leases and
leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life. Repairs and maintenance costs are expensed as incurred.
Fixed assets include the cost of internally developed software and website development, including software used to upgrade and enhance our websites. We expense all costs related to internally developed
software other than those costs incurred during the application development stage. Costs incurred during the application development stage are capitalized and amortized over the estimated useful life of the software, generally three years. Internal
labor costs, including benefit costs, and third-party consulting costs totaling $10.1 million, $6.6 million, and $12.0 million, were capitalized during the fiscal years ended January 2, 2011, January 3, 2010, and December 28,
2008, respectively.
Leases
We categorize leases at their inception as either operating or capital leases depending on certain defined criteria. We recognize operating lease costs on a straight-line basis without regard to deferred
payment terms and lease incentives are treated as a reduction of our costs over the term of the agreement.
Other
Intangible Assets
Other intangible assets consist of trade names, a service contract, developed technology, domain
names, patents and customer lists acquired in connection with the purchase of Salu, Vision Direct, CNS and our private label de~luxe™ brand of natural, spa quality personal care products. All definite-lived intangible assets are being amortized
over their expected useful lives, which range from two to ten years.
Goodwill
We test for impairment of goodwill during the fourth quarter of each year and whenever indicators of impairment occur. The first phase of
the test screens for impairment, while the second phase of the test (if
F-8
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
necessary) measures the amount of impairment. The first phase is performed by comparing the fair value of the applicable reporting unit to its carrying value. Fair value is determined using
either a discounted cash flow methodology or methodology based on comparable market prices. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the
carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.
During fiscal 2010, 2009 and 2008 we estimated the fair value of our reporting units by preparing a discounted cash flow analysis using forward looking projections of our estimated future operating
results. Based on the results of the discounted cash flow analysis each year, we concluded that the fair value of our reporting units exceeded the carrying value, and therefore goodwill was not impaired. We also considered as an indicator of market
value the market value of our common stock during the fourth quarter of the respective fiscal years.
The significant
assumptions used in our discounted cash flow analysis included: projected operating results, the discount rate used to present value future cash flows, and capital expenditures. Projected operating results assumptions include sales growth
assumptions which are based on historical trends, and to a lesser extent, future sales growth from new strategic partnerships or initiatives. Also included in projected operating results are gross margin and operating cost growth assumptions which
are based on the historical relationship of those measures compared to sales. Our discount rate is a “market participant” weighted average cost of capital (WACC). Our capital expenditure assumptions are based on our planned capital
expenditures for existing and new projects. Sensitivity tests were performed on our significant assumptions and determined that a reasonable, negative change in assumptions would not impact our conclusions.
Long-Lived Assets
We review the carrying values of our amortized long-lived assets, including definite-lived intangible assets, whenever an indicator of impairment exists. When facts and circumstances indicate that the
carrying values of long-lived assets may be impaired, we perform an evaluation of recoverability. The determination of whether impairment exists is based on any excess of the carrying value over the expected future cash flows, as estimated through
undiscounted cash flows, excluding interest charges. Any resulting impairment charge would be measured based on the difference between the carrying value of the asset and its fair value, as estimated through expected future discounted cash flows,
discounted at a rate of return for an alternate investment.
We review our indefinite-lived intangible assets, other than
goodwill, for impairment annually during the fourth quarter or when an indicator of impairment exists. We compare the carrying value of the asset to its estimated fair value based upon a discounted cash flow analysis and record an impairment charge
when the carrying value of the asset exceeds the estimated fair value. Based upon our review, we recorded no impairment for amortized or unamortized long-lived assets in fiscal 2010, 2009, or 2008.
Net Sales
We recognize revenue from product sales or services rendered (including advertising revenues), net of sales tax, when the following revenue recognition criteria are met: (1) persuasive evidence of an
arrangement exists; (2) delivery has occurred or services have been rendered; (3) the selling price or fee earned is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. Revenue arrangements
with multiple deliverables are divided into separate units and revenue is allocated using estimated selling prices if we do not have vendor-specific objective evidence or third-party evidence of the selling prices of the deliverables.
Revenues are recorded when the products are shipped and title passes to customers, net of promotional discounts, cancellations, rebates,
and returns allowances. We generally require payment at the point of sale. We
F-9
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
estimate return allowances, which reduce product sales by our estimate of expected product returns, based on our historical experience. Historically, product returns have not been significant and
have not differed significantly from our estimates. We evaluate whether it is appropriate to record the gross amount of product sales and related costs or the net amounts earned. Generally, when we are the primary party obligated in a transaction,
are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these indicators, we record revenue on a gross basis. In addition, when we report revenue from fulfillment partnerships, we
include in revenues, the costs of the products sold and our variable fulfillment costs to fulfill each order that are received from our fulfillment partners.
From time to time, we provide incentive offers to our customers to encourage purchases. Such offers include discounts on specific current purchases, or future rebates based on a percentage of the current
purchase, as well as other offers. We treat discounts, when our customers accept them, as a reduction in the sales price of the related transaction and we present them as a net amount in net sales. We treat rebates as a reduction in the sales price
based on estimated redemption rates. We estimate redemption rates using our historical experience for similar offers. Historically, our redemption rates have not differed materially from our estimates, which we adjust quarterly.
Cost of Sales
Cost of sales consists primarily of the cost of products sold to our customers, including allowances for shrinkage and damaged, slow-moving, and expired inventory; outbound and inbound shipping costs; and
expenses related to promotional inventory included in shipments to customers. We net against cost of sales payments that we receive from vendors in connection with volume purchases or rebate allowances and payment discount terms.
Shipping Activities
Our revenues from shipping charges to customers are included in net sales and were $15.0 million for the year ending on January 2, 2011, $13.5 million for the year ending on January 3, 2010, and
$13.8 million for the year ending on December 28, 2008. Outbound shipping costs are included in cost of sales and were $34.7 million for the year ending on January 2, 2011, $28.3 million for the year ending on January 3, 2010,
and $25.9 million for the year ending on December 28, 2008. The net cost to us of shipping activities was $19.7 million for the year ending on January 2, 2011, $14.8 million for the year ending on January 3, 2010, and $12.1 million
for the year ending on December 28, 2008.
Fulfillment and Order Processing
Fulfillment and order processing expenses include payroll and related expenses for personnel engaged in purchasing, fulfillment,
distribution, and customer care activities (including warehouse and vision prescription verification personnel), distribution center equipment and packaging supplies, credit card processing fees, and bad debt expenses. These expenses also include
rent and depreciation related to equipment and fixtures in our distribution centers and call center facility. Variable fulfillment costs represent the incremental costs of fulfilling, processing, and delivering the orders that are variable based on
sales volume.
Marketing and Sales
Marketing and sales expenses include advertising expenses, promotional expenditures, web analytic tools, web design, and payroll and related expenses for personnel engaged in marketing and merchandising
activities. Advertising expenses include our obligations under various advertising contracts. Advertising and other
F-10
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
promotional costs, which consist primarily of online advertising, and to a lesser extent, royalty and public relations expenditures, are expensed as incurred, and were $34.2 million, $27.3
million, and $22.8 million for the years ended January 2, 2011, January 3, 2010, and December 28, 2008.
Technology and Content
Technology and content expenses consist primarily of payroll and related expenses for personnel engaged in developing, maintaining, and making routine upgrades and improvements to our websites. Technology
and content expenses also include Internet access and hosting charges, depreciation on hardware, and IT structures, utilities, and website content and design expenses.
Technology and content costs are expensed as incurred, except for certain costs relating to the development of internal-use software and website development, including upgrades and enhancements to our
websites, which are capitalized and depreciated over their estimated useful life.
General and Administrative
General and administrative expenses consist of payroll and related expenses for executive and administrative
personnel, corporate facility expenses, professional service expenses, and other general corporate expenses.
Foreign
Currency
Assets and liabilities of our foreign subsidiaries are translated at exchange rates prevailing at the balance
sheet dates. Revenues, costs and expenses are translated into U.S. dollars using average exchange rates for the period. Gains and losses resulting from the translation of our consolidated balance sheet are recorded as a component of accumulated
other comprehensive income. Realized gains and losses from foreign currency transactions are recognized as interest and other income (expense), net.
Interest Income and Expense
Interest income consists of earnings on
our cash, cash equivalents, and marketable securities, and interest expense consists primarily of interest associated with capital leases and debt obligations. Interest income for the years ended January 2, 2011, January 3, 2010, and
December 28, 2008, totaled $0.1 million, $0.3 million, and $1.1 million, respectively. Interest expense was $0.5 million, $0.2 million, and $0.5 million for the years ended January 2, 2011, January 3, 2010, and December 28, 2008,
respectively.
Accumulated Other Comprehensive Income/Loss
Accumulated other comprehensive income/loss consists of the accumulated net unrealized gains and losses on available-for-sale securities
(see note 5) and cumulative translation adjustments from the translation of assets and liabilities of our foreign subsidiaries into U.S. dollars. Our currency translation adjustment included in accumulated other comprehensive income/loss as of
January 2, 2011 was an unrealized gain of $76,000 and as of January 3, 2010, and December 28, 2008, was an unrealized loss of $133,000 and $76,000, respectively.
Income Taxes
We account for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of
assets and
F-11
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. Deferred tax assets are evaluated for future
realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative
earnings experience and expectations of future taxable income and capital gains by taxing jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. We allocate our valuation allowance to current
and long-term deferred tax assets on a pro-rata basis.
We utilize a two-step approach to recognizing and measuring uncertain
tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related
appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our
tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes. We did not have any unrecognized tax benefits. Our policy is to recognize interest and penalties related to the
underpayment of income taxes as a component of income tax expense. To date, we have not incurred charges for interest or penalties in relation to the underpayment of income taxes. The tax years 1998 through the present remain open to examination by
the major taxing jurisdictions to which we are subject.
Stock-Based Compensation
Compensation cost for all stock-based awards is measured at fair value on the date of grant and recognized over the service period for
awards expected to vest. The fair value of stock options and stock appreciation rights is based on the estimated grant date fair value method using the Black-Scholes valuation model. The fair value of restricted stock and restricted stock units is
determined based on the number of shares granted and the quoted price of our common stock. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method. The estimation of stock awards that
will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors
when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results and future estimates may differ substantially from our current estimates.
Net Loss per Share
We compute net income (loss) per share using the two-class method. We compute basic net income (loss) per share by dividing net income (loss) by the weighted-average number of shares outstanding during
the applicable period, including outstanding participating securities when in a net income position. Participating securities include unvested restricted stock awards and restricted stock units, as holders of these securities are entitled to receive
non-forfeitable dividends prior to vesting at the same rate as holders of our common stock. Because we had a net loss for the years ended 2010, 2009 and 2008, none of the loss was allocated to the participating securities. In addition, 816,450
shares of common stock held in escrow in connection with the acquisition of Salu were also excluded from the computation of net income (loss) per share for the year ended January 2, 2011 as these shares were considered contingently issuable
shares. We compute diluted earnings per share using the weighted-average number of shares determined for the basic net income (loss) per share computation plus the dilutive effect of common stock equivalents to the extent it does not create
anti-dilution using the treasury stock method.
F-12
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We excluded the following shares from the calculation of diluted net loss per share
because their inclusion would have been anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2008
|
|
|
Stock options and stock appreciation rights (1)
|
|
|
20,064,342
|
|
|
|
16,635,725
|
|
|
|
16,706,547
|
|
|
Restricted stock units
|
|
|
1,274,672
|
|
|
|
—
|
|
|
|
—
|
|
|
Non-released restricted stock (2)
|
|
|
1,671,191
|
|
|
|
2,124,738
|
|
|
|
—
|
|
|
Warrants
|
|
|
700,000
|
|
|
|
400,000
|
|
|
|
400,000
|
|
|
Contingently issuable shares
|
|
|
816,450
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24,526,655
|
|
|
|
19,160,463
|
|
|
|
17,106,547
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Fiscal year 2009 excludes approximately 3.4 million shares subject to stock options and stock appreciation rights that were subject to stockholder approval, which
was obtained on June 10, 2010.
|
|
(2)
|
Fiscal year 2009 excludes approximately 700,000 shares of restricted stock that were subject to stockholder approval, which was obtained on June 10, 2010.
|
Recently Issued Accounting Standards
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (FASB) or other standard setting
bodies that are adopted by us as of the specified effective date. Unless otherwise discussed, our management believes that the impact of recently issued standards that are not yet effective will not have a material impact on our consolidated
financial statements upon adoption.
In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-13,
Revenue
Recognition
:
Multiple Deliverable Revenue Arrangements—A Consensus of the FASB Emerging Issues Task Force.
This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and
how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on
vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. This guidance is effective
prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We adopted this guidance on January 3, 2011.
In June 2008, the FASB issued new guidance that clarifies the determination of whether an instrument (or an embedded feature) is indexed
to an entity’s own stock, which would qualify as a scope exception under guidance related to certain contracts involving an entity’s own equity. We adopted the provisions of this guidance on the first day of our fiscal year 2009 and upon
adoption, we recorded a cumulative change in accounting principle, which resulted in a reduction to common stock of $407,000 and a reduction in our accumulated deficit of $285,000, as well as, we reclassified $285,000 to a long-term liability.
Additionally, we adjust the fair value of the warrants subject to this guidance to fair market value at the end of each reporting period. For the year ended January 2, 2011, we recorded a benefit to stock-based compensation of $192,000 and for
the year ended January 3, 2010, we recorded additional stock-based compensation of $345,000 related to the increase in the fair value of these warrants.
F-13
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. Acquisition of Salu
We account for acquisitions using the acquisition method of accounting. Under the acquisition method, assets acquired and liabilities assumed from acquisitions are recorded at their fair value as of the
acquisition date. Any excess of the purchase price over the fair values of the net assets acquired is recorded as goodwill.
On February 19, 2010, we acquired Salu. The acquisition was made pursuant to an Agreement and Plan of Merger, dated as of
December 27, 2009, by and among drugstore.com, Silk Acquisition Corporation, a Delaware corporation and a wholly owned subsidiary of drugstore.com, Salu, certain stockholders of Salu, and a representative of all stockholders of Salu. As
consideration for their shares of Salu, the stockholders of Salu received $19.4 million in cash (less approximately $1.9 million of Salu’s transaction expenses and the repayment of Salu’s outstanding debt obligation of $2.6 million
paid out of the merger consideration) and 5,425,678 shares of drugstore.com common stock with a fair value of $17.3 million. Of this initial consideration, drugstore.com paid approximately $2.7 million in cash and 816,450 shares of our common stock
into escrow to secure post-closing indemnification obligations of Salu’s stockholders. Additionally, certain employees of Salu are eligible to receive a performance incentive payment payable in cash over a two-year period commencing in fiscal
year 2010 with an aggregate value of $2.5 million if the surviving entity achieves certain financial and other performance targets. On the acquisition date, we recorded a liability of $0.5 million which represented the fair value of the portion of
the performance incentive payment that will be accounted for as additional consideration. Any adjustments to the fair value of our initial estimate of the performance incentive payment may affect our consolidated statements of operations and could
have a material impact on our financial results. In 2010, approximately $0.2 million of the initial purchase price, equal parts of cash and stock, was reimbursed and $0.2 million was due from escrow in connection with adjustments allowed for under
the Agreement and Plan of Merger. Also in 2010, we reduced the performance incentive liability to $0.3 million and recorded a benefit to the statement of operations of $0.2 million.
We financed a portion of the cash payable at the closing of the acquisition described above by borrowing $10.0 million under our
revolving two-year line of credit pursuant to our March 2009 loan and security agreement with our existing bank. In conjunction with the acquisition, we also paid $1.4 million in transaction fees in the first quarter of 2010, which are recorded in
general and administrative expenses in the statement of operations. In 2010, we also incurred integration costs and purchase accounting adjustments of approximately $0.7 million, which are recorded in general and administrative expenses and cost of
sales ($0.1 million) in our statements of operations. Salu’s results of operations are included in the consolidated statements of operations beginning February 20, 2010, and generated net sales of $42.3 million, and net income of $2.3
million, excluding integration costs and purchase accounting adjustments of $0.3 million.
F-14
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following summarizes the fair values of Salu’s acquired assets and liabilities
assumed based on the total consideration of $36.9 million, which represents $19.4 million of cash, $17.3 million of common stock issued, and $0.5 million of deferred acquisition payments, less $0.2 million of funds due from escrow. The following
table also includes cash acquired of $1.4 million as of the acquisition date (in thousands):
|
|
|
|
|
|
|
Total current assets
|
|
$
|
7,105
|
|
|
Fixed assets
|
|
|
406
|
|
|
Goodwill (1)
|
|
|
25,347
|
|
|
Identifiable intangible assets (2):
|
|
|
|
|
|
Trademarks
|
|
|
8,749
|
|
|
Service contract
|
|
|
2,087
|
|
|
Developed technology
|
|
|
501
|
|
|
|
|
|
|
|
|
Total assets acquired
|
|
|
44,195
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
(4,251
|
)
|
|
Long-term deferred tax liabilities
|
|
|
(3,070
|
)
|
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
(7,321
|
)
|
|
|
|
|
|
|
|
Total consideration
|
|
$
|
36,874
|
|
|
|
|
|
|
|
|
(1)
|
Goodwill represents the excess of the purchase price over the fair values of the net assets acquired and represents the value of the expected synergies to be realized
by combining Salu with our beauty business to become one of the largest online beauty retailers offering mass beauty products, prestige brands and clinical skincare products.
|
|
(2)
|
Purchased definite-lived intangible assets will be amortized on a straight-line basis over their respective useful lives ranging from three to nine years. Trademarks,
identified as indefinite-lived assets, will be tested annually or whenever an indicator of impairment exists. Any resulting impairment charge would be measured based on the difference between the carrying value of the asset and its fair value, as
estimated through expected future discounted cash flows, discounted at a rate of return for an alternate investment.
|
Unaudited Pro Forma Financial Information
The financial information in the table below summarizes the combined results of our operations and Salu’s on a pro forma basis, as though the companies had been combined as of the beginning of the
year ended January 3, 2010. The 2010 pro forma earnings were adjusted to exclude $2.1 million of acquisition-related costs and the 2009 pro forma earnings were adjusted to include those costs. The pro forma financial information is presented
for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had actually taken place at the beginning of the year ended January 3, 2010 and is not intended to be a projection of
future results or trends.
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
|
|
(in thousands)
|
|
|
Net sales
|
|
$
|
463,214
|
|
|
$
|
417,871
|
|
|
Net loss
|
|
$
|
(3,477
|
)
|
|
$
|
(3,612
|
)
|
3. Discontinued Operations
On July 29, 2010, drugstore.com and DS Pharmacy, Inc., our wholly owned subsidiary, entered into a second amendment
to the asset purchase agreement dated May 5, 2010, as amended July 14, 2010, with BioScrip, Inc., and BioScrip Pharmacy Services, Inc., its wholly owned subsidiary (BioScrip), of which the sale
F-15
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
closed on July 30, 2010. Under the terms of the agreement, BioScrip Pharmacy Services purchased substantially all of the assets of DS Pharmacy for a purchase price of $10.5 million, subject
to adjustment for changes in gross profit of the business. Of this initial consideration, BioScrip paid $5.0 million in connection with closing, with $0.5 million accounting for the purchase of inventory and $4.5 million accounting for the purchase
of other assets. BioScrip will pay the remaining $5.5 million of the consideration into escrow in installments, based on the monthly profitability of the business, over the 12 months following the closing. The final amount paid out of escrow will be
determined after the 12-month period based on the profitability of the prescription pharmacy business during that period. For the year ended January 2, 2011, we recognized $1.6 million of the contingent consideration and will continue to earn
all or a portion of the remaining consideration of $3.9 million over the remaining contract period in 2011. Additionally, the parties entered into a 5-year marketing agreement allowing drugstore.com pharmacy customers to continue to order as they
always have through the drugstore.com web store. Under the agreement, 12 months following the closing of July 30, 2010, BioScrip will pay drugstore.com a fee to continue to market the drugstore.com pharmacy, which will be served by BioScrip. We
consider the marketing service fees to be indirect cash inflows of our discontinued mail-order pharmacy segment, as the fees earned are not a significant source of ongoing future revenue.
On September 3, 2008, we entered into an amended and restated main agreement with Rite Aid whereby we transferred to Rite Aid the
rights to our local pick-up pharmacy business (LPU), which included prescription refills sold online through the drugstore.com web store or the Rite Aid online store and picked up by customers at Rite Aid stores, in exchange for $9.9 million, paid
in ten monthly installments beginning in September 2008. We recorded the purchase price as a deferred gain that we recognized over the ten-month contractual payment period ended June 2009. Additionally, Rite Aid paid drugstore.com ongoing marketing
service fees for the continued marketing of Rite Aid’s LPU offering on the drugstore.com site during the term of the agreement, which terminated in May 2010. In addition, the pharmacy agreement terminated as of July 2010. We considered the
marketing service fees to be indirect cash inflows of our discontinued LPU segment, as the fees earned are not a significant source of ongoing future revenue.
We have classified the results of operations of our mail-order pharmacy and LPU business segments as discontinued operations in the accompanying consolidated financial statements for all periods
presented.
The following table summarizes the results of operations that we have classified as discontinued operations.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2009
|
|
|
Net sales
|
|
$
|
16,664
|
|
|
$
|
37,258
|
|
|
$
|
44,365
|
|
|
Income from discontinued operations—mail-order pharmacy
|
|
|
162
|
|
|
|
2,531
|
|
|
|
2,540
|
|
|
Net gain from sale of mail-order pharmacy
|
|
|
5,902
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain from discontinued operations—mail-order pharmacy
|
|
|
6,064
|
|
|
|
2,531
|
|
|
|
2,540
|
|
|
Gain from discontinued operations—LPU pharmacy
|
|
|
—
|
|
|
|
5,946
|
|
|
|
8,080
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain from discontinued operations, net of tax
|
|
$
|
6,064
|
|
|
$
|
8,477
|
|
|
$
|
10,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-16
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We have classified the assets and liabilities of our mail-order pharmacy segment as net
assets and liabilities from discontinued operations in the accompanying consolidated balance sheets for all periods presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
Accounts receivable (1)
|
|
$
|
1,711
|
|
|
$
|
1,798
|
|
|
Inventories
|
|
|
—
|
|
|
|
912
|
|
|
Other current assets
|
|
|
10
|
|
|
|
61
|
|
|
Fixed assets, net
|
|
|
719
|
|
|
|
61
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets of discontinued operations
|
|
$
|
2,440
|
|
|
$
|
2,832
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
—
|
|
|
$
|
4,220
|
|
|
Accrued liabilities
|
|
|
—
|
|
|
|
340
|
|
|
Other current liabilities
|
|
|
—
|
|
|
|
21
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities of discontinued operations
|
|
|
—
|
|
|
|
4,581
|
|
|
|
|
|
|
|
|
|
|
|
|
Net assets (liabilities) of discontinued operations
|
|
$
|
2,440
|
|
|
$
|
(1,749
|
)
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Accounts receivable as of January 2, 2011, primarily represents amounts due from BioScrip.
|
4. Strategic Agreements
Agreements with Medco
In November 2008, we entered into a five-year web store hosting and fulfillment agreement with Medco Health Services, Inc. (Medco) whereby
drugstore.com provides technical development and operation services, consumer health products and OTC merchandising, fulfillment capabilities and customer care for the non-prescription drug offerings in the Medco-branded online store. In June 2009,
we launched the Medco-branded online store. Under the terms of the original agreement, we retained the revenue collected from the customer order at the Medco-branded online store, and Medco earned a percentage of the contribution margin generated by
the order. We recorded the amount paid to Medco as a marketing and sales expense in our consolidated statements of operations. In August 2010, we entered into an amended web store hosting and fulfillment agreement with Medco, extending the agreement
through 2018. Under the amended agreement, we now receive from Medco the costs of the products sold plus our variable fulfillment costs and a fixed fee on customer orders at the Medco-branded online store. Accordingly, beginning with the third
quarter of 2010, we record the amount received from Medco as revenue and do not incur any marketing and sales expense.
Agreements with Rite Aid
In June 1999, we entered into a ten-year strategic relationship with Rite Aid Corporation (Rite Aid). On September 3, 2008, we amended and restated both the main agreement and the pharmacy supply and
services agreement dated June 17, 1999 between Rite Aid and drugstore.com. In May 2010, the main agreement between Rite Aid and drugstore.com terminated. In July 2010, the pharmacy portions of the agreement were terminated.
Under the amended and restated pharmacy and private label supply and services agreement, Rite Aid had granted drugstore.com, during the
two-year term of the agreement, a nonexclusive, fully paid license to the Rite Aid information and pharmacy systems that were integrated with our systems, subject to third-party rights to such technology. Through this technology integration, Rite
Aid adjudicated and collected insurance reimbursement payments for prescription medications in our mail-order pharmacy segment on behalf of
F-17
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
drugstore.com. In addition, we have the right to purchase pharmaceutical inventory and Rite Aid private label over-the-counter products through Rite Aid. As a result of this relationship, Rite
Aid was one of our largest suppliers. On July 30, 2010, we closed the sale of substantially all of our pharmacy assets to BioScrip. As a result, we no longer procure pharmacy inventory or rely on Rite Aid’s pharmacy systems under these
agreements.
Also on September 3, 2008, we entered into a two-year web store and fulfillment agreement with Rite Aid
whereby drugstore.com provided site design, development, hosting, customer service, and fulfillment for the Rite Aid online store. In December 2008, we launched the Rite Aid online store. In December 2010, this agreement renewed for an additional
one-year term. Under the terms of this agreement, we retain revenues collected from the order at the Rite Aid online store, and Rite Aid earns a percentage of the contribution margin generated by the order. We record the amount paid to Rite Aid as a
marketing and sales expense in our consolidated statements of operations.
Agreements with Luxottica Group, S.p.A.
In November 2009, we entered into a strategic multi-year e-commerce partnership with Luxottica Group, S.p.A.
(Luxottica) whereby our subsidiary Vision Direct, Inc. provides site design, development and hosting services, the purchasing, inventory management, and other fulfillment services, and the marketing, merchandising and related customer services,
including prescription verification, for the Luxottica-branded online stores. In January 2011, we launched two of Luxottica’s branded web stores,
www.pearlevisioncontacts.com
and
www.lenscrafterscontacts.com
. Under the
partnership, we receive from Luxottica the costs of the products sold plus our variable fulfillment costs and a fixed percentage of the sales generated through the Luxottica-branded online stores and certain sales generated in the Luxottica-branded
offline stores. We will record the amounts received from Luxottica as revenue.
Agreements with Amazon.com
In June 2009, we entered into a three-year merchant agreement with Amazon.com, a related party, to sell OTC products
through the marketplace on the Amazon.com website. In September 2007, we entered into a three-year merchant agreement with Amazon.com to sell prestige beauty products through the Beauty.com marketplace on the Amazon.com website, and as of early 2011
we continued to sell prestige beauty products through this marketplace. We ship the Amazon.com orders from our distribution facility in exchange for an agreed-upon product price less a referral fee. Product revenue generated by the merchant
agreements totaled $10.8 million in 2010, $3.6 million in 2009, and $1.3 million in 2008, and referral fees paid totaled $1.7 million in 2010, $0.6 million in 2009, and $0.2 million in 2008. As of January 2, 2010, January 3, 2010, and
December 28, 2008, amounts due from Amazon.com totaled $0.4 million, $0.3 million, and $49,000, respectively.
5. Fair Value
We measure the fair value of money market funds based on quoted prices in active markets for identical assets. All other
financial instruments measured at fair value were valued either based on recent trades of securities in inactive markets or based on quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable
market data.
As of January 2, 2011, we had deferred acquisition payments totaling $0.3 million, in conjunction with our
acquisition of Salu on February 19, 2010, that is categorized as a Level 3 liability. We utilized a discounted cash flow model that incorporated several different assumptions of future performance and a discount rate to
F-18
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
determine fair value. In the fourth quarter of 2010, we decreased the deferred acquisition payment from $0.5 million and recognized a benefit of $0.2 million in the statement of operations.
The carrying value approximates the fair value for all other financial instruments that we do not measure at fair value on
the balance sheets, including accounts receivable and debt, due to the short-maturities or variable interest rate of the instruments.
Assets and liabilities measured at fair value consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2, 2011
|
|
|
|
|
Cost or
Amortized
Cost
|
|
|
Gross
Unrealized
Holding
Gains
|
|
|
Gross
Unrealized
Holding
Losses (1)
|
|
|
Total
Fair Value
|
|
|
|
|
(in thousands)
|
|
|
Cash
|
|
$
|
11,973
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
11,973
|
|
|
Level 1 securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
|
7,065
|
|
|
|
—
|
|
|
|
—
|
|
|
|
7,065
|
|
|
Level 2 securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
|
2,727
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,727
|
|
|
U.S. government agency obligations
|
|
|
8,128
|
|
|
|
—
|
|
|
|
2
|
|
|
|
8,126
|
|
|
Corporate notes and bonds (2)
|
|
|
3,638
|
|
|
|
2
|
|
|
|
—
|
|
|
|
3,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash, cash equivalents and marketable securities
|
|
$
|
33,531
|
|
|
$
|
2
|
|
|
$
|
2
|
|
|
$
|
33,531
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 3 liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred acquisition payment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
289
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 3, 2010
|
|
|
|
|
Cost or
Amortized
Cost
|
|
|
Gross
Unrealized
Holding
Gains
|
|
|
Gross
Unrealized
Holding
Losses (1)
|
|
|
Total
Fair Value
|
|
|
|
|
(in thousands)
|
|
|
Cash
|
|
$
|
12,316
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
12,316
|
|
|
Level 1 securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
|
7,059
|
|
|
|
—
|
|
|
|
—
|
|
|
|
7,059
|
|
|
Level 2 securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
|
6,398
|
|
|
|
—
|
|
|
|
—
|
|
|
|
6,398
|
|
|
U.S. government agency obligations
|
|
|
9,365
|
|
|
|
35
|
|
|
|
—
|
|
|
|
9,400
|
|
|
Corporate notes and bonds (2)
|
|
|
1,680
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,680
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash, cash equivalents and marketable securities
|
|
$
|
36,818
|
|
|
$
|
35
|
|
|
$
|
—
|
|
|
$
|
36,853
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
As of January 2, 2011, U.S. government agency obligations had unrealized losses totaling $2,000 and as of January 3, 2010, there were no investments with loss
positions. We evaluated the nature of our investments, credit worthiness of the issuer, and the duration of any impairments to determine if an other-than-temporary decline in fair value had occurred.
|
|
(2)
|
Corporate notes and bonds include investments in corporate institutions. No single issuer represents a significant portion of the total corporate notes and bonds
portfolio.
|
F-19
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes contractual maturities of marketable securities including
cash equivalents as of January 2, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or Amortized
Cost
|
|
|
Fair Value
|
|
|
Due within one year
|
|
$
|
11,577
|
|
|
$
|
11,577
|
|
|
Due one year through two years
|
|
|
2,916
|
|
|
|
2,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
14,493
|
|
|
$
|
14,493
|
|
|
|
|
|
|
|
|
|
|
|
6. Fixed Assets
Fixed assets consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
|
|
(in thousands)
|
|
|
Computers and equipment
|
|
$
|
23,112
|
|
|
$
|
22,780
|
|
|
Purchased and internally developed software
|
|
|
50,659
|
|
|
|
45,000
|
|
|
Furniture and fixtures
|
|
|
2,334
|
|
|
|
2,531
|
|
|
Leased assets
|
|
|
5,982
|
|
|
|
6,121
|
|
|
Leasehold improvements
|
|
|
10,160
|
|
|
|
10,094
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
92,247
|
|
|
|
86,526
|
|
|
Less accumulated depreciation and amortization
|
|
|
(75,607
|
)
|
|
|
(65,973
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,640
|
|
|
|
20,553
|
|
|
Construction in progress
|
|
|
8,541
|
|
|
|
3,551
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
25,181
|
|
|
$
|
24,104
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation expense on fixed assets was $13.7 million in 2010, $12.7 million in 2009, and $10.9 million in
2008. Accumulated amortization on leased assets was $5.9 million and $5.8 million as of January 2, 2011 and January 3, 2010. Amortization on leased assets is included in depreciation expense.
7. Other Intangible Assets and Goodwill
Intangible Assets
The other intangible assets balances as of
January 2, 2011 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average
Years
Useful Life
|
|
|
Balance
January 3,
2010
|
|
|
Acquisitions (1)
|
|
|
Other (2)
|
|
|
Accumulated
Amortization
|
|
|
Balance
January 2,
2011
|
|
|
Vision Direct trade name
|
|
|
indefinite
|
|
|
$
|
2,700
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,700
|
|
|
Salu trademarks
|
|
|
indefinite
|
|
|
|
—
|
|
|
|
8,749
|
|
|
|
138
|
|
|
|
—
|
|
|
|
8,887
|
|
|
Trademarks
|
|
|
indefinite
|
|
|
|
292
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
292
|
|
|
Salu service contract and developed technology (3)
|
|
|
7.8
|
|
|
|
—
|
|
|
|
2,588
|
|
|
|
—
|
|
|
|
(318
|
)
|
|
|
2,270
|
|
|
Technology license, domain names and other
|
|
|
8.2
|
|
|
|
406
|
|
|
|
64
|
|
|
|
—
|
|
|
|
(116
|
)
|
|
|
354
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets
|
|
|
7.9
|
|
|
$
|
3,398
|
|
|
$
|
11,401
|
|
|
$
|
138
|
|
|
$
|
(434
|
)
|
|
$
|
14,503
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-20
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
(1)
|
On February 19, 2010, in conjunction with the acquisition of Salu, we acquired identifiable intangible assets of $11.3 million.
|
|
(2)
|
Represents the impact of foreign exchange rate differences.
|
|
(3)
|
The Salu service contract assumes the five-year renewal period is exercised.
|
The other intangible assets balances as of January 3, 2010 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average
Years
Useful Life
|
|
|
Balance
December 28,
2008 (1)
|
|
|
Acquisitions
|
|
|
Accumulated
Amortization (1)
|
|
|
Balance
January 3,
2010
|
|
|
Vision Direct trade name
|
|
|
indefinite
|
|
|
$
|
2,700
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,700
|
|
|
Trademarks
|
|
|
indefinite
|
|
|
|
252
|
|
|
|
40
|
|
|
|
—
|
|
|
|
292
|
|
|
Technology license, domain names and other
|
|
|
8.4
|
|
|
|
709
|
|
|
|
105
|
|
|
|
(408
|
)
|
|
|
406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets
|
|
|
8.4
|
|
|
$
|
3,661
|
|
|
$
|
145
|
|
|
$
|
(408
|
)
|
|
$
|
3,398
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
During 2009, we wrote off $12.3 million of fully amortized intangible assets related to our GNC vendor agreement with a net book value of $0.
|
The following table summarizes our estimated amortization expense for each of the next five fiscal years (in thousands):
|
|
|
|
|
|
|
Fiscal year
|
|
|
|
|
2011
|
|
$
|
529
|
|
|
2012
|
|
|
502
|
|
|
2013
|
|
|
355
|
|
|
2014
|
|
|
256
|
|
|
2015
|
|
|
236
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,878
|
|
|
|
|
|
|
|
Goodwill
The following table summarizes our goodwill by business segment (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTC
|
|
|
Vision
|
|
|
Total
|
|
|
Balance at December 28, 2008 and January 3, 2010
|
|
$
|
8,404
|
|
|
$
|
23,798
|
|
|
$
|
32,202
|
|
|
Acquisitions (1)
|
|
|
25,347
|
|
|
|
—
|
|
|
|
25,347
|
|
|
Other (2)
|
|
|
44
|
|
|
|
—
|
|
|
|
44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at January 2, 2011
|
|
$
|
33,795
|
|
|
$
|
23,798
|
|
|
$
|
57,593
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
On February 19, 2010, we completed our acquisition of Salu resulting in goodwill of $25.3 million from the excess of the purchase price over the fair value of the
net assets acquired.
|
|
(2)
|
Represents the impact of foreign exchange rate differences.
|
F-21
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. Long-Term Obligations
Line of Credit
In March 2011, we entered into a loan and security
agreement with our existing bank, which includes a revolving three-year line of credit allowing for borrowings up to $40.0 million, which accrue interest at LIBOR plus 2.5% – 3%, or prime plus 0% – 0.5%. This agreement
replaced our two-year $25.0 million line of credit scheduled to mature in March 2011. As of January 2, 2011, $13.0 million was outstanding under the line of credit, which was refinanced under the new three-year line of credit maturing in March
2014. As a result we have classified the balance outstanding on the line of credit as long-term. Availability under each line of credit was also reduced by a $541,000 letter of credit we provided to our corporate headquarters landlord. As of
January 2, 2011, the available borrowings under the two-year line of credit were approximately $11.5 million and in March 2011, the available borrowings under the three-year line of credit were approximately $26.5 million. Advances available
under the revolving line of credit are limited, based on eligible inventory, accounts receivable, cash and investment balances, and balances outstanding under our line of credit. The agreement contains certain covenants that are customary in
transactions of this nature, including a prohibition on other debt and liens, requirements regarding the payment of taxes, and certain restrictions on mergers and acquisitions, investments, and transactions with our affiliates, as well as certain
financial covenants. As of January 2, 2011, we exceeded our capital expenditure covenant of $14.0 million by $0.1 million, and as of January 30, 2011 we failed our adjusted quick ratio covenant, which were both waived in conjunction with
the March 2011 loan and security agreement renewal. In our new agreement, the adjusted quick ratio definition was redefined to reduce the possibility of non-compliance in the future. The agreement identifies certain events of default that are
customary for transactions of this nature and subject to materiality provisions and grace periods where appropriate, including failure to pay any principal or interest under this facility or other instruments when due, the occurrence of a material
adverse change, violations of any covenants, a material cross-default to our other debt, or a change of control. As of January 2, 2011, none of these events had occurred.
Capital Leases
We lease equipment and software under non-cancelable
capital leases. Capital lease obligations bear interest ranging from 3% to 8% and mature 24- 36 months from the date of funding. We secured additional funds of $1.7 million during 2010 and $0.2 million during 2009, through capital lease financing
agreements. We are in compliance with all covenants required by these agreements.
Maturities of capital leases at
January 2, 2011 are as follows (in thousands):
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
|
2011
|
|
$
|
625
|
|
|
2012
|
|
|
589
|
|
|
2013
|
|
|
442
|
|
|
|
|
|
|
|
|
Total minimum payments
|
|
|
1,656
|
|
|
Less amounts representing interest
|
|
|
(76
|
)
|
|
|
|
|
|
|
|
Present value of minimum payments
|
|
|
1,580
|
|
|
Less current portion of capital lease obligations
|
|
|
(581
|
)
|
|
|
|
|
|
|
|
Non-current portion of capital lease obligations
|
|
$
|
999
|
|
|
|
|
|
|
|
F-22
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Commitments and Contingencies
Operating Leases
We lease office, distribution center, and call center facilities under non-cancelable operating leases. We have the option to extend some of these leases for one or two additional terms of five years.
Total rent expense under operating leases was $3.6 million in 2010 and 2009, and $3.7 million in 2008.
Future minimum
commitments at January 2, 2011 are as follows (in thousands):
|
|
|
|
|
|
|
Fiscal Year
|
|
Operating Leases
|
|
|
2011
|
|
$
|
3,120
|
|
|
2012
|
|
|
3,174
|
|
|
2013
|
|
|
2,336
|
|
|
2014
|
|
|
1,582
|
|
|
2015
|
|
|
1,562
|
|
|
Thereafter
|
|
|
6,050
|
|
|
|
|
|
|
|
|
Total minimum payments
|
|
$
|
17,824
|
|
|
|
|
|
|
|
Other
In connection with the lease arrangements for our corporate headquarters, we are required to provide a standby letter of credit to our landlord as a security deposit, which will be renewed annually until
the end of the lease term. The standby letter of credit is funded under our revolving line of credit and is not required to be secured with cash. As of January 2, 2011, cash and money market funds include $5.0 million, which serves as
collateral on a contract. The contract is cancelable upon 30-days written notice and therefore the cash equivalent is considered readily available within 30 days and reported as cash and cash equivalents on our consolidated balance sheet. In
December 2010, we entered into an agreement to purchase approximately $5.0 million of hardware and software to automate our primary distribution center.
Legal Proceedings
Class Action Laddering Litigation.
A
consolidated amended complaint, which is now the operative complaint, was filed on April 19, 2002 in the U.S. District Court for the Southern District of New York. It names drugstore.com as a defendant, along with the underwriters and certain
of our present and former officers and directors (the Individual Defendants), in connection with our July 27, 1999 initial public offering and March 15, 2000 secondary offering (together, the Offerings). The suit purports to be a class
action filed on behalf of purchasers of our common stock during the period July 28, 1999 to December 6, 2000.
In
general, the complaint alleges that the prospectuses through which we conducted the Offerings were materially false and misleading because they failed to disclose, among other things, that (i) the underwriters of the Offerings allegedly had
solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriters allocated to those investors’ material portions of the restricted number of shares issued in connection with the
Offerings and (ii) the underwriters allegedly entered into agreements with customers whereby the underwriters agreed to allocate drugstore.com shares to customers in the Offerings in exchange for which customers agreed to purchase additional
drugstore.com shares in the after-market at predetermined prices. The complaint asserts violations of various sections of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. The action seeks damages in an
unspecified
F-23
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
amount and other relief. The action is being coordinated with approximately 300 other nearly identical actions filed against other companies or their present and former officers and directors.
On October 9, 2002, the District Court dismissed the Individual Defendants from the case without prejudice. On
December 5, 2006, the U.S. Court of Appeals for the Second Circuit vacated a decision by the District Court granting class certification in six of the coordinated cases, which are intended to serve as test, or “focus,” cases. The
plaintiffs selected these six cases, which do not include us. On April 6, 2007, the Second Circuit denied a petition for rehearing filed by plaintiffs, but noted that plaintiffs could ask the District Court to certify more narrow classes than
those that were rejected.
The parties in the approximately 300 coordinated cases, including the parties in
drugstore.com’s case, reached a settlement. The insurers for the issuer defendants in the coordinated cases will make the settlement payment on behalf of the issuers, including drugstore.com. The District Court approved the settlement on
October 5, 2009. Two appeals of the settlement approval are proceeding. Plaintiffs have moved to dismiss both appeals.
Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of this matter. We are unable to
estimate the potential damages that might be awarded if the appeal is successful and we were found liable, there arose a material limitation with respect to our insurance coverage, or the amount awarded were to exceed our insurance coverage. Because
our liability, if any, cannot be reasonably estimated, no amounts have been accrued for this matter. An adverse outcome in this matter could have a material adverse effect on our financial position and results of operations.
Other
. From time to time, we are subject to other legal proceedings and claims in the ordinary course of business. We are not
currently aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business prospects, financial condition, or operating results, other than those listed above.
10. Income Taxes
No federal tax benefit or expense was recorded in 2010, 2009, and 2008, due to our ongoing operating losses. In addition, no tax benefit or expense related to discontinued operations has been recorded due
to the continuing and historical tax losses related to the LPU and mail-order pharmacy businesses. Our deferred tax assets consist primarily of net operating loss carry-forwards and amortization and impairment of intangible assets. We have provided
a valuation allowance for our deferred tax assets to an amount expected to be realized.
At January 2, 2011, we had
approximately $626.9 million of federal net operating loss carry-forwards that will expire beginning in 2018. Internal Revenue Code Section 382 imposes limitations on our ability to utilize net operating losses if we experience an ownership
change. An ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percentage points over a three-year period. The value of the stock at the time of an ownership
change is multiplied by the applicable long-term tax exempt interest rate to calculate the annual limitation. Any unused annual limitation may be carried over to later years. Based upon our cumulative historic ownership activity, it likely results
in a significant limitation on the utilization of our net operating loss carryforwards.
F-24
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
At January 2, 2011, we had approximately $77.9 million of state net operating loss
carry-forwards that will expire beginning in 2011.
Approximately $12.0 million of our net loss carry-forwards are related to
tax-deductible stock-based compensation in excess of amounts recognized for financial reporting purposes. To the extent that net operating loss carry-forwards, if realized, relate to stock-based compensation, the resulting tax benefits will be
recorded to stockholders’ equity, rather than to results of operations.
Deferred income tax balances reflect the effects
of temporary differences between the carrying amount of assets and liabilities and their tax bases and are stated at the enacted tax rates expected to be in effect when taxes are actually paid or recovered. Significant components of our deferred tax
assets and liabilities are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
|
|
(in thousands)
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
|
Net operating loss carry-forward (federal)
|
|
$
|
219,408
|
|
|
$
|
201,837
|
|
|
Net operating loss carry-forward (state)
|
|
|
4,690
|
|
|
|
3,822
|
|
|
Net operating loss carry-forward (foreign)
|
|
|
106
|
|
|
|
—
|
|
|
Depreciation, amortization and impairment of intangible assets
|
|
|
20,937
|
|
|
|
27,537
|
|
|
Tax credit carry-forwards
|
|
|
1,462
|
|
|
|
1,414
|
|
|
Stock based compensation
|
|
|
13,760
|
|
|
|
10,451
|
|
|
Other temporary differences
|
|
|
1,659
|
|
|
|
2,749
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross deferred tax assets
|
|
|
262,022
|
|
|
|
247,810
|
|
|
Less valuation allowance
|
|
|
(262,022
|
)
|
|
|
(247,810
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets, net of valuation allowance
|
|
|
—
|
|
|
|
—
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
|
Indefinite-lived intangible assets
|
|
|
(4,079
|
)
|
|
|
(959
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax liability
|
|
$
|
(4,079
|
)
|
|
$
|
(959
|
)
|
|
|
|
|
|
|
|
|
|
|
A reconciliation of income taxes from continuing operations computed at the statutory rate to the income tax
amount recorded is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2008
|
|
|
|
|
(in thousands)
|
|
|
Income tax benefit at statutory rate
|
|
$
|
1,244
|
|
|
$
|
481
|
|
|
$
|
2,899
|
|
|
State taxes, net of federal impact
|
|
|
394
|
|
|
|
242
|
|
|
|
2,093
|
|
|
State net operating loss expiration
|
|
|
(744
|
)
|
|
|
(7,569
|
)
|
|
|
(597
|
)
|
|
Prior period adjustment-true up deferred balance
|
|
|
(1,541
|
)
|
|
|
—
|
|
|
|
—
|
|
|
Nondeductible transaction costs
|
|
|
(494
|
)
|
|
|
—
|
|
|
|
—
|
|
|
Impact of rate change—State
|
|
|
3,049
|
|
|
|
430
|
|
|
|
(172
|
)
|
|
Other
|
|
|
34
|
|
|
|
(188
|
)
|
|
|
(190
|
)
|
|
Decrease (increase) in valuation allowance, net of amounts acquired
|
|
|
(1,942
|
)
|
|
|
6,604
|
|
|
|
(4,033
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax benefit
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-25
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Stockholders’ Equity
Outstanding Warrants
We have the following warrants outstanding as of January 2, 2011, issued in connection with various consulting agreements. The fair value of the warrants was determined using the Black-Scholes option
pricing model and recorded in general and administrative expenses in the consolidated statements of operations as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Exercise
Price
|
|
|
Expiration Date
|
|
Stock-compensation expense
(in thousands)
|
|
|
Issue Date
|
|
|
|
|
FY 2010
|
|
|
FY 2009
|
|
|
FY 2008
|
|
|
February 2010
|
|
|
300,000
|
|
|
$
|
2.00
|
|
|
February 2020
|
|
$
|
727
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
June 2008
|
|
|
50,000
|
|
|
$
|
2.53
|
|
|
June 2018
|
|
|
—
|
|
|
|
—
|
|
|
|
69
|
|
|
March 2008
|
|
|
100,000
|
|
|
$
|
2.53
|
|
|
March 2018
|
|
|
—
|
|
|
|
—
|
|
|
|
163
|
|
|
June 2007 (1)
|
|
|
200,000
|
|
|
$
|
2.50
|
|
|
June 2017
|
|
|
(192
|
)
|
|
|
345
|
|
|
|
—
|
|
|
July 2007
|
|
|
50,000
|
|
|
$
|
2.53
|
|
|
July 2017
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
700,000
|
|
|
|
|
|
|
|
|
$
|
535
|
|
|
$
|
345
|
|
|
$
|
232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
At the end of each reporting period, we adjust the fair value of the June 2007 warrants as they are considered liability instruments.
|
12. Employee Benefit Plans
Defined Contribution Plan
We have a defined contribution retirement
plan under Section 401(k) of the Internal Revenue Code, which covers substantially all of our employees (401(k) Plan). Eligible employees may contribute amounts to the 401(k) Plan via payroll withholding, subject to certain limitations.
Under the 401(k) Plan, employees may elect to reduce their current compensation by up to the statutorily prescribed annual limit and to have the amount of such reduction contributed to the 401(k) Plan. The 401(k) Plan permits us but does not require
us to make additional matching contributions to the 401(k) Plan on behalf of all participants in the 401(k) Plan. Beginning in 2008, we began matching 25% of the employee contributions up to $1,000. We made matching contributions under our 401(k)
Plan of approximately $200,000 in 2010 and 2009 and $180,000 in 2008.
Stock-Based Benefit Plans
1998 Stock Plan
—Under the terms of our 1998 Stock Plan, as amended (1998 Stock Plan), our board of directors could grant
incentive and nonqualified stock options to employees, officers, directors, agents, consultants, and independent contractors of drugstore.com. Options under this plan generally vest over four years, as follows: 20% of the shares vest after six
months, and the remaining 80% vest quarterly over the subsequent 42 months. Option grants generally had exercise prices equal to the fair market value of the common stock on the date of grant and expire ten years from the date of grant. The 1998
Stock Plan expired in June 2008 and was replaced with the 2008 Equity Incentive Plan (2008 Equity Plan) and no further awards have been or will be granted under the 1998 Stock Plan. The 1998 Stock Plan, however, will continue to govern awards
previously granted under that plan and any outstanding options will continue to vest and will remain outstanding until they are exercised, are forfeited, or expire.
2008 Equity Incentive Plan
—Under the terms of the 2008 Equity Plan, which replaced the 1998 Stock Plan, our board of directors may grant stock options, stock appreciation rights,
restricted stock, restricted stock units,
F-26
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
performance shares and performance units, and other stock or cash awards to employees, directors, and consultants who provide services to drugstore.com. The board of directors has reserved
8.0 million shares of our common stock for issuance under the 2008 Equity Plan, as well as up to 15.0 million shares from stock options or similar awards granted under the 1998 Stock Plan that expire or otherwise terminate without having
been exercised in full and shares issued pursuant to awards granted under the 1998 Stock Plan that are forfeited or that we repurchase. The shares may be authorized, but unissued, or reacquired common stock. As of January 2, 2011, there
were 5.5 million shares available for grant under the 2008 Equity Plan.
Under the 2008 Equity Plan, stock appreciation
rights, which are the rights to receive the appreciation in fair market value of common stock between the exercise date and the date of grant, become exercisable at the times and on the terms established by the plan administrator. The plan
administrator has complete discretion to determine the terms and conditions of stock appreciation rights granted under the 2008 Equity Plan; provided, however, that the exercise price may not be less than 100% of the fair market value of a share on
the date of grant. The term of a stock appreciation right may not exceed ten years. Under the 2008 Equity Plan, the plan administrator may issue awards of restricted stock, restricted stock units, and performance units and performance
shares at its sole discretion. Restricted stock awards and restricted stock units generally vest every six-months over a period of four years. In June 2010, the Board of Directors approved the granting of restricted stock units as permitted under
the 2008 Plan.
On March 10, 2010, we notified the staff of the Nasdaq Stock Market that we were in material
noncompliance with Rule 5635(c) of the Corporate Governance Requirements of the NASDAQ listing requirements with respect to certain equity awards granted under the 2008 Plan. The 2008 Plan previously required that any award of restricted stock,
among other securities, be counted against the 2008 Plan share reserve as three shares for every one share subject to the award (the “Full Value Award Provision”). In the first quarter of 2010, our management became aware that we exceeded
the share limit set forth in the 2008 Plan as a result of the inadvertent incorrect application of the Full Value Award Provision. Because the grant of approximately 700,000 shares of restricted stock and awards of options and stock appreciation
rights with respect to approximately 3.4 million shares of common stock exceeded the share reserve limit after proper application of the Full Value Award Provision, we were deemed to have issued securities pursuant to the 2008 Plan without
stockholder approval. Accordingly, we were not in compliance with Rule 5635(c) of the Nasdaq Corporate Governance Requirements.
We submitted our plan to regain compliance with Rule 5635(c) to NASDAQ on March 10, 2010. Our compliance plan conditioned the
release and delivery of certain shares of restricted stock and unvested options and stock appreciation rights on approval by our stockholders of certain amendments to the 2008 Plan. We included those amendments in our 2010 proxy statement as
proposals which were presented at the annual meeting of stockholders, held on June 10, 2010. We also provided notice to affected award recipients on March 15, 2010. On March 16, 2010, NASDAQ informed us that by providing the foregoing
notice to affected equity award recipients, we had regained compliance with Rule 5635(c). On June 10, 2010, our stockholders approved the release and delivery of the restricted stock and unvested options and stock appreciation rights impacted
by the noncompliance with the 2008 Plan. The stockholders also approved an amendment to our 2008 Plan, retroactive to the inception of the 2008 Plan, to decrease from 3.0 to 1.33 the share ratio applied for purposes of counting full value awards.
Under the codification guidance for stock compensation, a grant date cannot occur before all necessary approvals have been
obtained, including stockholder approval of the reservation of sufficient additional shares under the plan. Accordingly, the restricted stock awards, stock options, and stock appreciation rights to purchase common stock granted under the 2008 Plan
beginning on March 6, 2009 were not considered valid grants. Upon
F-27
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
stockholder approval, the grants became valid grants and the measurement date for the approximately 700,000 restricted stock awards and the 3.4 million stock options and stock appreciation
rights, originally impacted, was June 10, 2010. On the measurement date, the restricted stock awards, stock options, and stock appreciation rights were valued at the closing stock price of $3.47. The stock options and stock appreciation rights
have exercise prices ranging from $0.85 to $2.44, resulting in the stock options and stock appreciation rights being granted as in-the-money awards for purposes of measuring stock compensation expense. In addition, the vesting terms of the
restricted stock awards, stock options, and stock appreciation rights were accelerated. As a result, we recognized $2.5 million of stock compensation expense in the second quarter of 2010 relating to these awards.
1999 Employee Stock Purchase Plan
—Under the terms of our 1999 Employee Stock Purchase Plan, as amended (1999 ESPP), eligible
employees could purchase common stock for a purchase price equal to 85% of the fair market value of our common stock on the first or last day, whichever is less, of the applicable six-month purchase period, which periods end in January and July of
each year, except in 2009, when the period ended in June upon the expiration of the 1999 ESPP. For the years ended January 3, 2010 and December 28, 2008 employees purchased 106,500 and 92,047 shares, respectively, of our common stock under
the 1999 ESPP in exchange for $94,000 and $189,000, respectively.
Determining Fair Value
The following weighted-average assumptions were used in arriving at the fair value of each stock option and stock appreciation right
grant:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2008
|
|
|
Expected volatility
|
|
|
71
|
%
|
|
|
70
|
%
|
|
|
65
|
%
|
|
Expected term (in years)
|
|
|
4.7
|
|
|
|
4.7
|
|
|
|
4.3
|
|
|
Risk-free interest rate
|
|
|
1.8
|
%
|
|
|
1.8
|
%
|
|
|
2.5
|
%
|
|
Expected dividend
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
Weighted-average fair value
|
|
$
|
2.30
|
|
|
$
|
0.28
|
|
|
$
|
1.40
|
|
Volatility
Our computation of expected volatility is based on our historical volatility, adjusted for changes in capital structure and corporate
changes, information available that may indicate future volatility, and observable mean reversion tendencies of historical volatility.
Expected Term
Our
expected term estimates are based on a comprehensive weighted average life (WAL) analysis. The WAL analysis provides a historical based platform for use in developing expected term estimates for the future based on the historically observed time
periods from grant date through post-vesting activities, such as exercise and cancellation. The historical grant data is segregated into pre-vesting forfeitures, post-vesting forfeitures, outstanding and unvested grants, and outstanding and vested
grants and then data is included or excluded in the WAL depending on the applicable contractual or vesting provisions, differences in other option terms and insufficient elapsed time from grant date or from vesting dates. We also analyze by
homogenous group, which includes employees, executives, our chief executive officer, board members, and other non-employees, the weighted average time from grant date to post-vesting activity. For those grants still outstanding, we developed a
reasonable assumption regarding the expected time of settlement.
F-28
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Risk-Free Interest Rate and Dividend Yield
We base the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent
remaining term. Where the expected term of our stock-based awards do not correspond with the terms for which interest rates are quoted, we average the periods to determine the rate from the available term maturities. A dividend yield of 0% was
considered appropriate as we have not issued and do not anticipate issuing any dividends in the near future.
Forfeitures
We are required to recognize stock-based compensation expense based on the number of awards expected to vest. Accordingly, we apply a
forfeiture rate of 35% to employee options and stock appreciation rights, a 15% forfeiture rate to employee restricted stock and restricted stock unit awards, except that we use a forfeiture rate of 0% for our chief executive officer and board
members. When estimating forfeitures, we considered historical voluntary termination behavior and turnover, in addition to analyzing actual forfeitures.
Stock Option and Stock Appreciation Rights Activity
The following table summarizes
our stock option and stock appreciation rights activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
|
Weighted-
Average
Exercise
Price per
Share
|
|
|
Weighted-
Average
Remaining
Contractual
Term
|
|
|
Outstanding at January 3, 2010
|
|
|
16,635,725
|
|
|
$
|
3.16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options granted (1)
|
|
|
4,551,624
|
|
|
$
|
2.28
|
|
|
|
|
|
|
Options exercised
|
|
|
(355,650
|
)
|
|
$
|
2.22
|
|
|
|
|
|
|
Options forfeited
|
|
|
(767,357
|
)
|
|
$
|
6.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 2, 2011
|
|
|
20,064,342
|
|
|
$
|
2.86
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at January 2, 2011
|
|
|
17,597,559
|
|
|
$
|
2.95
|
|
|
|
5.36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at January 2, 2011
|
|
|
16,367,193
|
|
|
$
|
2.98
|
|
|
|
5.13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes 3.4 million stock options and stock appreciation rights that were subject to stockholder approval, which was obtained on June 10, 2010.
|
The aggregate intrinsic value for stock options and stock appreciation rights was $0.8 million for awards
vested and expected to vest and $0.7 million for awards exercisable at January 2, 2011. The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the market price of our common stock
for the 1.1 million shares subject to options that were in-the-money at January 2, 2011 (i.e., with an exercise price of $2.21 or less). As of January 2, 2011, the total compensation cost related to unvested options and stock
appreciation rights granted totaled $3.2 million, net of estimated forfeitures of approximately $4.9 million. This cost will be amortized on a straight-line basis over a weighted-average period of 2.3 years and will be adjusted for subsequent
changes in estimated forfeitures.
The aggregate intrinsic value of options exercised was $0.4 million, $41,000, and $32,000,
as of January 2, 2011, January 3, 2010, and December 28, 2008.
F-29
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Restricted Stock Awards Activity
The following table summarizes our restricted stock awards activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
|
Weighted-Average
Grant Date
Fair Value
|
|
|
Unvested at January 3, 2010
|
|
|
2,130,000
|
|
|
$
|
0.76
|
|
|
|
|
|
|
|
|
|
|
|
|
Awards granted (1)
|
|
|
693,503
|
|
|
$
|
3.47
|
|
|
Awards released
|
|
|
(1,063,644
|
)
|
|
$
|
1.66
|
|
|
Awards forfeited
|
|
|
(88,668
|
)
|
|
$
|
1.79
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested at January 2, 2011
|
|
|
1,671,191
|
|
|
$
|
1.26
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes 0.7 million restricted stock awards that were subject to stockholder approval, which was obtained on June 10, 2010.
|
The weighted average fair value of restricted stock awards granted during 2009 was $0.78.
Restricted Stock Units Activity
The following table summarizes our restricted stock units activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
|
Weighted-Average
Grant Date
Fair Value
|
|
|
Unvested at January 3, 2010
|
|
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Units granted
|
|
|
1,363,646
|
|
|
$
|
2.26
|
|
|
Units vested
|
|
|
(53,151
|
)
|
|
$
|
3.47
|
|
|
Units forfeited
|
|
|
(35,823
|
)
|
|
$
|
3.04
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested at January 2, 2011
|
|
|
1,274,672
|
|
|
$
|
2.19
|
|
|
|
|
|
|
|
|
|
|
|
As of January 2, 2011, the total compensation cost related to unvested restricted stock
awards and restricted stock units granted totaled $3.5 million, net of estimated forfeitures of approximately $1.3 million. This cost will be amortized on a straight-line basis over a weighted-average period of 2.9 years and will be adjusted for
subsequent changes in estimated forfeitures.
Stock Compensation Expense
The following table summarizes stock-based compensation by operating function recorded in the Statements of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2008
|
|
|
|
|
(in thousands)
|
|
|
Fulfillment and order processing
|
|
$
|
949
|
|
|
$
|
512
|
|
|
$
|
576
|
|
|
Marketing and sales
|
|
|
2,158
|
|
|
|
1,576
|
|
|
|
1,619
|
|
|
Technology and content
|
|
|
1,588
|
|
|
|
1,102
|
|
|
|
1,265
|
|
|
General and administrative
|
|
|
4,254
|
|
|
|
2,210
|
|
|
|
4,104
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
8,949
|
|
|
$
|
5,400
|
|
|
$
|
7,564
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-30
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. Segment Information
We have two reporting segments: over-the-counter (OTC) and vision. The OTC segment is comprised of the sales and related costs of selling all non-prescription health, beauty, personal care, household, and
other products, and includes the results of Salu beginning as of February 20, 2010. Our vision segment is comprised of sales and the related costs of selling contact lenses and other contact lens supplies through Vision Direct. On July 30,
2010, we closed our sale of our mail-order pharmacy assets to BioScrip, as discussed in Note 3 of our consolidated financial statements. As a result, we have presented our mail-order pharmacy segment as discontinued operations beginning with the
second quarter of 2010 and for all prior periods presented. We operate and evaluate our business segments based on contribution margin results. We define contribution margin as net sales attributable to a segment, less the direct cost of these sales
and the incremental (variable) costs of fulfilling, processing, and delivering the order (labor, packaging supplies, and credit card fees that are variable based on sales volume). In the second quarter of 2010, our chief operating decision makers
modified our definition of variable order costs to exclude partnership-related royalty costs, which are variable in nature, but are considered more reflective of a marketing cost since we consider our partnerships a marketing channel, thus we have
restated prior periods to reflect this change in the definition of contribution margin. The information presented below for these segments is the information our management uses in evaluating operating performance.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
December 28,
2008
|
|
|
|
|
(in thousands)
|
|
|
OTC:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
385,234
|
|
|
$
|
306,854
|
|
|
$
|
260,794
|
|
|
Cost of sales
|
|
|
267,681
|
|
|
|
210,456
|
|
|
|
180,252
|
|
|
Variable order costs (a)
|
|
|
32,851
|
|
|
|
26,528
|
|
|
|
23,408
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contribution margin (b)
|
|
$
|
84,702
|
|
|
$
|
69,870
|
|
|
$
|
57,134
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vision:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
71,273
|
|
|
$
|
68,720
|
|
|
$
|
61,420
|
|
|
Cost of sales
|
|
|
54,330
|
|
|
|
52,894
|
|
|
|
47,279
|
|
|
Variable order costs (a)
|
|
|
3,343
|
|
|
|
3,172
|
|
|
|
2,899
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contribution margin (b)
|
|
$
|
13,600
|
|
|
$
|
12,654
|
|
|
$
|
11,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales (c)
|
|
$
|
456,507
|
|
|
$
|
375,574
|
|
|
$
|
322,214
|
|
|
Cost of sales
|
|
|
322,011
|
|
|
|
263,350
|
|
|
|
227,531
|
|
|
Variable order costs (a)
|
|
|
36,194
|
|
|
|
29,700
|
|
|
|
26,307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contribution margin (b)
|
|
$
|
98,302
|
|
|
$
|
82,524
|
|
|
$
|
68,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
These amounts include all variable costs of fulfillment and order processing, including labor, packaging supplies, and credit card fees that are variable based on sales
volume. These amounts exclude depreciation, fixed overhead costs, and stock-based compensation.
|
|
(b)
|
Contribution margin represents a measure of how well each segment is contributing to our operating goals. It is calculated as net sales less the direct cost of these
sales and the incremental (variable) fulfillment and order processing costs of delivering orders to our customers.
|
|
(c)
|
Net sales in 2010, 2009 and 2008 were comprised of 97%, 98% and 99% of sales in the United States of America, respectively.
|
F-31
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated contribution margin for reportable segments
|
|
$
|
98,302
|
|
|
$
|
82,524
|
|
|
$
|
68,376
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed fulfillment and order processing (d)
|
|
|
13,410
|
|
|
|
12,191
|
|
|
|
12,589
|
|
|
Marketing and sales
|
|
|
46,550
|
|
|
|
37,727
|
|
|
|
32,464
|
|
|
Technology and content
|
|
|
27,303
|
|
|
|
24,864
|
|
|
|
22,995
|
|
|
General and administrative
|
|
|
20,221
|
|
|
|
17,642
|
|
|
|
19,866
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
$
|
(9,182
|
)
|
|
$
|
(9,900
|
)
|
|
$
|
(19,538
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(d)
|
These amounts include all fixed costs of fulfillment and order processing that are not discernable by business segment.
|
The following table presents assets by segment and geographic asset information:
|
|
|
|
|
|
|
|
|
|
|
|
|
January 2,
2011
|
|
|
January 3,
2010
|
|
|
|
|
(in thousands)
|
|
|
Total Assets:
|
|
|
|
|
|
|
|
|
|
OTC
|
|
$
|
103,268
|
|
|
$
|
58,744
|
|
|
Vision
|
|
|
37,457
|
|
|
|
36,542
|
|
|
Discontinued operations
|
|
|
2,440
|
|
|
|
2,832
|
|
|
Corporate
|
|
|
57,207
|
|
|
|
56,411
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
$
|
200,372
|
|
|
$
|
154,529
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Equipment, Net:
|
|
|
|
|
|
|
|
|
|
United States of America
|
|
$
|
25,120
|
|
|
$
|
24,071
|
|
|
Australia
|
|
|
54
|
|
|
|
—
|
|
|
Canada
|
|
|
7
|
|
|
|
33
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
$
|
25,181
|
|
|
$
|
24,104
|
|
|
|
|
|
|
|
|
|
|
|
F-32
DRUGSTORE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. Quarterly Results of Operations (unaudited)
The following tables contain selected unaudited consolidated statement of operations information for each quarter of fiscal years 2010 and
2009. We believe that the following information reflects all normal recurring adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results
for any future period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year 2010
|
|
|
Fiscal Year 2009
|
|
|
|
|
First
Quarter (3)
|
|
|
Second
Quarter
|
|
|
Third
Quarter
|
|
|
Fourth
Quarter
|
|
|
First
Quarter
|
|
|
Second
Quarter
|
|
|
Third
Quarter
|
|
|
Fourth
Quarter (1)
|
|
|
|
|
($ in thousands, except per share data)
|
|
|
Net sales
|
|
$
|
110,933
|
|
|
$
|
113,147
|
|
|
$
|
108,791
|
|
|
$
|
123,636
|
|
|
$
|
89,528
|
|
|
$
|
88,880
|
|
|
$
|
88,576
|
|
|
$
|
108,590
|
|
|
Cost of sales
|
|
|
77,753
|
|
|
|
78,705
|
|
|
|
77,160
|
|
|
|
88,393
|
|
|
|
63,526
|
|
|
|
62,040
|
|
|
|
61,937
|
|
|
|
75,847
|
|
|
Loss from continued operations
|
|
|
(3,116
|
)
|
|
|
(2,948
|
)
|
|
|
(2,335
|
)
|
|
|
(1,215
|
)
|
|
|
(2,718
|
)
|
|
|
(2,530
|
)
|
|
|
(2,353
|
)
|
|
|
(2,253
|
)
|
|
Gain from discontinued operations
|
|
|
500
|
|
|
|
274
|
|
|
|
4,738
|
|
|
|
552
|
|
|
|
3,572
|
|
|
|
3,556
|
|
|
|
719
|
|
|
|
630
|
|
|
Net income (loss)
|
|
|
(2,616
|
)
|
|
|
(2,674
|
)
|
|
|
2,403
|
|
|
|
(663
|
)
|
|
|
854
|
|
|
|
1,026
|
|
|
|
(1,634
|
)
|
|
|
(1,623
|
)
|
|
Basic and diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations per share
|
|
$
|
(0.03
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.02
|
)
|
|
Gain from discontinued operations per share
|
|
$
|
0.00
|
|
|
$
|
0.00
|
|
|
$
|
0.04
|
|
|
$
|
0.00
|
|
|
$
|
0.04
|
|
|
$
|
0.04
|
|
|
$
|
0.01
|
|
|
$
|
0.01
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share (2)
|
|
$
|
(0.03
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
0.02
|
|
|
$
|
(0.01
|
)
|
|
$
|
0.01
|
|
|
$
|
0.01
|
|
|
$
|
(0.02
|
)
|
|
$
|
(0.02
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in computation of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share
|
|
|
102,605,614
|
|
|
|
104,992,447
|
|
|
|
105,628,635
|
|
|
|
103,406,014
|
|
|
|
97,355,613
|
|
|
|
99,727,521
|
|
|
|
96,932,740
|
|
|
|
97,390,984
|
|
|
Diluted net income (loss) per share
|
|
|
102,605,614
|
|
|
|
104,992,447
|
|
|
|
105,628,635
|
|
|
|
103,406,014
|
|
|
|
97,355,613
|
|
|
|
99,727,521
|
|
|
|
96,932,740
|
|
|
|
97,390,984
|
|
|
(1)
|
The fourth quarter of 2009 is a 14-week quarter.
|
|
(2)
|
Net income (loss) per share on a quarterly basis does not sum to the annual net loss per share as a result of the impact of participating securities on the weighted
average number of shares used in the computation in the periods with net income.
|
|
(3)
|
The first quarter of 2010 includes $1.8 million of transaction and integration related costs to the acquisition of Salu, and $0.65 million of vision migration costs
related to our move of our vision fulfillment operations from Ferndale, Washington, to Swedesboro, New Jersey.
|
F-33
DRUGSTORE.COM, INC.
SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description
|
|
Balance at
beginning of
fiscal period
|
|
|
Charges to
revenue, costs
and expenses,
and additions
|
|
|
Deductions
|
|
|
Balance at end
of fiscal period
|
|
|
Allowance for doubtful accounts (a)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended January 2, 2011
|
|
|
69
|
|
|
|
200
|
|
|
|
(214
|
)
|
|
|
55
|
|
|
Year Ended January 3, 2010
|
|
|
16
|
|
|
|
310
|
|
|
|
(257
|
)
|
|
|
69
|
|
|
Year Ended December 28, 2008
|
|
|
41
|
|
|
|
183
|
|
|
|
(208
|
)
|
|
|
16
|
|
|
Allowance for sales returns (b)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended January 2, 2011
|
|
|
418
|
|
|
|
4,804
|
|
|
|
(4,844
|
)
|
|
|
378
|
|
|
Year Ended January 3, 2010
|
|
|
320
|
|
|
|
4,642
|
|
|
|
(4,544
|
)
|
|
|
418
|
|
|
Year Ended December 28, 2008
|
|
|
493
|
|
|
|
3,633
|
|
|
|
(3,806
|
)
|
|
|
320
|
|
|
Deferred tax asset valuation allowance (c)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended January 2, 2011
|
|
|
247,810
|
|
|
|
14,212
|
|
|
|
—
|
|
|
|
262,022
|
|
|
Year Ended January 3, 2010
|
|
|
254,414
|
|
|
|
—
|
|
|
|
(6,604
|
)
|
|
|
247,810
|
|
|
Year Ended December 28, 2008
|
|
|
250,381
|
|
|
|
4,033
|
|
|
|
—
|
|
|
|
254,414
|
|
|
(a)
|
Deductions consist of write-offs of uncollectible accounts, net of recoveries.
|
|
(b)
|
Deductions consist of sales credits to customers for product returns.
|
|
(c)
|
Additions and deductions are the result of changes in our net deferred assets.
|
F-34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 18, 2011.
|
|
|
|
|
DRUGSTORE.COM, INC.
|
|
|
|
|
By:
|
|
/
S
/ D
AWN
G.
L
EPORE
|
|
|
|
Dawn G. Lepore
President, Chief Executive Officer
and Chairman of the
Board
|
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes and appoints Dawn G. Lepore and Robert P. Potter, and each of
them, with full power of substitution and resubstitution and full power to act without the other, as his or her true and lawful attorney-in-fact and agent to act in his or her name, place and stead and to execute in the name and on behalf of each
person, individually and in each capacity stated below, and to file, any and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission,
granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing, ratifying and confirming all that said attorneys-in-fact and agents or any of them or their or his or her
substitute or substitutes may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the
Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 18, 2011.
|
|
|
|
|
Signature
|
|
Title
|
|
|
|
|
/
S
/ D
AWN
G.
L
EPORE
Dawn G. Lepore
|
|
President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)
|
|
|
|
|
/
S
/ R
OBERT
P.
P
OTTER
Robert P. Potter
|
|
Vice President, Chief Accounting Officer (Principal Financial and Accounting Officer)
|
|
|
|
|
/
S
/ R
ICHARD
W. B
ENNET
III
Richard W. Bennet III
|
|
Director
|
|
|
|
|
/
S
/ G
EOFFREY
R.
E
NTRESS
Geoffrey R. Entress
|
|
Director
|
|
|
|
|
/
S
/ J
EFFREY
M.
K
ILLEEN
Jeffrey M. Killeen
|
|
Director
|
|
|
|
|
/
S
/ W
ILLIAM
D.
S
AVOY
William D. Savoy
|
|
Director
|
|
|
|
|
/
S
/ G
REGORY
S.
S
TANGER
Gregory S. Stanger
|
|
Director
|
F-35
Exhibit 4.11
|
|
|
|
|
411 108
th
Ave NE, Suite 1400• Bellevue, Washington 98004 • Telephone 425. 372.3200 •
Facsimile 425. 372.3800
|
|
P Amy Reischauer
Associate General Counsel &
Assistant Secretary
425-372-3511 telephone
425-372-3801 facsimile
|
March 15, 2011
Via Fax to 201-680-4616 or 4617
Mellon Investor Services
DWAC Department
Ridgefield Park, New Jersey
|
Re:
|
DWAC Issuance of Stock Pursuant to Restricted Stock Unit Release(s) – Control No. 10-041
|
You are hereby authorized to issue and deliver via DWAC shares of the Common Stock of drugstore.com, inc. (the “Company”) as indicated below,
pursuant to release(s) of restricted stock units under a Company stock equity plan:
|
|
|
|
|
|
|
Equity Plan Issued Under:
|
|
2008 Equity Incentive Plan
|
|
|
|
Issue to:
|
|
ETRADE Securities
|
|
|
|
Date of Issuance:
|
|
October 4, 2010
|
|
|
|
Total Number of Shares Issued
|
|
53,151 shares
|
|
|
|
Address:
|
|
4005 Windward Plaza Dr
Alpharetta GA 30005
|
|
|
|
Taxpayer Identification Number:
|
|
77-0054242
|
|
|
|
Legend:
|
|
None
|
|
|
|
Broker Name:
|
|
ETRADE Securities
|
|
|
|
Broker Phone:
|
|
1-888-680-2132
|
|
|
|
Special Handling:
|
|
None
|
|
|
Should you have any questions, please contact me as indicated above.
Regards,
P. Amy Reischauer
Exhibit 4.12
DRUGSTORE.COM, INC.
2008 EQUITY INCENTIVE PLAN
NOTICE OF GRANT OF RESTRICTED STOCK UNITS
Unless otherwise defined herein, the terms defined in the 2008 Equity Incentive Plan (the “
Plan
”) will have the same defined meanings in this Notice of Grant of Restricted Stock Units
(the “
Notice of Grant
”) and the Terms and Conditions of the Restricted Stock Units attached hereto as
Exhibit A
(together, the “
Agreement
”).
Dawn G. Lepore
1425 Broadway, PMB 41
Seattle WA 98122
The Participant (as defined below) has been granted an Award of Restricted Stock Units, subject to the terms and conditions of the Plan
and this Agreement, as follows:
|
|
|
|
|
Grant Number
|
|
U0002013
|
|
|
|
|
Date of Grant
|
|
November 12, 2010
|
|
|
|
|
Vesting Commencement Date
|
|
October 3, 2010
|
|
|
|
|
Number of Restricted Stock Units
|
|
300,000
|
Vesting Schedule
:
Subject to any acceleration provisions contained in the Plan or set forth below, the Restricted Stock Units will vest in accordance with the following schedule:
One-eighth (1/8
th
) of the Shares of Restricted Stock will vest on each six (6) month anniversary of the Vesting Commencement
Date, subject to Participant continuing to be a Service Provider through each such date.
In the event the Participant ceases
to be a Service Provider for any or no reason before the Participant vests in the Restricted Stock Unit, the Restricted Stock Unit and the Participant’s right to acquire any Shares hereunder will immediately terminate.
Notwithstanding the foregoing or anything in the Plan or this Agreement to the contrary, if there is a Change in Control, one hundred
percent (100%) of the Restricted Stock Units will immediately vest.
Notwithstanding the foregoing or anything in the
Plan or this Agreement to the contrary, if Participant’s status as a Service Provider is terminated (i) by the Company without Cause (as defined below) or (ii) by Participant for Good Reason (as defined below), Participant will
receive twelve (12) additional months of vesting credit with respect to the Shares of Restricted Stock Unit.
For purposes of this Agreement, “Cause” shall mean (a) Participant’s
willful or negligent failure to comply with the lawful directions of the Company; (b) gross negligence or willful misconduct in the performance of Participant’s duties to the Company, (c) commission of any act of fraud against the
Company that results in an injury to the Company other than a de minimus injury to the Company, or (d) misappropriation of material property of the Company to the material detriment of the Company.
For purposes of this Agreement, “Good Reason” means the occurrence of one or more of the following, without Participant’s
consent (a) the failure of the Company to pay or cause to be paid to Participant his or her annual salary or any other earned compensation when due; (b) the substantial reduction of Participant’s annual salary; (c) a material
diminution in Participant’s authority, responsibilities, or duties; (d) relocation of Participant’s primary work place for the Company to a location more than thirty-five (35) miles from its current location; provided that such
events shall constitute Good Reason only if the Company fails to cure such event within a reasonable period of time (not to exceed fifteen (15) business days) after receipt from Participant of written notice of the event constituting Good
Reason; provided, further, that “Good Reason” shall cease to exist for an event on the 90th day following its occurrence, unless Participant have given the Company written notice thereof prior to such date.
Except as may be provided in the Restricted Stock Unit Agreement, Participant will not vest in the Restricted Stock Unit unless he or she
is a Service Provider through the applicable vesting date(s). Important additional information on vesting and forfeiture of the Restricted Stock Unit covered by this grant is contained in the attached Restricted Stock Unit Agreement; please be sure
to read the entire agreement.
The Restricted Stock Units evidenced by this Notice of Grant is part of and subject in all
respects to the terms and conditions of the Plan (a copy of which has been made available to you by the Company) and the attached Restricted Stock Unit Agreement (together with this Notice of Grant, the “Agreement”).
By the Participant’s acceptance, the Participant represents that he or she is familiar with the terms and provisions of the Plan,
and hereby accepts this Agreement subject to all of the terms and provisions thereof. The Participant has reviewed the Plan and this Agreement in their entirety, has had an opportunity to obtain the advice of counsel prior to executing this
Agreement and fully understands all provisions of this Agreement. The Participant agrees to accept as binding, conclusive and final all decisions or interpretations of the Administrator upon any questions arising under the Plan and or this
Agreement. The Participant further agrees to notify the Company upon any change in the residence indicated above.
Important Note:
If the Participant fails to make satisfactory arrangements in accordance with Section 7 of this
Agreement for the payment of any Tax-Related Items (as defined below) at the time any applicable Shares otherwise are scheduled to vest or tax withholdings are otherwise due with respect to the Restricted Stock Units or the Shares issuable
thereunder, the Participant will permanently forfeit such Shares and the Shares will be returned to the Plan at no cost to the Company.
-2-
|
|
|
|
|
|
|
|
|
PARTICIPANT
|
|
|
|
DRUGSTORE.COM, INC.
|
|
|
|
|
|
|
/s/ Dawn G. Lepore
|
|
|
|
By
|
|
/s/ Yukio Morikubo
|
|
Signature
|
|
|
|
|
|
|
|
|
|
|
|
|
Dawn G. Lepore
|
|
|
|
Title
|
|
VP, Strategy, General Counsel & Secretary
|
|
Print Name
|
|
|
|
|
|
|
-3-
EXHIBIT A
TERMS AND CONDITIONS OF THE RESTRICTED STOCK UNITS
1.
Grant
. The Company hereby grants to the individual named in the Notice of Grant (the “
Participant
”) under the Plan the number of Restricted Stock Units indicated in the Notice
of Grant, subject to all of the terms and conditions in this Agreement and the Plan, which is incorporated herein by reference. Subject to Section 19(c) of the Plan, in the event of a conflict between the terms and conditions of the Plan and
the terms and conditions of this Agreement, the terms and conditions of the Plan will prevail.
2.
Company’s
Obligation to Pay
. Each Restricted Stock Unit represents the right to receive a Share on the date it vests. Unless and until the Restricted Stock Units will have vested in the manner set forth in Sections 3 or 4, the Participant will have
no right to payment of any such Restricted Stock Units. Prior to actual payment of any vested Restricted Stock Units, such Restricted Stock Units will represent an unsecured obligation of the Company, payable (if at all) only from the general assets
of the Company. Any Restricted Stock Units that vest in accordance with Sections 3 or 4 will be paid to the Participant (or in the event of the Participant’s death, to his or her estate) in whole Shares, subject to the Participant satisfying
any applicable tax withholding obligations as set forth in Section 7. Subject to the provisions of Section 4, such vested Restricted Stock Units will be paid in Shares upon or as soon as practicable after vesting (but in each such case
within the period ending no later than sixty (60) days following the vesting date). In no event will the Participant be permitted, directly or indirectly, to specify the taxable year of payment of any Restricted Stock Units payable under this
Agreement. No fractional Shares will be issued under this Agreement.
3.
Vesting Schedule
. Except as provided in
Section 4, and subject to Section 5, the Restricted Stock Units awarded by this Agreement will vest in accordance with the vesting provisions set forth in the Notice of Grant. Restricted Stock Units scheduled to vest on a certain date or
upon the occurrence of a certain condition will not vest in the Participant in accordance with any of the provisions of this Agreement, unless the Participant will have been continuously a Service Provider from the Date of Grant until the date such
vesting occurs.
4.
Administrator Discretion
.
(a) The Administrator, in its discretion, may accelerate the vesting of the balance, or some lesser portion of the balance, of the unvested Restricted Stock Units at any time, subject to the terms of the
Plan. If so accelerated, such Restricted Stock Units will be considered as having vested as of the date specified by the Administrator.
(b)
Acceleration
.
(i) If the Administrator, in its discretion, accelerates
the vesting of the balance, or some lesser portion of the balance, of the Award of Restricted Stock Units, subject to the provisions of this paragraph 4 , paragraph 5 and paragraph 7, the payment of such accelerated portion of the
Award shall be made as soon as practicable after the new vesting date; provided,
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however, if the Restricted Stock Units are “deferred compensation” within the meaning of “Section 409A” (as defined below), the payment of such accelerated Restricted Stock
Units nevertheless shall be made at the same time or times as if such Restricted Stock Units had vested in accordance with the vesting schedule set forth in paragraph 3, including any necessary application of the six-month delay provided for in
paragraph 4(c) (whether or not the Participant remains employed by the Company or a Parent or Subsidiary of the Company as of such date(s)), unless an earlier payment date, in the judgment of the Administrator, would not cause the Participant
to incur an additional tax under Section 409A, in which case, payment of such accelerated Award shall be as soon as administratively practicable upon or following the earliest permissible payment date that would not cause the Participant to
incur an additional tax under Section 409A, subject to paragraph 5(c) with respect to specified employees. Notwithstanding the foregoing, any delay in payment pursuant to this paragraph 3(c) will cease upon the Participant’s death and such
payment will be made as soon as practicable after the date of Participant’s death. In no event will the Participant be permitted, directly or indirectly, to specify the taxable year of payment of any Restricted Stock Units payable under this
Agreement. For purposes of this Agreement, “Section 409A” means Section 409A of the Internal Revenue Code of 1986, as amended, and any proposed, temporary or final Treasury Regulations and Internal Revenue Service guidance thereunder,
as each may be amended from time to time, as well as any applicable state law equivalent.
(ii) Notwithstanding anything in
the Plan or this Agreement to the contrary, if the vesting of all or a portion of the Restricted Stock Units accelerate pursuant to any plan, agreement, resolutions or arrangement that provides for acceleration in the event of a change in control
that is not a “change in control” within the meaning of Section 409A, then the payment of such accelerated portion of the Restricted Stock Units (including any new or additional awards existing as a result of Section 14 of the
Plan) will be made in accordance with the timing of payment rules that apply to discretionary accelerations under paragraph 4(b)(i) (with the general payment timing rule or payment rules relating to “deferred compensation” Restricted
Stock Units applying as appropriate). If the vesting of all or a portion of the Restricted Stock Units accelerates in the event of a change in control that is a “change in control” within the meaning of Section 409A, then the payment
of such accelerated Restricted Stock Units (including any new or additional awards existing as a result of Section 14 of the Plan) will be made within sixty (60) days following the change in control event.
(c) Notwithstanding anything in the Plan or this Agreement to the contrary, if the vesting of the balance, or some lesser portion of the
balance, of the Restricted Stock Units is accelerated in connection with the Participant’s termination as a Service Provider, such accelerated Restricted Stock Units will not be payable until and unless the Participant has a “separation
from service” within the meaning of Section 409A if the Restricted Stock Units are “deferred compensation” within the meaning of Section 409A or would be exempt from Section 409A pursuant to Treasury Regulation
Section 1.409A-1(b)(9). Further, and notwithstanding anything in the Plan or this Agreement to the contrary, if any such accelerated Restricted Stock Units would otherwise become payable upon a “separation from service” within the
meaning of Section 409A, and if (x) the Participant is a “specified employee” within the meaning of Section 409A at the time of such “separation from service” within the meaning of Section 409A (other than due
to the Participant’s death) and (y) the payment of all or a portion of
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such accelerated Restricted Stock Units would result in the imposition of additional tax under Section 409A if paid to the Participant on or within the six (6) month period following
the Participant’s “separation from service” within the meaning of Section 409A, then the payment of the portion of such accelerated Restricted Stock Units that would result in the additional tax imposition will not be made until
the date six (6) months and one (1) day following the date of the Participant’s “separation from service” within the meaning of Section 409A, unless the Participant dies following his or her termination as a Service
Provider, in which case the Restricted Stock Units will be paid in Shares to the Participant’s estate as soon as practicable following his or her death.
(d) It is the intent of this Agreement to be exempt from or comply with the requirements of Section 409A so that none of the Restricted Stock Units provided under this Agreement or Shares issuable
thereunder will be subject to the additional tax imposed under Section 409A, and any ambiguities or ambiguous terms herein and in the Plan will be interpreted to be exempt or to so comply. Each payment and benefit payable under this Agreement
is intended to constitute a separate payment for purposes of Section 1.409A-2(b)(2) of the Treasury Regulations.
5.
Forfeiture upon Termination of Status as a Service Provider
. Notwithstanding any contrary provision of this Agreement, the balance of the Restricted Stock Units that have not vested as of the time of the Participant’s termination as a
Service Provider for any or no reason will be forfeited and automatically transferred to and reacquired by the Company at no cost to the Company and the Participant’s right to acquire any Shares hereunder will immediately terminate.
6.
Death of the Participant
. Any distribution or delivery to be made to the Participant under this Agreement will, if the
Participant is then deceased, be made to the Participant’s designated beneficiary, or if no beneficiary survives the Participant, the administrator or executor of the Participant’s estate. Any such transferee must furnish the Company with
(a) written notice of his or her status as transferee, and (b) evidence satisfactory to the Company to establish the validity of the transfer and compliance with any laws or regulations pertaining to said transfer.
7.
Withholding of Taxes
. Until and unless the Administrator determines otherwise, if, on the date Participant incurs a liability
for Tax-Related Items (as defined below), Participant is an employee of the Company or its Affiliate who is subject to Section 16 of the Exchange Act (a “Section 16 Officer”), then the Company (or the employing or retaining Parent or
Subsidiary), will withhold from the number of Shares otherwise issuable under this Award of Restricted Stock Units a number of Shares sufficient to pay such Tax-Related Items; provided, however, that the Shares to be withheld must have vested
pursuant to the terms of this Agreement and the Plan. The Company shall not retain fractional Shares to satisfy any portion of the Tax-Related Items. Accordingly, if any withholding is done through the withholding of Shares, Participant shall pay to
the Company an amount in cash sufficient to satisfy the remaining Tax-Related Items due and payable as a result of the Company not retaining fractional Shares. Should the Company be unable to procure such cash amounts from Participant, Participant
agrees and acknowledges that Participant is giving the Company permission to withhold from Participant’s paycheck(s) an amount equal to the remaining Tax-Related Items due and payable as a result of the Company not retaining fractional Shares.
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For this purpose, “Tax-Related Items” means the minimum statutorily required
income tax, social insurance, payroll tax, payment on account, employment or other tax-related withholding which the Company determines must be withheld or collected with respect to the Shares subject to this Award (the “Tax-Related
Items”).
Until and unless the Administrator determines otherwise, if, on the date Participant incurs a liability for
Tax-Related Items, Participant is not a Section 16 Officer, then the Participant shall pay by “Sell-to-Cover” (as defined below) such Tax-Related Items. By virtue of his or her execution of this Agreement, the Participant hereby
expressly consents to pay by Sell-to-Cover any Tax-Related Items which the Company determines must be withheld or collected with respect to such Restricted Stock Units. In addition, the Participant hereby expressly confers on the Company a power of
attorney to irrevocably instruct a broker to assign to the Company the proceeds of the sale of that number of shares of Stock necessary to pay any Tax-Related Items which the Company determines must be withheld or collected with respect to the
Restricted Stock Units.
In addition, the Administrator, in its sole discretion and pursuant to such procedures as it may
specify from time to time, may require the Participant to satisfy such tax withholding obligations with respect to the Tax-Related Items, in whole or in part by one or more of the following: (a) paying cash, (b) having the Company withhold
otherwise deliverable Shares having a value equal to the minimum amount statutorily required to be withheld, (c) delivering to the Company already vested and owned Shares having a value equal to the amount required to be withheld,
(d) selling a sufficient number of such Shares otherwise deliverable to the Participant through such means as the Administrator may determine in its sole discretion (whether through a broker or otherwise) equal to the amount required to be
withheld, (e) requiring Participant to make appropriate arrangements with the Company (or the Parent or Subsidiary employing or retaining Participant) for the satisfaction of all Tax-Related Items, or (f) a combination of the foregoing.
Notwithstanding any contrary provision of this Agreement, no Shares shall be distributed to the Participant unless and until all Tax-Related Items have been satisfied with respect to such Shares or satisfactory arrangements (as determined by the
Administrator) will have been made by Participant for the satisfaction of all Tax-Related Items. If the Participant fails to make satisfactory arrangements for the payment of any Tax-Related Items at the time any applicable Shares otherwise are
scheduled to vest or tax withholdings are otherwise due with respect to the Restricted Stock Units or the Shares issuable thereunder, the Participant will permanently forfeit such Shares and the Shares will be returned to the Plan at no cost to the
Company.
Regardless of any action taken by the Company or Participant’s employer (the “Employer”) with respect
to the Tax-Related Items, Participant acknowledges that the ultimate liability for all Tax-Related Items legally due by Participant is and remains Participant’s responsibility and that the Company and/or the Employer (i) make no
representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the Award of Restricted Stock Units, including the grant, vesting, assignment, release or
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cancellation of the Shares of Restricted Stock Units, the subsequent sale of Shares acquired pursuant to the vesting of Restricted Stock Units, or the receipt of any dividends and (ii) do
not commit to structure the terms of the grant or any other aspect of the Award of Restricted Stock Units to reduce or eliminate Participant’s liability for Tax-Related Items.
For this purpose, a “Sell-to-Cover” means the automatic sale of a portion of the Shares issued upon the vesting of such
Restricted Stock Units to the extent and through delivery by the Company of irrevocable instructions to a broker (or through such other means as the Company may determine in its sole discretion), such that the Company is assigned the proceeds of the
sale of that number of Shares necessary to pay any Tax-Related Items which the Company determines must be withheld or collected with respect to the Restricted Stock Units. The net proceeds from such sale shall be remitted to the relevant tax
authorities for the benefit of the Participant in the amounts directed by the Company and any remaining net proceeds, if any, shall be delivered to the Participant.
8.
Rights as Stockholder
. Neither the Participant nor any person claiming under or through the Participant will have any of the rights or privileges of a stockholder of the Company in respect of
any Shares deliverable hereunder unless and until certificates representing such Shares will have been issued, recorded on the records of the Company or its transfer agents or registrars, and delivered to the Participant. After such issuance,
recordation and delivery, the Participant will have all the rights of a stockholder of the Company with respect to voting such Shares and receipt of dividends and distributions on such Shares.
9.
No Guarantee of Continued Service
. THE PARTICIPANT ACKNOWLEDGES AND AGREES THAT THE VESTING OF THE RESTRICTED STOCK UNITS
PURSUANT TO THE VESTING SCHEDULE HEREOF IS EARNED ONLY BY CONTINUING AS A SERVICE PROVIDER AT THE WILL OF THE COMPANY (OR THE PARENT OR SUBSIDIARY EMPLOYING OR RETAINING THE PARTICIPANT) AND NOT THROUGH THE ACT OF BEING HIRED, BEING GRANTED THIS
AWARD OF RESTRICTED STOCK UNITS OR ACQUIRING SHARES HEREUNDER. THE PARTICIPANT FURTHER ACKNOWLEDGES AND AGREES THAT THIS AGREEMENT, THE TRANSACTIONS CONTEMPLATED HEREUNDER AND THE VESTING SCHEDULE SET FORTH HEREIN DO NOT CONSTITUTE AN EXPRESS OR
IMPLIED PROMISE OF CONTINUED ENGAGEMENT AS A SERVICE PROVIDER FOR THE VESTING PERIOD, FOR ANY PERIOD, OR AT ALL, AND WILL NOT INTERFERE IN ANY WAY WITH THE PARTICIPANT’S RIGHT OR THE RIGHT OF THE COMPANY (OR THE PARENT OR SUBSIDIARY EMPLOYING
OR RETAINING THE PARTICIPANT) TO TERMINATE THE PARTICIPANT’S RELATIONSHIP AS A SERVICE PROVIDER AT ANY TIME, WITH OR WITHOUT CAUSE.
10.
Address for Notices
. Any notice to be given to the Company under the terms of this Agreement will be addressed to the Company, in care of in care of its General Counsel at drugstore.com, inc.,
411 108th Avenue, Suite 1400, Bellevue, Washington 98004, or at such other address as the Company may hereafter designate in writing.
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11.
Grant is Not Transferable
. Except to the limited extent provided in
Section 6, this grant and the rights and privileges conferred hereby will not be transferred, assigned, pledged or hypothecated in any way (whether by operation of law or otherwise) and will not be subject to sale under execution, attachment or
similar process. Upon any attempt to transfer, assign, pledge, hypothecate or otherwise dispose of this grant, or any right or privilege conferred hereby, or upon any attempted sale under any execution, attachment or similar process, this grant and
the rights and privileges conferred hereby immediately will become null and void.
12.
Binding Agreement
. Subject to
the limitation on the transferability of this grant contained herein, this Agreement will be binding upon and inure to the benefit of the heirs, legatees, legal representatives, successors and assigns of the parties hereto.
13.
Additional Conditions to Issuance of Stock
. If at any time the Company will determine, in its discretion, that the listing,
registration or qualification of the Shares upon any securities exchange or under any state or federal law or law of another jurisdiction, Company stockholder approval requirements under applicable law or securities exchange requirements, or the
consent or approval of any governmental regulatory authority or any securities exchange is necessary or desirable as a condition to the issuance of Shares to the Participant (or his or her estate), the issuance of such Shares will not occur prior to
fulfillment of all the following conditions: (a) the admission of such Shares to listing on all securities exchanges on which such class of stock is then listed; (b) the completion of any registration or other qualification of such Shares
under any state or federal law or under the rulings or regulations of the Securities and Exchange Commission, any other governmental regulatory body or any securities exchange on which such class of stock is then listed, which the Administrator
will, in its absolute discretion, deem necessary or advisable; (c) the approval of the Plan and/or the Award pursuant to Company stockholder approval requirements under applicable law or securities exchange requirements; or (d) the
obtaining of any approval or other clearance from any state or federal governmental agency or the securities exchanges on which such class of stock is then listed, which the Administrator will, in its absolute discretion, determine to be necessary
or advisable. Where the Company determines that the delivery of the payment of any Shares will violate federal securities laws, other applicable laws or the requirements of any securities exchange on which such class of Shares is then listed, the
Company will defer delivery until the earliest date at which the Company reasonably anticipates that the delivery of Shares will no longer cause such violation. The Company will make all reasonable efforts to meet the requirements of any such state
or federal law or securities exchange and to obtain any such consent or approval of any such governmental authority.
14.
Restrictions on Sale of Securities
. Any sale of the Shares issued as payment for vested Restricted Stock Units awarded under this Agreement must comply with the Company’s insider trading policies (including any applicable market
black-out periods) and other policies as in effect from time to time, as well as all applicable law.
15.
Plan Governs
.
This Agreement is subject to all terms and provisions of the Plan. In the event of a conflict between one or more provisions of this Agreement and one or more provisions of the Plan, the provisions of the Plan will govern. Capitalized terms used and
not defined in this Agreement will have the meaning set forth in the Plan.
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16.
Administrator Authority
. The Administrator will have the power to interpret the
Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Plan as are consistent therewith and to interpret or revoke any such rules (including, but not limited to, the determination of whether or
not any Restricted Stock Units have vested). All actions taken and all interpretations and determinations made by the Administrator in good faith will be final and binding upon the Participant, the Company and all other interested persons. No member
of the Administrator will be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or this Agreement.
17.
Electronic Delivery
. The Company may, in its sole discretion, decide to deliver any documents related to Restricted Stock Units awarded under the Plan or future Restricted Stock Units that may
be awarded under the Plan by electronic means or request the Participant’s consent to participate in the Plan by electronic means. The Participant hereby consents to receive such documents by electronic delivery and agrees to participate in the
Plan through any on-line or electronic system established and maintained by the Company or another third party designated by the Company.
18.
Captions
. Captions provided herein are for convenience only and are not to serve as a basis for interpretation or construction of this Agreement.
19.
Agreement Severable
. In the event that any provision in this Agreement will be held invalid or unenforceable, such provision
will be severable from, and such invalidity or unenforceability will not be construed to have any effect on, the remaining provisions of this Agreement.
20.
Modifications to the Agreement
. This Agreement constitutes the entire understanding of the parties on the subjects covered. The Participant expressly warrants that he or she is not accepting
this Agreement in reliance on any promises, representations, or inducements other than those contained herein. Modifications to this Agreement or the Plan can be made only in an express written contract executed by a duly authorized officer of the
Company. Notwithstanding anything to the contrary in the Plan or this Agreement, the Company reserves the right to revise this Agreement as it deems necessary or advisable, in its sole discretion and without the consent of the Participant, to comply
with Section 409A or to otherwise avoid imposition of any additional tax or income recognition under Section 409A in connection to this Award of Restricted Stock Units.
21.
Amendment, Suspension or Termination of the Plan
. By accepting this Award, the Participant expressly warrants that he or she
has received an Award of Restricted Stock Units under the Plan, and has received, read and understood a description of the Plan. The Participant understands that the Plan is discretionary in nature and may be amended, suspended or terminated by the
Company at any time.
22.
Governing Law
. This Award Agreement will be governed by the laws of the State of Washington,
without giving effect to the conflict of law principles thereof. For purposes of litigating any dispute that arises under this Award of Restricted Stock Units or this Award
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Agreement, the parties hereby submit to and consent to the jurisdiction of the State of Washington, and agree that such litigation will be conducted in the courts of King County, Washington, or
the federal courts for the United States for the Western District of Washington, and no other courts, where this Award of Restricted Stock Units is made and/or to be performed..
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Exhibit 10.12
SECOND AMENDMENT TO LEASE AGREEMENT
THIS SECOND AMENDMENT
(“Second Amendment”) is made this
1
day of December, 2009, by and between
LIBERTY VENTURE I, LP,
a Delaware limited partnership (“Landlord”), and
DS DISTRIBUTION, INC.,
a Delaware corporation
(“Tenant”).
BACKGROUND
:
A. Landlord’s predecessor, The Northwestern Mutual Life Insurance Company, and Tenant entered into a Lease Agreement dated
August 30, 1999 (the “Original Lease”), as amended by First Amendment to Lease Agreement dated December 10, 2003 (the “First Amendment” and, together with the Original Lease, collectively, the “Lease”),
covering premises containing approximately 270,378 rentable square feet at 407 Heron Drive, Bridgeport, New Jersey, as more fully described in the Lease (the “Premises”).
B. Tenant and Landlord desire to extend the term of the Lease and modify the Lease in certain respects pursuant to the provisions of this
Second Amendment.
NOW, THEREFORE,
the parties hereto, in consideration of the mutual promises and covenants contained
herein and in the Lease, and intending to be legally bound hereby, agree that the Lease is amended as follows:
1. All
capitalized terms used herein and not otherwise defined herein shall have the meanings ascribed to them in the Lease.
2.
Section 1.6 of the Lease, entitled “
Term
”, is amended and restated in its entirety as follows:
“For the period expiring on December 31, 2020, with two (2) options to renew for an additional period of five
(5) years each.”
3. Effective on January 1, 2010, Section 1.9 of the Lease, entitled “
Base
Rent
”, is deleted and the following schedule of Base Rent is substituted therefor:
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Period
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Per
Square
Foot
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Annual Base Rent
|
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Monthly Installment
|
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|
1/1/10-12/31/10
|
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$
|
3.50
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$
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946,323.00
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$
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78,860.25
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1/1/11-12/31/11
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$
|
3.35
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$
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905,766.30
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$
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75,480.53
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1/1/12-12/31/12
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$
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3.45
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$
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932,804.10
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$
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77,733.68
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1/1/13-12/31/13
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$
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3.55
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$
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959,841.90
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$
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79,986.83
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1/1/14-12/31/14
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$
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3.95
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$
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1,067,993.10
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$
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88,999.43
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1/1/15-12/31/15
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$
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4.05
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$
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1,095,030.90
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$
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91,252.58
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1/1/16-12/31/16
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$
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4.15
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$
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1,122,068.70
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$
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93,505.73
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1/1/17-12/31/17
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$
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4.25
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$
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1,149,106.50
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$
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95,758.88
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1/1/18-12/31/18
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$
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4.35
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$
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1,176,144.30
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$
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98,012.03
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1/1/19-12/31/19
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$
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4.45
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$
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1,203,182.10
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$
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100,265.18
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1/1/20-12/31/20
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$
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4.55
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$
|
1,230,219.90
|
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$
|
102,518.33
|
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4. (a) The Premises is currently occupied by Tenant, and, subject to the provisions of the
Lease, Tenant has accepted same in its “as is” “where is” condition and Landlord shall have no obligations whatsoever to improve the Premises for Tenant’s use and occupancy, except as set forth in subsection (b) of this
Section 4.
(b) Landlord shall install a new HVAC system in the warehouse portion of the Premises (the “HVAC Tenant
Improvement”) in accordance with plans or a description of improvements to be mutually agreed upon by Landlord and Tenant in writing. Promptly after Landlord and Tenant have finalized the plans and specifications for the HVAC Tenant
Improvement, Landlord shall solicit competitive bids for all labor and materials to complete the HVAC Tenant Improvement and Tenant shall have the right to include one subcontractor per trade on the bidding list and shall have a right to examine all
solicited bids. Such bidding process shall not exceed fifteen (15) business days. Landlord shall cooperate with Tenant to develop a schedule of construction for the HVAC Tenant Improvement, which may include times for obtaining materials and
times for performance of the work after delivery of such materials. Tenant shall have the right to revise the plans and specifications in order to adjust or accelerate such work schedule, if possible. Landlord shall work with Tenant to hire the
contractor with no construction management fee. The HVAC Tenant Improvement shall be performed in a good and workmanlike manner and shall comply at the time of completion with all applicable laws of the governmental authorities having jurisdiction.
(c) Landlord agrees to complete the HVAC Tenant Improvement, at Tenant’s sole cost and expense, equal to the aggregate
of all costs, expenses and fees incurred by or on behalf of Landlord in connection therewith (the “Tenant’s Cost”), including, without limitation, (i) architectural, engineering and design costs, (ii) the cost charged to
Landlord by Landlord’s general contractor and all subcontractors for performing the HVAC Tenant Improvement, and (iii) the cost to Landlord of performing directly any portion of the HVAC Tenant Improvement; provided, however, that no
construction management fee shall be charged by Landlord. Landlord agrees to credit Tenant with an allowance (the “HVAC Tenant Allowance”) equal to the lesser of the Tenant’s Cost or $250,000.00. Payments will be made directly to
Landlord’s contractor and all subcontractors performing the HVAC Tenant Improvement only after Tenant has given approval of the work, such approval not to be unreasonably withheld, conditioned or delayed. Tenant agrees to pay to Landlord,
within 10 days of being billed therefor, the excess (if any) of the Tenant’s Cost above the HVAC Tenant Allowance. In the event the Tenant’s Cost is less than $250,000.00, and provided Tenant is not then in default under the Lease, within
thirty (30) days after Tenant’s written request, Landlord shall reimburse Tenant, to the extent of the unused portion of such $250,000.00, for the bona fide, documented, out of pocket, actual costs incurred by Tenant for alterations made
to the Premises by Tenant between the date of this Second Amendment and June 30, 2011 pursuant to the provisions of Section 15 of the Lease for which Landlord shall not charge Tenant a construction management fee.
2
(d) The provisions of Subsections 14(A)(2)(d), (e) and (g) and 14(A)(3) of the
Lease shall apply to the HVAC Tenant Improvement.
5. Section 3 of the Lease, entitled “
Term and Commencement of
Lease
”, is amended as follows:
(a) The introductory paragraph of Section 3.1 of the Lease, entitled
“
Renewal of Term
”, is deleted and restated in its entirety as follows:
“Tenant shall have the option to
renew the Term of the Lease for two (2) additional terms of five (5) years each with twelve (12) months prior written notice (each a “Renewal Term,” which if exercised shall be deemed part of the Term), and subject to the
following provisions:”.
(b) Subsection 3.1(a) of the Lease is deleted and restated in its entirety as follows:
“In order to exercise either option to renew the Lease, Tenant must give Landlord written notice of its election to renew
not later than 365 days before the expiration of the then-current Term. All terms of the Lease shall remain in full force and effect for the Renewal Term, except that the Base Rent applicable during the Renewal Term shall be the greater of
(i) the Base Rent payable at the expiration of the immediately preceding Term of the Lease, or (ii) Fair Market Value. Fair Market Value shall mean the then prevailing market rate of rent and all other charges for comparable space for a
new tenant not yet in occupancy which receives no allowances for improvements above a base building shell, and reflecting such conditions as Tenant’s use of the Premises, location of the Building, size of rental area, condition of the Premises
and the time the particular rate under consideration become effective. However, in no event shall the Fair Market Value be deemed to be less than the Base Rent payable at the expiration of the immediately preceding Term of the Lease. If Tenant
exercises either option in accordance with the foregoing, then, unless Landlord accepts as Tenant’s Base Rent obligation for each Lease Year of the Renewal Term an amount equal to the Base Rent payable at the expiration of the immediately
preceding Term of the Lease, Landlord shall notify Tenant in writing, within fifteen (15) days after receiving the notice of exercise of the applicable option, of the market rate of rent to apply during the applicable Renewal Term.”
(c) Subsection 3.1(c) of the Lease is deleted in its entirety.
(d) A new Section 3.2, entitled “
Early Termination
,” is added to the Lease as follows:
3
“3.2
Early Termination
.
Provided that Landlord has not given Tenant notice of default more than two (2) times, that there then exists no Event of Default by
Tenant under the Lease, nor any event that with the giving of notice and/or the passage of time would constitute an Event of Default, and that Tenant is the sole occupant of the Premises, Tenant shall have the right and option, exercisable by giving
Landlord prior written notice thereof not later than December 31, 2016, to terminate this Lease on December 31, 2017 (the “Early Termination Date”) and by paying Landlord at the time of giving notice an amount (the
“Termination Fee”) equal to the sum of (a) $500,000.00, plus (b) the unamortized portion of “Lease Transaction Costs” (as hereinafter defined). For purposes hereof, “Lease Transaction Costs” shall mean the sum
of (i) the Tenant Allowance, (ii) brokers commissions incurred by Landlord in connection with this Second Amendment, and (iii) $162,226.80 (representing the savings in Base Rent for 2010 effectuated by this Second Amendment),
amortized over 10 years (commencing January 1, 2011) at an interest rate of 10% per annum. Tenant shall pay all Rent under the Lease and abide by all of the terms and conditions of the Lease through and including the Early Termination
Date. Notwithstanding the foregoing, in the event that Tenant exercises this option to terminate because the size of the Premises is not adequate for the conduct of its business and Liberty Venture I, LP enters into a lease with Tenant for more
space than the Premises in any building owned by Liberty Venture I, LP, no Termination Fee shall be payable by Tenant in connection with such termination of the Lease. It is expressly agreed and understood that the immediately preceding
sentence shall be of no further force or effect if, as and when Liberty Venture I, LP sells the Premises and shall not be binding upon future owners of the Premises.”
Landlord’s approval:
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/s/
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/s/
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Regional Director
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City Manager
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6. Tenant shall not
be required to increase the amount of the Security Deposit held by Landlord pursuant to Section 4.2 of the Lease in connection with the extension of the Term pursuant to this Second Amendment or any Renewal Term exercised by Tenant pursuant to
Section 3.1(a) of the Lease, as amended by this Second Amendment.
7. Section 4.3 of the Lease, entitled
“
Additional Rent
”, is amended as follows:
(a) Subsection (a) is amended by adding at the end thereof:
“Tenant shall have the right, at its own cost and expense, to initiate and prosecute any proceeding permitted by law for
the purpose of obtaining abatement or reduction of any real estate taxes assessed against the Lot and the Premises. Landlord, at no cost to Landlord, shall cooperate with Tenant as Tenant may reasonably require in connection with such proceedings,
including, without limitation, providing Tenant with any relevant information pertaining to the cost of any work performed by Landlord at the Lot or the Premises. In the event that Landlord receives any written notice from the tax assessor of Logan
Township with respect to the Lot or the Premises, Landlord agrees to promptly forward a copy thereof to Tenant. To the extent that
4
Tenant is successful in obtaining any abatement or reduction through such proceedings, and Landlord receives a refund of taxes previously paid by Tenant, Landlord shall credit to Tenant the
Proportionate Share of such refund as part of the reconciliation of Operating Costs for the year in which such refund is received. Unless otherwise provided for above, Tenant shall pursue all real property tax refund claims directly.”
(b) Subsection (b)(6) is deleted in its entirety and the following is substituted therefor:
“(6) all property management fees (Tenant’s Proportionate Share of which shall not exceed four percent (4%) of Base Rent)
and expenses”.
8. Section 31 of the Lease, entitled “
Holding Over
”, is amended
by deleting the first (1
st
) sentence and substituting
the following therefor:
“In the event of holding over by Tenant after the expiration or termination of this Lease, the
holdover shall be as a tenant at will and all of the terms and provisions of this Lease shall be applicable during that period, except that Tenant shall pay Landlord as rent for each of the first twelve (12) months of such holdover an amount
equal to 150% of the rent payable by Tenant in the month immediately preceding the holdover and thereafter during such holdover Tenant shall pay Landlord as rent for each month of such holdover an amount equal to 200% of the rent payable by Tenant
in the month immediately preceding the holdover.”
9. Section 32 of the Lease, entitled “
Rights of First
Mortgagee
”, is amended by adding at the end thereof:
“Upon Tenant’s request, Landlord shall request and
use commercially reasonable efforts to obtain a commercially reasonable non-disturbance agreement from all current and future mortgagees and ground lessees having superior rights with respect to the Lot and the Premises.”
10. Section 38 of the Lease, entitled “
Notice
”, as restated in Section 36 of the First Amendment, is amended
to provide for notices to Landlord to be sent to:
Liberty Venture I, LP
c/o Liberty Property Trust
901 Lincoln Drive West, Suite 100
Marlton, NJ 08053
Attn: Vice President, City Manager
Fax No.: (856) 797-7130
With a copy to:
Liberty Venture I, LP
c/o Liberty Property Trust
5
500 Chesterfield Parkway
Malvern, PA 19355
Attn: Real Estate Counsel
Fax No.: (610) 644-2175
11. Section 45 of the Lease, entitled “
Right of First Offer
”, is deleted in its entirety.
12. Section 16 of the First Amendment is deleted in its entirety.
13. Upon Tenant’s request, Landlord agrees to certify to any New Jersey state or local governmental authority providing or being
requested to provide tax incentives to Tenant that Tenant has the right, pursuant to Section 3.2 of the Lease, to terminate the Lease and, at its option, to relocate its operation to, or consolidate its operation with another operation in, a
facility outside of the State of New Jersey.
14. Upon Landlord’s receipt of written notice from Tenant that Tenant
requires more space for the operation of its business than the Premises provides, Landlord shall cooperate with Tenant to seek to identify an existing facility and/or land site within the portfolio of properties owned by Landlord in the Southern New
Jersey market area that could accommodate Tenant’s increased space needs and, if the parties agree on a facility or site, to cooperate with Tenant in pursuing a lease with respect thereto on mutually acceptable terms.
15. The parties agree that they have dealt with no brokers in connection with this Section Amendment, except for Studley, Inc.
(Broker”), whose commission shall be paid by Landlord pursuant to the terms and conditions contained in a separate agreement to be executed by Landlord and Broker. Each party agrees to indemnify and hold the other harmless from any and all
claims for commissions or fees in connection with the Premises and this Second Amendment from any other real estate brokers or agents with whom they may have dealt.
16. Tenant acknowledges and agrees that the Lease is in full force and effect and, to Tenant’s knowledge, Tenant has no claims or offsets against Base Rent and Additional Rent due or to become due
hereunder.
17. Except as expressly modified herein, the terms and conditions of the Lease shall remain unchanged and in full
force and effect.
18. This Second Amendment shall be binding upon and inure to the benefit of the parties and their
respective successors and permitted assigns.
6
IN WITNESS WHEREOF,
Landlord and Tenant have executed this Second Amendment as of the
day and year first above written.
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LANDLORD:
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LIBERTY VENTURE I, LP
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By:
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Liberty Venture I, LLC, Sole General Partner
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By:
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Liberty Property Limited Partnership, Sole Member
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By:
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Liberty Property Trust, Sole General Partner
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By:
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/s/
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Name: James J. Mazzarelli, Jr.
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Title: Senior Vice President,
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Regional Director
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TENANT:
DS DISTRIBUTION, INC.
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By:
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/s/
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Name: Dawn Lepore
Title: President, CEO and Chairman
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7
JOINDER OF GUARANTOR
The undersigned, Drugstore.Com, Inc., guarantor of Tenant’s obligations under the Lease pursuant to Guaranty of Lease dated as of
August 30, 1999 (the “Guaranty”), hereby (a) joins in and consents to the foregoing Second Amendment, (b) ratifies and confirms the Guaranty and agrees that the Guaranty remains in full force and effect with respect to the
Lease, as amended by the Second Amendment, and (c) agrees that it has no claim or offset against any sums due or to become due under the Guaranty.
IN WITNESS WHEREOF, the undersigned, intending to be legally bound, has executed this Joinder of Guarantor this
day of
, 2009.
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DRUGSTORE.COM, INC.
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By:
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Name:
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Title:
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Exhibit 10.13
L E A S E
BETWEEN:
CROMBIE DEVELOPMENTS LIMITED
(the “Landlord”)
AND
DS DISTRIBUTION CANADA LIMITED
(the “Tenant”)
CENTRE:
BARRINGTON TOWER, 1894 BARRINGTON ST., HALIFAX, NS
LEASE OF OFFICE SPACE
INDEX
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1.01
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Summary of Terms
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8.03
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Insurable Interest / Indemnity
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1.02
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Definitions
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8.04
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Waiver of Subrogation
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2.01
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Grant
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8.05
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Form of Policy
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2.02
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Covenants of Landlord & Tenant
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9.01
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Damage and Abatement
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3.01
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Acceptance of Premises
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9.02
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Destruction and Surrender
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4.01
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Minimum Rent
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9.03
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Limitation of Tenant’s Ability to Recover
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4.02
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Additional Rent
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10.01
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Remedies of the Landlord on Default by Tenant
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4.03
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Operating Costs
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and Provisions for Entry
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4.04
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Operating Costs –
Further Defined
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10.02
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Non-Waiver of Default
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4.05
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Payment - Operating Costs
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11.01
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Sale, Conveyance and Assignment
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4.06
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Services by the Landlord
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11.02
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Effect of Sales, Conveyance or Assignment
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4.07
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Prepaid Deposit
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11.03
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Subordination
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4.08
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Net Lease
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11.04
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Attornment
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4.09
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Interest on Arrears
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11.05
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Execution of Instruments
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5.01
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Property Taxes
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12.01
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Month-to-Month Tenancy
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5.02
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Business Taxes
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12.02
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Tenancy at Sufferance
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5.03
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Harmonized Sales Tax
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12.03
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General
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5.04
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Monthly Payment
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13.01
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Expropriation
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6.01
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Use
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13.02
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Relocation
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6.02
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Rent
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13.03
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Regulations Form Part of Agreement
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6.03
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Utilities - Tenant’s Costs
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13.04
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Further Regulations
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6.04
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Tubes, Ballasts
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13.05
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Entire Agreement
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6.05
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Repair and Maintenance
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13.06
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Interpretation
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6.06
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Nuisance
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13.07
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Loading and Delivering
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6.07
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Heavy Objects
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13.08
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Temporary Obstruction
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6.08
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Assignments
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13.09
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Right to Alter / Demolish
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6.09
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Compliance with Insurance
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13.10
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Merger
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6.10
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Compliance with Laws
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13.11
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Applicable Law
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6.11
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Signs
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13.12
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Binding Effect
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6.12
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Windows
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13.13
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Commissions
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6.13
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Blinds
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13.14
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Force Majeure
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6.14
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Additional Costs
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13.15
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Registration
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6.15
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Tenant’s Insurance
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13.16
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Limitation of Landlord’s Liability
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6.16
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Access and Maintenance
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13.17
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Limitation on Length of Term
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6.17
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Notice of Accident
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13.18
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Environment
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6.18
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Mechanics’ Liens
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13.19
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Recycling
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6.19
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Surrender
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13.20
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No Exclusive
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6.20
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Tenant’s Work
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13.21
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Shorter Statute of Limitations
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6.21
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Heat, Vent and/or Air-Conditioning Premises
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13.22
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No Presumption Against Drafter
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6.22
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Other Charges
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13.23
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Indemnifier**
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7.01
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Quiet Enjoyment
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14.01
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Notice
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7.02
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Landlord’s Insurance
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15.01
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Parking 18.01 Emergency Power
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7.03
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Heating and Air-Conditioning
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16.01
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Temporary Premises 19.01 Satellite
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7.04
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Electricity and Water
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17.01
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Non-Disturbance Agreement 20.01 Option to Terminate
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7.05
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Maintenance
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Schedule “A”
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Plan of Premises
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7.06
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Janitorial Service
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Schedule “A-1”
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Temporary Premises
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7.07
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Elevator Service
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Schedule “B”
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Plan of Building
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7.08
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Access To Tenant
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Schedule “C”
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Landlord’s Work and Tenant’s Work
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7.09
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Security
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Schedule “D”
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Tenant’s Proportionate Share for Taxes
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7.10
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Landlord’s Work
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Schedule “E”
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Tenant’s Proportionate Share for
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7.11
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Repairs
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Operating Costs
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7.12
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Right to Alter
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Schedule “F”
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Rules and Regulations
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7.13
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Lettering
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Schedule “G”
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Renewal
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8.01
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Landlord’s Liability
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Schedule “H”
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Leasehold Allowance
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8.02
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Tenant’s Liability
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** Deleted in its entirety
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- 2 -
LEASE OF OFFICE SPACE
PROPERTY: BARRINGTON TOWER
THIS LEASE DATED day of , 20
BETWEEN:
CROMBIE
DEVELOPMENTS LIMITED
a body corporate, the (“Landlord”)
AND
DS
DISTRIBUTION CANADA LIMITED
a body corporate, the (“Tenant”)
WITNESSETH THAT
in consideration of the rents, covenants and other agreements hereinafter contained, the parties hereto covenant
and agree as hereinafter set out.
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SUMMARY OF TERMS
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1.01
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In this Lease:
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(a) Area of Premises:
11,388
square feet more or less located
on the
11
th
floor of the Building as outlined on Schedule “A”,
annexed hereto (the “Premises”)
.
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(b) Term:
Five
(
5
) year(s) commencing on the
1st
day of
April,
20
11 (the “Commencement”)
and terminating on the
31st
day of
March
, 20
16
.
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(c) Minimum Rent Commencement:
1st
day of
April
, 20
11
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Additional Rent Commencement:
1st
day of
April
,
20
11
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(d) Minimum Rent:
Commencing April 1, 2011 and ending March 31, 2016 –
Twelve dollars and eighty-one cents ($12.81) per square foot per annum, plus HST.
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- 3 -
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(e)
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Deposit:
Fifteen thousand dollars and zero cents ($15,000.00) (the “Deposit”) to be held by the Landlord and applied to instalments of Minimum and Additional Rents
as they fall due under this Lease until the Deposit is exhausted.
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(f)
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Use: The Premises shall be used solely for the
use and occupation of a business office and for no other purpose
.
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(g)
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Trade Name:
drugstore.com
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(h)
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Schedules Attached:
A, A-1, B, C, D, E, F, G and H
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(i)
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Additional Clauses:
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PARKING
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15.01 Throughout the Term of the Lease, the Landlord shall provide to the Tenant or its employees with up to twelve (12) on-site parking stalls at the then current
monthly rate which is currently $143.50 per stall per month, plus H.S.T. Tenant must accept from Landlord all of the parking stalls to which it is entitled on or before twelve (12) months from the Commencement Date (March 31, 2012) or at that time
the Landlord shall relinquish the Tenant’s rights to any uncommitted stalls. The Tenant shall further have the right to relinquish any of its committed parking stalls at any time during the Term, upon thirty (30) days notice to the Landlord.
All parking at the Building shall be assignable to any approved assignee or subtenant of the Tenant. In the event the Tenant expands its Premises, the Landlord shall provide additional parking stalls at the then current monthly rate, based on the
ration of one (1) parking stall per 1,000 rentable square feet.
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TEMPORARY
PREMISES
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16.01 The Landlord, at no additional cost to the Tenant, agrees to provide
the Tenant the use of approximately 6,490 square feet of temporary premises on the 12
th
floor of the Building, as outlined in green on Schedule “A-1” annexed hereto, (the “Temporary
Premises”) during the months of November and December 2010 for the Tenant’s use while carrying out its Tenant’s Improvements to the Premises, subject to approval by Nova Scotia Power Incorporated. The Landlord shall provide the
Temporary Premises in as is condition and the Tenant agrees to maintain and return the Temporary Premises broom clean and in the same repair as when it was tendered to Tenant.
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NON-DISTURBANCE
AGREEMENT
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17.01 If the Tenant is not in default under the terms of this Lease, and upon the receipt of a written request from the Tenant, which request shall include a
$750.00 plus HST, non-refundable processing fee, the Landlord shall use reasonable efforts in attempting to obtain and deliver to the Tenant a Non-Disturbance Agreement in which the holder of such mortgage or other encumbrance agrees not
to disturb the Tenant’s right of possession of the Premises.
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- 4 -
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EMERGENCY
POWER
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18.01 The Landlord and the Tenant hereby covenant and agree that the Tenant shall have the right to install an uninterrupted power supply (UPS) and diesel generator with
associated aboveground fuel tank, outside the Building for emergency back-up power, at its sole cost and responsibility, subject to prior written approval by the Landlord of its specifications, such approval not to be commercially unreasonably
withheld. Location to be mutually agreed upon by both the Landlord and the Tenant, both acting commercially reasonable.
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Subject to availability and the Landlord’s commercially reasonable approval of the Tenant’s specifications, the Tenant shall have the right to connect to the
Building’s generator for emergency power at a commercially reasonable additional cost to be determined by the Landlord, based on load capacity.
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SATELLITE
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19.01 If appropriate space is available in the Centre, Tenant shall have the right to install, operate, maintain, repair, replace and remove a satellite dish or antenna (the
“Dish”) and all necessary related equipment at the Centre subject to the following terms, conditions and limitations: (i) the location of the Dish shall be on the roof of the Building containing the Premises or such other location at the
Centre as Landlord shall reasonably direct (so long as such location provides for clear reception and transmission of signals) and Tenant agrees that in the event Landlord expands or reconfigures the Centre so as to require the relocation of the
Dish, Tenant agrees to relocate same, as its sole cost and expense, to a new location at the Centre reasonably designated by Landlord (so long as such location provides for clear reception and transmission of signals); (ii) installation, operation,
maintenance, repair, replacement and removal of the Dish and related equipment, and any attendant costs and expense, shall be the sole responsibility of Tenant; (iii) if reasonably required by Landlord, Tenant shall screen the Dish by providing
fencing, screening material or landscaping reasonably satisfactory to Landlord; (iv) Tenant shall obtain the Landlord’s prior written approval, which shall not be unreasonably withheld, with regards to the plans and specifications of the Dish,
and any approval required by an regulatory body, either local or federal, having authority over the installation or operation of the Dish shall be delivered to the Landlord as evidence of same; (v) Tenants installation or operation of the Dish shall
not materially interfere with the operation or any other transmission or receiving device at the Centre present at the time of installation (Landlord shall similarly require other tenants and their Dishes to not so materially interfere with
Tenant’s Dish); (vi) Tenant shall give Landlord reasonable prior notice of the necessity to access the Dish for service, except in the case of an emergency; (vii) at the expiration or earlier termination of the Lease, Tenant shall, upon
Landlord’s request, remove the
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Dish and repair any and all damage caused by such removal; (viii) Tenant assumes all responsibility for any losses, damages, or injuries which may occur as a result of the
Dish except to the extent caused by the negligence or wilful misconduct of the Landlord, its agents, employees or contractors; (ix) the Tenant shall incur any costs associated with relocation or re-calibration of the Dish due to re-roofing, roof
maintenance purposes, or for any other reason, except if such cost is incurred as a result of Landlord’s negligence or wilful misconduct; and (x) rental rate shall be $300.00 plus HST per dish per month per annum.
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OPTION TO
TERMINATE
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20.10 The Landlord and the Tenant hereby covenant and agree that the Tenant shall have the one-time only right to terminate this Lease effective on March 31, 2014 upon
providing the Landlord with nine (9) months prior written notice (the “Option to Terminate”). In the event the Tenant does not exercise this right within the said time period, this Option shall become null and void. In the event the Tenant
shall exercise such early termination right, it shall pay to the Landlord on or before the termination date $118,158.43 plus HST.
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ARTICLE 1.02 DEFINITIONS
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1.02
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Definitions in this Lease:
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(a)
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“Article” means an article of this Lease.
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(b)
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“Building” means the structure (including parking structures, if any), improvements, facilities and amenities in which the Premises are located constructed on
the Lands as it exists on the Lands from time to time.
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(c)
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“Centre” means the Lands and Buildings as they may be respectively constituted by the Landlord from time to time all as more particularly set out in Schedule
“B”;
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(d)
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“Common Areas” means, on a floor occupied by more than one tenant, those areas which do not constitute Occupiable Space on such multiple occupancy floor, but
which would have been included in Occupiable Space if such floor was being fully occupied by one tenant.
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(e)
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“Premises” means that part of the Centre which the Tenant has agreed to rent from the Landlord and being that portion of the Building outlined in red on the
plan annexed hereto as Schedule “A” and described more fully in Article 1.01(a). The rentable area and usable area of the Premises have been calculated in accordance with the methods of measuring rentable area and usable area as described
in the Standard Method for Measuring Floor Area in Office Buildings, as promulgated by the Building Owners and Managers Association (BOMA) International, which may be changed or modified from time to time.
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(f)
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“Fiscal Period” or “Fiscal Year” shall mean such fiscal period as the Landlord shall adopt and communicate reasonably to Tenant for the purposes of
accounts for the Centre.
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(g)
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“Lands” mean the Lands of the Building described and/or outlined in blue on Schedule “B” annexed hereto and the driveways, sidewalks, public
areas, landscaped areas
,
parking lots and/or parking structures as required to achieve the parking ratios established by the Centre and shall also include such additional lands as the Landlord shall from time to time own, lease or otherwise
control and declare by commercially reasonable notice to the Tenant to have become constituted a part of the Lands and shall exclude such Lands as the Landlord shall declare by notice to the Tenant to have been excluded, and to have ceased to
constitute a part of the Lands.
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(h)
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“Lease” means this Lease and all Schedules hereby attached to this Lease, and every properly executed instrument which by its terms amends, modifies or
supplements this Lease, but shall exclude any offers to lease, letters of intent or letters of agreement previously executed prior to this Lease.
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(i)
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The first “Lease Year” means the period beginning on the date specified in Clause 1.01(b) and terminating on the first anniversary of the last day of the
month in which the Term begins
,
unless the Commencement of the Term is the first day of a month, in which event the first “Lease Year” terminates on the expiration of the period of twelve (12) months thereafter. Each subsequent
“Lease Year” commences on the first day following the expiration of the preceding Lease Year and terminates on the earlier of the expiration of twelve (12) months thereafter or on the termination of this Lease.
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(j)
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“Leasehold Improvements” means all fixtures, improvements, installations, alterations and additions from time to time made, constructed, erected or installed
in or to the Leased Premises, with the exception of trade fixtures; but notwithstanding such exception, Leasehold Improvements shall include, without limitation:
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(i) storefronts and doors, all partitions, however affixed, light fixtures, slatwall, and all carpeting and floor coverings affixed in any way to the Premises (with the exception of carpeting laid over
vinyl tile or finished floor and affixed so as to be readily removable without damage to such tile or floor); and
(ii) all or
any portion of any:
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b.
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sewage, sprinkler, mechanical and electrical equipment, machinery, installations and facilities, and
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c.
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equipment, machinery, installations and facilities for or in connection with the supply of Utilities or communications,
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wherever located, exclusively serving the Leased Premises.
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(k)
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“Occupiable Space” means:
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(i) with respect to a full floor occupied by one tenant, all area within the exterior walls calculated by measuring from and to the line of the outside surface of glass in exterior walls, with no
deductions for columns or projections, but excluding service areas on such floor;
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(ii) with respect to that part of a floor (being less than a full floor) occupied by any
tenant, all area measured from the line of the outside surface of glass and exterior walls to the outside surface of corridor walls and the centre line of other demising walls, with no deductions for columns or projections.
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(l)
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“Operating Costs” means amounts payable by the Tenant to the Landlord under Article 4.03 of this Lease.
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(m)
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“Property Tax” means amounts payable by the Tenant to the Landlord under Article 5.01 of this Lease.
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(n)
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“Rentable Space” means:
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(i) with respect to a full floor occupied by one tenant, Occupiable Space;
(ii)
with respect to that part of a floor (being less than a full floor) occupied by any tenant, Occupiable Space plus a proportion of all Common Areas on that floor and such proportion of Common Areas shall be a fraction of such Common Areas, the
numerator of which shall be the Occupiable Space of the Premises, and the denominator of which shall be the total Occupiable Space (whether actually tenanted or not) on such floor; provided that if the Landlord changes the size of Common Areas or
any part thereof pursuant to Clause 7.12 from that which previously existed then a reasonable change of the proportion of Common Areas for purposes of this definition, will be calculated and made.
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(o)
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“Schedules” means all Schedules listed in Article 1.01(h) which shall form a part of this Lease.
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(p)
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“Service Areas” means all elevator shafts, stairwells (excluding those within the Premises of a tenant which are restricted to the exclusive use of such
tenant) and those areas on floors within the Building to the extent that they contain or comprise mechanical areas, facilities and apparatus designed and used for the purpose of servicing the Centre, or portions of the Centre beyond the floor on
which they are actually located, and the enclosing walls of all of the foregoing.
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(q)
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“Term” means the period of time set out in Article 1.01(b).
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(r)
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Indemnification Obligations” means, in cases where one party (the “Indemnifying Party”) has agreed to indemnify the other (the “Indemnified
Party”) in any respect (an “Indemnified Claim”), the requirement:
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(a)
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Of the Indemnified Party to promptly notify the Indemnifying Party in writing of any occurrence of an Indemnified Claim; provided that no failure of the Indemnified
Party to so notify shall relieve the Indemnifying Party from the obligation to indemnify the Indemnified Party unless and to the extent the Indemnifying Party is actually prejudiced by such failure.
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(b)
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Of the Indemnified Party to accord the Indemnifying Party the opportunity to assume entire control for the defense, compromise or settlement of any such Indemnified
Claim through counsel of its choice and at its own expense; provided that no such compromise or settlement shall include any non-monetary terms and conditions that legally bind or are otherwise applicable to the Indemnified Party without the consent
of the Indemnified Party; and provided further, that the Indemnified Party may retain its own counsel at its own expense; provided further that if the Indemnifying Party does not assume control of the defense, compromise or settlement of such
an Indemnified Claim within 30 days of its receipt of notice, the Indemnified Party may retain counsel and compromise or settle any such Indemnified Claim, subject to reimbursement by the Indemnifying Party.
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(c)
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Of both the Indemnified Party and the Indemnifying Party to cooperate fully with respect to the defense of any Indemnified Claim.
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ARTICLE 2.00 GRANT OF LEASE
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2.01
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Grant
The Landlord, as Owner of the Land described in Schedule “B” with Buildings attached thereon, hereby demises and leases the Premises as described
in Schedule “A” and the Tenant hereby leases and accepts the Premises from the Landlord, to have and to hold during the Term outlined in Article 1.01(b) and subject to the terms and conditions of this Lease.
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2.02
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Covenants of Landlord and Tenant
The Landlord covenants to observe and perform all of the terms and conditions to be observed and performed by the Landlord under
this Lease. The Tenant covenants to pay the Rent when due under this Lease, and to observe and perform all of the terms and conditions to be observed and performed by the Tenant under this Lease.
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ARTICLE 3.00 TERM AND POSSESSION
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3.01
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Acceptance of Premises
The Tenant acknowledges having received the Premises in good order and repair with all the Landlord’s Work completed and its
acceptance of the Premises (
each of which subject to a thirty (30) day period
to notify for deficiencies after
actual
possession) shall be deemed to be a waiver of any right to claim or to state that the Premises were not in good
order and repair subject only to latent defects.
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Subject to the preceding sentence
, the Tenant has fully
investigated the condition of the Premises or waived its right to do so and is fully familiar with the physical condition of the Premises and every part thereof and Tenant accepts the same “as is.”
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ARTICLE 4.00 RENT AND OPERATING COSTS
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4.01
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Minimum Rent
Yielding and paying, therefore, yearly and every year during the said Term unto the Landlord without any deduction, set-off or abatement (except as
herein expressly provided) in lawful money of Canada during the Term of this Lease the fixed Minimum rent (herein sometimes called “Minimum Rent”) in the annual amounts as described in Article 1.01(d); said Minimum Rent to be paid in
advance in equal monthly installments commencing on the date set forth in Article 1.01(c) and on the first day of each calendar month thereafter during the Term, provided that if the Minimum Rent Commencement Date is not the first day of a calendar
month, then the rent payable on the Minimum Rent Commencement Date shall be calculated at a rate per day of one-three hundred and sixty-fifth (1/365th) of the Minimum and Additional Rent then applicable pursuant to this sub-paragraph.
The
Tenant shall not be in default for vacating the Premises prior to the expiration date of the term so long as the Tenant continues to pay its Minimum Rent and Additional Rent as per this Lease and is not in default on the other provisions of the
Lease, and written notice is provided to the Landlord at least thirty (30) days in advance of vacating the Premises. In the event the Tenant provides proper notice, has vacated and is not in default of the Lease Agreement, the Landlord shall
have the option to terminate this Lease, upon providing thirty (30) days notice (“Landlord’s Right to Terminate”). Upon Landlord’s notice to Tenant of Landlord’s exercise of the Landlord’s Right to Terminate,
Tenant’s obligation to pay Minimum Rent and Additional Rent will cease as of the date specified in the Landlord’s notice. At any time prior to Landlord’s notice of such termination, Tenant shall be entitled to resume its occupation of
the Premises.
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The Landlord may,
at its sole cost and expense
, have prepared by an architect, land
surveyor or engineer a certified measurement of the Premises to establish the actual square footage of the Premises. If a certified measurement is completed for the Premises, the Landlord may provide to the Tenant a copy of the aforesaid certificate
of the architect or engineer and the square footage indicated thereon shall be the square footage of the Premises. Should such square footage indicated thereon be different from the square footage indicated in Article 1.01(a) of this Lease, then
rent indicated in Article 4.01 and all other charges in this Lease shall be adjusted on a per square footage basis to reflect this difference, and the Tenant shall pay to the Landlord without deduction all such adjusted rent and other charges.
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4.02
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Additional Rent A
dditional Rent and all such other amounts payable herein (such as, but not limited to, Operating Costs, taxes, utilities, interest) shall become
due and payable hereunder by the Tenant to the Landlord
as of the Additional Rent Commencement Date, and thereafter, each as described in this Lease
, and is to be paid at the office of the Landlord, 115 King Street, Stellarton, Nova Scotia,
B0K 1S0, or at such other place as the Landlord may designate in writing from time to time. All amounts payable hereunder to the Landlord shall be deemed to be rent.
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4.03
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Operating Costs
The Tenant shall pay to the Landlord as Additional Rent and in the manner hereinafter specified for each Fiscal Period adopted by the Landlord in
connection with its operation of the Centre, a proportionate share of the Landlord’s
commercially reasonable
gross costs of maintaining, operating and repairing the Common Areas and Service Areas, all in
the manner described in
Schedule “E,”
and further defined in section 4.04
(hereinafter referred to as “Operating Costs”).
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4.04
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Operating Costs – Further Defined
The Landlord’s gross costs of maintaining, operating and repairing the Common Areas and Service Areas shall include
all
commercially reasonable
direct and indirect costs
pursuant thereto
and shall for the purpose of this Clause include, without limiting the generality of the foregoing, all
commercially reasonable
amounts paid or payable by
the Landlord for (1) accounting; (2) public liability and property damage insurance and insurance against other casualties against which the Landlord may reasonably insure (other than that insurance which is specifically dealt with in
Article 7.02); (3) cleaning (including snow and ice removal) in the Common Areas and Service Areas; (4) operation of all lighting systems, loudspeakers, public address or music broadcasting systems in the Common Areas;
(5) policing; (6) supervising Common Areas with attendant; (7) repairs and maintenance in and operation of Common Areas and Service Areas (including the maintenance and upkeep of landscaped areas); (8) the salary and expenses of
the management and supervisory staff of the Centre; (9) depreciation and amortization of all fixtures and equipment serving Common Areas and which by their nature require periodic replacement or substantial replacement, excluding buildings or
structures and permanent parts thereof; (10) the cost of heating, ventilating and/or air-conditioning the Common Areas; (11) all taxes, including business taxes, applicable to Common Areas and Service Areas
as
included in Article
5:00, Taxes,
of this Lease; (12) operation and maintenance of any escalators and elevators servicing the Building; (13) other amounts paid or allocated by the Landlord or auditors on behalf of the Landlord for the operation,
maintenance and repair of the Common Areas and Service Areas but excluding costs of a capital nature; (14) One ($1.00) Dollar per square foot per annum of the Premises as depreciation and amortization of the parking facilities (where
applicable) (15) an administrative fee equal to fifteen percent (15%) of the total annual costs referred to in items (1) to (14) inclusive. Costs shall be allocated in each Fiscal Period in accordance with generally accepted
accounting principles, and insurance premiums for any policy having a term other than a Fiscal Year may be allocated to the Fiscal Year in which the premium therefor is paid. If any dispute arises as to whether an item is a Common Area or Service
Area cost or as to its allocation thereof the
commercially reasonable and unbiased
decision of the Landlord’s
independent
auditors in settlement of the dispute shall be final and binding.
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If applicable to the Centre, the Landlord’s gross costs of operating, maintaining, repairing and/or replacing the said heating,
ventilating, and air-conditioning systems as provided herein shall include all
commercially reasonable
direct and indirect costs of operating, maintaining, repairing and/or replacing the said systems and providing heating, ventilating and/or
air-conditioning including, but not restricted to, the cost of (1) accounting; (2) wages and expenses paid to persons hired to operate, maintain and/or supervise the said systems; (3) fuel, steam and all other properties used to
generate heat; (4) supplies to said systems; (5) necessary inspections of said systems; (6) necessary licenses for the said systems; (7) providing insurance which the Landlord considers reasonably necessary with respect to said
systems; (8) repairs and maintenance; (9) capital expenditures made by the Landlord in an effort to promote energy conservation; (10) depreciation and interest on the capital cost of the said systems in an aggregate amount not greater
than the amount required to amortize this cost together with interest at the rate of prime plus 2% per annum as calculated by the main branch of the Bank of Nova Scotia, Halifax, Nova Scotia
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Over a period of twenty (20) years; and (11) an administrative fee equal to fifteen percent (15%) of the total annual costs referred to in items (1) to (10) inclusive. If
any dispute arises as to whether an item is a cost of operating, maintaining, repairing and/or replacing the heating, ventilating and/or air-conditioning systems or the allocation thereof the
reasonable and unbiased
decision of the
Landlord’s independent auditors in settlement of the dispute shall be final and binding.
The Tenant shall reimburse the
Landlord for a
proportionate
portion of all
reasonable
premiums paid by the Landlord in relation to any insurance. The cost of insurance shall include an amount sufficient to reimburse the Landlord for the premium cost and deductible,
if any. The amount of the Tenant’s portion shall be such as the Landlord, in consultation with the agent for its insurer(s), may reasonably determine and the Tenant covenants to pay to the Landlord monthly as Additional Rent or in a manner
hereinafter specified, for each Fiscal Period adopted by the Landlord in connection with its operation of the Centre, the Landlord’s gross cost of insuring the Centre.
Operating Costs shall include, if applicable, all
reasonable
costs and expenses relating to monitoring and maintaining suitable indoor air quality in the Building and regularly inspecting,
monitoring, maintaining, and repairing the Building’s HVAC system; hiring outside consultants to investigate and identify the sources of any suspected indoor air quality problems that may be identified; remedying any such problems; modifying,
renovating, or encapsulating any portion of the Building, Building systems, or Building components reasonably required to continuously and efficiently maintain acceptable indoor air quality in the Building, and complying with any and all local,
provincial, and federal laws, rules, regulations, or real estate industry standards relating to indoor air quality.
Notwithstanding the above, the Tenant’s Additional Rent shall exclude the following:
a) expenses incurred by the Landlord in leasing any portions of the Building and any other tenant’s leasehold improvements;
b) principal and interest on mortgages and other debt costs;
c) the cost of rents in default and in enforcing leases against other tenants;
d) tenant improvement allowances, leasing commissions, leasing costs and termination expenses;
e) costs of alterations or improvements to premises of other tenants in the Building;
f) any ground rent, any fee associated with any underlying license or other similar charge or cost payable by the Landlord in respect
of the Building or the lands upon which the Building is situated;
g) any costs, depreciation or amortization which
should be associated with the original construction of the Building;
h) the cost of any repairs or replacements to the
extent that the cost of the same is recovered by the Landlord pursuant to original construction warranties or recovered by the Landlord for third parties or tenants responsible for such repairs or replacements;
i) all costs and expenses incurred as a result of the negligent or wilful acts or omissions of the Landlord or those for whom the
Landlord is in law responsible, provided that the Tenant shall, in any event, contribute to the cost of the Landlord’s insurance premises and any deductibles which may be paid through its contribution to Operating costs;
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j) any loss or damage to any art of the Building or any personal injury to the extent to
which the Landlord recovers for the same or is entitled to recover for the same from its insurers, provided that the Tenant shall, in any event, contribute to the cost of the Landlord ‘s insurance premiums and any deductibles which may be paid
through its contribution to Operating Costs; and
k) fines, suits, claims, demands, actions, costs, charges and expenses
of any kind made necessary by the Landlord’s non-compliance with both existing and future laws relating to the Building.
Management and administration fees will not exceed 15% of the aggregate of all Operating Costs and shall not be applicable to taxes.
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4.05
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Payment - Operating Costs
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(a)
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Prior to the Additional Rent Commencement Date and each Fiscal Period or as soon thereafter as possible, the Landlord shall calculate and deliver notice of the
Tenant’s share of the estimated Operating Costs for the appropriate Fiscal Year, and without further notice the Tenant shall pay to the Landlord in monthly instalments, the estimated Operating Costs simultaneously with the Tenant’s
payments of Minimum Rent during such Fiscal Year, including Property Taxes.
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(b)
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Within a reasonable period of time following the end of each Fiscal Period, the Landlord shall furnish the Tenant with a statement (the “Statement”) setting
out in reasonable detail the amount of
all
Operating Costs
(including those described in Schedule E)
(except Property Taxes) for such Fiscal Period certified to be correct by an independent auditor of the company. If such amount is
greater or less than the payments on account thereof made by the Tenant, appropriate adjustments will be made between the parties hereto within thirty (30) days after the delivery of such statement.
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4.06
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Services by the Landlord
Subject to Article 4.00 hereof and excluding services by the Landlord and charged to the Tenant as Operating Costs (Schedule
“E”) , one hundred and fifteen percent (115%) of the cost to the Landlord of all additional services, provided by the Landlord or its agent to the Tenant (including performance by the Landlord on behalf of the Tenant of any of the
Tenant’s obligations set out in this Lease which the Tenant fails to perform) shall be payable by the Tenant upon
thirty (30) days written
demand by the Landlord. Such services shall include any services performed at the
Tenant’s request including, without limitation, maintenance, repair, special janitorial or cleaning services, construction of additional Leasehold Improvements, replacement of non-standard bulbs, tubes and ballasts and any heating, ventilation,
air-conditioning, electrical or elevator service provided during hours other than business hours. Such services shall also include any services provided at the
Tenant’s request
including, operating elevators for the sole benefit of the
Tenant and supervising the movement of furniture, equipment, freight and supplies for the Tenant.
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4.07
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Prepaid Deposit
The Landlord acknowledges having received from the Tenant the amount specified in Article 1.01(e) as a non-interest bearing deposit to be held by
the Landlord for application against
instalments of Minimum and Additional Rents as they fall due under this Lease until the Deposit is exhausted.
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4.08
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Net Lease
It is the intention of the Landlord and Tenant that this Lease shall be net to the Landlord and that the Tenant shall pay for its own account, to the
complete exoneration of the Landlord, all costs and expenses affecting the Premises and the business carried on therein.
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4.09
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Interest on Arrears
If the Tenant
wrongfully
fails to pay to the Landlord when the same is due and payable any Minimum Rent, Additional Rent or any other
charge under this Lease such amount or amounts shall bear interest at a rate of two percent (2%) per month compounded monthly from the date upon which same was due until actual payment thereof.
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ARTICLE 5.00 TAXES
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(a)
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The term “tax” or “taxes” means all taxes, rates, duties and levies whatsoever whether Municipal, Provincial, Parliamentary or otherwise,
directly and solely
attributable to the Tenant’s use of the Centre including the Lands on which it is situated and levied in respect of the Centre, including any capital tax or tax imposed on the capital invested in or allocated to the
Centre, federal large corporation tax (or any tax
substantially
similar to or in replacement thereof)
or business occupancy tax
.
The term also
includes any taxes, rates, assessments or charges directly attributable to the
Tenant’s use of the Centre which may in the future be levied in substitution for Municipal, other real property or business occupancy taxes currently levied, or tax on rent.
Furthermore, the term also includes
all
commercially
reasonable
costs or expenses incurred, paid or payable by the Landlord, in contesting or appealing any assessments for such tax or taxes, but does not include the income and personal taxes of the Landlord,
or any tax based on the assets or
entity structure of the Landlord.
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(b)
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The Landlord shall pay all taxes assessed against the Centre.
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(c)
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The Tenant shall pay to the Landlord as Additional Rent for each taxation year during the Term of this Lease
the Tenant’s “
Proportionate Share of
taxes” as defined in Schedule “D,” in the manner described in section 5.04.
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5.02
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Business Tax
The Tenant covenants to pay as and when they fall due all taxes and rates charged, assessed or levied by any governmental authority
against either the Landlord or the Tenant in respect of any business or other activity carried on, upon or in connection with the Premises
by the Tenant,
including any
such
taxes and rates which may in the future be levied against
either the Landlord or the Tenant in addition to or in substitution for business occupancy taxes currently levied, and taxes personal to the Tenant and on or in respect of its business, income or property and taxes which may be levied by any
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governmental authority
(“Business Occupancy Tax”)
against either the Landlord or the Tenant in respect to the Tenant’s fixtures and equipment or any rent or Additional Rent
paid to the Landlord, and to indemnify and reimburse the
Landlord (subject to each party’s Indemnification Obligations)
at the Landlord’s option, either upon demand or as Additional Rent for any of such taxes which may be assessed
to and payable by or paid by the Landlord.
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5.03
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Harmonized Sales Tax
In addition to the rent payable hereunder, the Tenant will pay to (the Landlord (acting as agent for the taxing authority if applicable) or
directly to the taxing authority (if required by the applicable legislation) in the manner
commercially reasonably
specified by the Landlord, the full amount of all goods and services taxes, sales taxes, value-added taxes, multi-stage taxes,
business transfer taxes and any other taxes imposed in respect of rent and other charges payable by the Tenant under this Lease or in respect of the rental of space by the Tenant under this Lease (collectively and individually, “HST”). HST
is payable by the Tenant whether characterized as a goods and services tax, sales tax, value-added tax, multi-stage tax, business transfer tax, or otherwise. HST so payable by Tenant will: (i) be calculated by the Landlord in accordance with
the applicable legislation; (ii) be paid by the Tenant at the same time as the amounts to which the HST applies are payable to the Landlord under the terms of this Lease (or upon demand at such other time or times as the Landlord from time to
time
reasonably
determines); and (iii) notwithstanding anything else in this Lease, be considered not to be rent, but the Landlord shall have all of the same remedies for and rights of recovery with respect to such amounts as it has for
non-payment of rent under this Lease or at law.
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5.04
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Monthly Payment
Prior to the commencement of each Fiscal Year or taxation year or as soon thereafter as possible, the Landlord will furnish to the Tenant a
reasonable estimate of the taxes of the
Building
for the current taxation period and the amount thereof payable by the Tenant. The Tenant shall pay to the Landlord the amount so estimated, in advance, in equal monthly instalments on the first
day of each month throughout the current taxation year. Within sixty (60) days after the end of the taxation period, or as soon thereafter as possible, the Landlord shall furnish to the Tenant a statement of the Landlord’s actual taxes and
the amount thereof payable by the Tenant and showing in reasonable detail the information relevant and necessary to the exact calculation and determination thereof. If such amount is greater or less than the payments on account thereof made by the
Tenant, appropriate adjustments will be made between the parties hereto within thirty (30) days after the delivery of such statement.
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ARTICLE 6.00 TENANT COVENANTS
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6.01
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Use
The Premises shall be used and occupied for the use as determined in Article 1.01(f) or for such other purpose as the Landlord may specifically authorize in
writing. The Tenant shall operate under the firm name as set out in Article 1.01(g).
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If any other business is
operated on the Premises, the Tenant shall cease such operation upon receipt of notice from the Landlord. The Landlord, after this written notice to the Tenant, may at its option terminate this Lease if the other business being operated has not
ceased. Upon Landlord’s notice to Tenant of Landlord’s exercise of the Landlord’s election to terminate this Lease, Tenant’s obligation to pay Minimum Rent and Additional Rent will cease effective on the date stated in the
Landlord’s notice to terminate this Lease.
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Nothing
,
in the Landlord’s determination, shall be done or omitted or permitted
by the Tenant upon the Premises which shall be or result in a nuisance.
The Tenant shall not be in default for vacating the
Premises prior to the expiration date of the Term so long as the Tenant continues to pay its Minimum Rent and Additional Rent as per the Lease and is not in default on the other provisions of the Lease, and provided written notice is provided to the
Landlord at least thirty (30) days in advance of vacating the Premises. Should the Tenant provide proper notice, has vacated and is not in default of the Lease, the Landlord will have the option to terminate the Lease upon providing thirty
(30) days notice. At any time prior to Landlord’s notice of such termination, Tenant shall be entitled to resume its occupation of the Premises, upon providing thirty (30) days notice
.
For the avoidance of doubt, if Landlord
chooses to so terminate, all obligations of Tenant, including without limitation any Rent or Additional Rent amounts remaining over the balance of the Lease, shall terminate.
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6.02
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Rent
The Tenant covenants to pay all Minimum Rent and Additional Rent and all other charges as referred to in Articles 4.01 and 4.02, promptly, when due.
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6.03
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Utilities - Tenant’s Costs
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(a)
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All electricity, water and other utilities of any nature supplied to the Premises shall be paid for by the Tenant and, if supplied by the Landlord, shall be supplied at
then current
market
rates; and the amounts payable therefore shall be deemed to be Additional Rent. If arrangements are not made by the Landlord for the supply of any such services by a public utility or other supplier, the Tenant will
contract directly with such utility or supplier for the supply thereof.
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(b)
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In no event shall the Landlord be liable for damages arising from the interruption or failure of such supply; and in the event that a public utility or supplier
providing any such service ceases to do so, the Landlord will use its best efforts to arrange an alternative supply and may at its option supply any of such services itself but shall be under no obligation to do so and shall not be liable in damages
by reason of the cessation of such supply. Electricity required by the Tenant other than normal lighting and the operation of small business office equipment shall be paid for by the Tenant as Additional Rent.
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6.04
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Tubes, Ballasts
The Landlord shall have the exclusive right to attend to any replacement of electric light bulbs, tubes and ballasts in the Premises throughout
the Term and any renewal thereof. The
commercially reasonable
cost of such replacement and installation shall be paid by the Tenant to the Landlord within thirty (30) days after receipt of an invoice by the Tenant from the Landlord on
account thereof as Additional Rent.
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The Landlord may adopt a system of relamping and reballasting periodically
on a group basis in accordance with good practice. If the Landlord adopts such a system, the Tenant shall pay as Additional Rent to the Landlord a
commercially reasonable
monthly charge
- 16 -
per bulb, tube and ballast on the account of the cost of such replacement in the Premises. If the cost of such replacement shall increase or decrease during the Term or any renewal thereof, the
Landlord shall adjust the Additional Rent payable for such replacement hereunder on an equitable basis and the Tenant agrees to pay such Additional Rent as adjusted, on
thirty (30) days written demand
. The
commercially reasonable
decision of the Landlord, with respect to any such adjustment, shall be final and binding upon the parties hereto.
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6.05
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Repair and Maintenance
The Tenant will at all times keep the Premises in a clean and sanitary condition and in accordance with the laws, directions, rules and
regulations of the governmental agencies having jurisdiction, and will keep and maintain the Premises and all interior fixtures and equipment therein including, without limiting the generality of the foregoing, the plumbing, heating,
air-conditioning (if applicable) and electrical equipment and including all glass, windows, doors and door-closing devices and all permitted signs, in good order and condition and in good repair and painted or otherwise presentable. Upon
commercially
reasonable notice to the Tenant, the Landlord or its agents shall have the right to enter upon the Premises at all reasonable times to view the state of repair, condition and use thereof and to request in writing to the Tenant
that the Tenant make such repairs, alterations, improvements or additions as the Landlord acting reasonably may deem advisable. Should the Tenant not comply or commence to comply with the Landlord’s written request within thirty (30) days
of the aforesaid request then the Landlord may make such repairs, alterations, improvements or additions as it may deem advisable,
acting reasonably
. The
reasonable
cost, plus 15% of such cost for overhead and supervision, will be
billed to the Tenant as Additional Rent and payable
within thirty (30) days of receipt of
an invoice therefor; and the Landlord shall be allowed to take all materials into and upon the Premises that may be required therefor without the
same constituting an eviction of the Tenant in whole or in part. The rent hereunder shall in no way abate while such repairs, alterations, improvements or additions are being made by reason of loss or interruption of the business of the Tenant
because of the prosecution of such work, provided that the same are made as expeditiously as is reasonably possible.
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The use by the Tenant of electrical and other services shall at no time exceed the capacity of the wiring, mains, pipes or conduits on the Premises or the fixtures or equipment within the Premises so as
to constitute a hazard. If the Tenant wishes to install any electrical or other equipment which may overload the electrical or other service facilities, the Tenant shall at its own expense make whatever changes are necessary to comply with the
reasonable and lawful requirements of the insurance underwriters and governmental authorities having jurisdiction, but no changes shall be made by the Tenant until the Tenant first submits to the Landlord plans and specifications for the proposed
work and obtains the Landlord’s written approval to perform same,
which approval shall not be unreasonably withheld.
The Tenant shall have the right to make alterations and installations to the Premises at its sole cost and expense, subject to prior
written approval of the Landlord, not to be unreasonably withheld.
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6.06
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Nuisance
The Tenant covenants not to suffer or permit any waste upon the Premises and not to cause or permit any nuisance in, at or on the Premises or any other
part of the Building or Centre.
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- 17 -
The Premises shall not be used for any dangerous, noxious, or offensive trade or business or
for any purpose, trade, or business that will adversely affect the indoor air quality for the Premises or Building (including any Common Areas and Service Areas);
The Tenant will at all times use and operate the Premises in such a manner as to minimize the risk of indoor air quality problems, “sick-building syndrome,” and/or any diagnosable illness that
can be identified and attributed directly to contaminants in the Building;
The Tenant will take all steps
reasonably
necessary to prevent: inadequate ventilation, emission of chemical contaminants from indoor and/or outdoor sources, emissions of biological contaminants;
The Tenant will assure adequate ventilation and operation of any HVAC systems and/or office equipment under its control;
The Tenant will not allow any unsafe levels of chemical or biological contaminants (including volatile organic compounds) in the Premises, and will take all steps
reasonably
necessary to prevent
the release of such contaminants from adhesives (for example, upholstery, wallpaper, carpet, machinery, supplies, and cleaning agents);
The Tenant will not bring, generate, treat, store, or dispose of any chemicals, materials, or other potential pollution sources without Landlord’s prior consent. Notwithstanding the foregoing, the
levels of these chemicals, materials, or other potential pollution sources shall not exceed legal limits.
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6.07
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Heavy Objects
The Tenant covenants not to overload any of the floors of the Premises nor place upon the Premises any safe, heavy business machine or other heavy
object without first obtaining the consent in writing of the Landlord,
which consent shall not be unreasonably withheld.
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6.08
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Assignments
The rights of the Tenant under this Lease shall not be transferred, assigned or sold and the Tenant shall not sublet the whole or any part of the
Premises nor grant any concession or license within or with respect to the Premises to any party without the prior written consent of the Landlord, which consent may
not
be unreasonably withheld. All requests to the Landlord for consent to
any transfer, assignment, sublet or grant shall be made to the Landlord in writing and such information in writing as the Landlord might reasonably require respecting a proposed transferee, assignee, sublessee or grantee including, without
limitation, the name, address, number of years business experience or in lieu of business experience evidence of competent personnel, financial position, and banking and personal references of such proposed transferee, assignee, sublessee or grantee
and in the event that the proposed transferee, assignee, sublessee or grantee is a corporation, similar information respecting the corporation and all of its principal shareholders, officers and directors. As a condition precedent to any assignment
of this Lease or subleasing of the whole or any part of the Premises, the Tenant shall first offer to assign or sublease, as the case may be, to Landlord on the same terms and conditions and for the same rental as provided in this Lease. The
Landlord will not be liable for any damages resulting from the withholding of a consent to transfer assignment, sublet or sale.
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- 18 -
Approvals required of the Landlord shall not be commercially unreasonably withheld or
delayed.
In no event shall the proposed sub-tenant or assignee be an existing occupant of any space in the Building or the
Centre or an Affiliate of any such occupant. For purposes of this Article, an “Affiliate” means a corporation or other business entity that directly or indirectly controls, is controlled by, or is under common control with such occupant.
In no event shall the Tenant sublet all or a portion of the Premises to a person or entity with whom the Landlord or its agent is negotiating or has negotiated within the past six (6) months regarding a lease, purchase, or license of space in
the Centre.
Without limiting the foregoing, the following shall be deemed to be an assignment or sublease for the purposes of
the Lease and shall require the prior written consent of the Landlord and the prior compliance with all of the provisions of this Article:
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(a)
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if any person other than the Tenant has or exercises the right to occupy, manage or control the Premises or any part thereof, or any of the business carried on therein
other than subject to the direct and full supervision and control of the Tenant; and
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(b)
|
if effective control of the Tenant is acquired or exercised by a person not having effective control of Tenant at the date of execution of the Lease.
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The Landlord,
acting in a commercially reasonable manner,
may grant its consent to assign or sublet all
or any part of the Premises or refuse to grant its consent to assign or sublet all or any part of the Premises, or, within thirty (30) days of the receipt of such request in writing to assign this Lease or sublet all or any part of the Premises
elect to cancel this Lease. If the Landlord elects to cancel this Lease, the Landlord shall give the Tenant notice of cancellation and sixty (60) days following such notice of cancellation
to withdraw its request. If Tenant foes not withdraw
its request to assign or sublet within that sixty (60) day period,
this Lease shall expire and the Tenant shall vacate and surrender the Premises to the Landlord.
For the avoidance of doubt, in the event Landlord so cancels this Lease,
all obligations of Tenant, including without limitation any Rent or Additional Rent amounts remaining over the balance of the lease, shall terminate
Whether or not the Landlord consents to any request to a transfer, assignment, sublease or grant the Tenant shall pay to the Landlord all reasonable costs incurred by the Landlord in considering any
requests for consent to a transfer, assignment, sublease or grant and in completing any of the documentation involved in implementing such transfer, assignment, sublease or grant including the agreements between the Landlord and each of the Tenant
and the transferee, assignee, sublessee or grantee referred to above and the document of transfer, assignment, sublease or grant and the consent thereto.
As an alternative to giving its consent to any sublease or assignment of lease, Landlord shall have the right to require the prospective sub-tenant or assignee to execute a new lease with Landlord under
the same terms and conditions as contained in the offer from the bona fide assignee or sub-tenant, the performance of all obligations of such sub-tenant or assignee under the new lease.
Notwithstanding anything in this Lease to the contrary, if
Landlord requires a prospective sub-tenant or assignee to execute a new
- 19 -
lease with Landlord, Tenant will be released from all covenants and obligations under this Lease. Except as described in the foregoing sentence,
in the event of any transfer, assignment,
sublease or grant, the Tenant shall remain responsible to the Landlord for the fulfillment of all of the Tenant’s obligations pursuant to the terms of this Lease for the balance of the Term regardless of any disclaimers of the Lease by any
trustee in bankruptcy or receiver. If this Lease is disclaimed or terminated by any trustee in bankruptcy or any transferee of this Lease, the original Tenant named in this Lease, upon notice from the Landlord given within sixty (60) days of
such disclaimer or termination, shall enter into a Lease with the Landlord upon the same terms and conditions as contained herein except for the duration of the Term, which shall expire on the date this Lease would have expired save for such
disclaimer or termination. The Landlord’s consent to any transfer, assignment, sublease or grant shall not be effective unless given by the Landlord in writing and no such consent shall be deemed or presumed by any act or omission of the
Landlord other than consent in writing; without limiting the generality of the foregoing, the Landlord may collect rent and any other amounts from the transferee, assignee, sublessee or grantee and apply the net amount collected to the rent and
other amounts payable pursuant to this Lease and the collection or acceptance of such amounts shall not be deemed to be a waiver of the Landlord’s rights under this Article or any acceptance of or consent to any such transfer, assignment,
sublease or grant.
The Tenant acknowledges that the Landlord will not be held responsible for any financial or non-financial
losses caused by withholding the Landlord’s consent to any assignment, transfer, sublease or grant. In the event the Landlord shall grant its consent to assign or sublet or part with possession of any part or all of the Premises and also in the
event that the Assignee, Sublessee, or Receiver of the Premises pays any higher Minimum Rent or Additional Rent than is payable under this Lease then in every instance the Tenant shall reimburse the Landlord with such higher Minimum Rent or
Additional Rent through the remainder of the Term and any renewals thereto.
If the Tenant assigns this Lease without the
Landlord’s prior written consent, and regardless of whether or not the Landlord has accepted rent from any party other than the Tenant, the Landlord has the right to terminate this Lease with no liability whatsoever.
The Tenant shall not print, publish, post, mail, display, broadcast or otherwise advertise or offer for any reason, the whole or any part
of the Leased Premises for the purposes of an occupancy transaction, sub-letting, assigning or the sharing of the Leased Premises in any way, in whole or in part, by a third party and shall not permit any broker or other party to do any of the
foregoing, unless the complete text and format of any such notice, advertisement or offer shall have first been approved in writing by the Landlord. Without in any way restricting or limiting the Landlord’s right to refuse any text and format
on other grounds, any text and format proposed by the Tenant shall not contain any reference to the Minimum Rent or any other amount payable under this Lease.
Notwithstanding the foregoing, the Tenant shall be entitled to, without the consent of the Landlord, but on prior written notice to the Landlord, assign the Lease or sublet all or any part of the
Premises to:
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a)
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any corporation which is affiliated with Tenant, as the term “Affiliate” is defined in the
Canada Business Corporations Act
,
hereinafter called the “affiliate”); or
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- 20 -
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b)
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a purchaser of all or substantially all of the shares of the Tenant; or
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c)
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any corporation with which the Tenant is amalgamated or merged as part of a corporate reorganization or takeover; or
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d)
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a purchaser of all or substantially all of the assets of the Tenant.
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Tenant will be permitted to advertise or allow any agent, broker, or other person to advertise the Premises as being available for lease subject to the Landlord’s prior approval of text and
format. The Landlord will permit all such approved sub-tenancies a position on the lobby directory board of the Building.
The Tenant shall be permitted the right to transfer any parking permits or agreements that it has in place with the Landlord as part of
a transfer of the Premises.
The Tenant shall be entitled to recapture its commercially reasonable cost of subletting
including real estate fees, third party legal fees, marketing costs, down time, tenant inducements, free rent periods or Sublandlord’s Work required to be completed in order to procure the sublease and any profits after re-capturing these costs
shall be shared equally by the Landlord and Tenant.
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6.09
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Compliance with Insurance
The Tenant agrees that it will not keep, use, sell or offer for sale in or upon the Premises any article which may be prohibited by the
standard form of fire insurance policy in force from time to time covering the Centre. In the event the Tenant’s occupancy of, conduct of, business in, or sale of any merchandise from or on the Premises, whether or not the Landlord has
consented to the same, causes any increase in premiums for the insurance carried from time to time by the Landlord with respect to the Centre, the Tenant shall pay any such increase in premiums as Additional Rent within ten (10) days after
bills for such additional premiums are rendered by the Landlord. In determining whether increased premiums are a result of the Tenant’s use or occupancy of the Premises, or the sale of any article therein or therefrom, a schedule issued by the
organization setting the insurance rate on the Centre, showing the various components of such rate, shall be conclusive evidence of the several items and charges which make up such rate. The Tenant shall comply promptly with all reasonable
requirements of any underwriters association or of any insurer now or hereafter in effect, pertaining to or affecting the Premises.
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6.10
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Compliance with Laws
The Premises shall be used and occupied in a safe, careful and proper manner so as not to contravene any present or future governmental or
quasi-governmental laws in force or regulations or orders. If due solely to the Tenant’s
unique needs and
use of the Premises, improvements are necessary to comply with any of the foregoing or with the requirements of insurance carriers,
the Tenant shall pay the entire
reasonable
costs thereof.
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Each party
shall, at its sole cost,
comply with all current and future federal, provincial, and local environmental and indoor air quality laws, regulations, and industry standards, including, without limitation, any restrictions on smoking in the workplace.
- 21 -
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6.11
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Signs
The Tenant covenants not to exhibit, inscribe, paint or affix any signs, advertisements, notices or any other lettering upon any part of the outside or
inside of the Premises or other part of the Building except on the directories and doors of offices and then only of such size, colour and style as Landlord shall determine and approve.
In the event of the violation of this Clause by the
Tenant, the Landlord may remove such sign, advertisement, notice or other lettering, without any liability, and may collect from the Tenant as Additional Rent the
reasonable
expense incurred in removing the same. Upon termination of this
Lease, the Tenant will remove any and all such signs, advertisements, notices and other lettering and shall make good any damages occasioned by the installation or removal thereof.
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6.12
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Windows
The Tenant covenants to pay the
reasonable
cost of replacement with as good quality and size of any window glass serving the Premises which
becomes broken during the continuance of this Lease, excluding exterior windows which will be replaced at the Landlord’s cost, unless damage is caused by the Tenant, its employees, agents, invitees or licensees.
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6.13
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Blinds
The Tenant shall not install window shades, curtains or Venetian blinds of any colour other than the typical colours from time to time approved by the
Landlord, if Landlord provides or requires a standard.
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6.14
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Additional Costs
The Tenant covenants to pay all additional costs referred to in Clause 4.02 of this Agreement.
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6.15
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Tenant’s Insurance
The Tenant shall, before entering the Premises and during the entire Term hereof, at its sole cost and expense, take out and keep in full
force and effect, in the names of the Tenant, the Landlord and the Landlord’s mortgagee (including trustee for bond holders), the following:
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(a)
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An “Occurrence” liability insurance policy insuring all operations of the Tenant, including but not limited to, bodily injury and property damage liability,
contractual liability and contingent liability. Such policy shall be written on a comprehensive basis with limits of not less than $5,000,000.00 per occurrence (or such higher limits as the Landlord or its mortgagees require from time to time)
including Tenant’s Legal Liability insurance on an All-Risk replacement cost basis for the Premises with respect to the occupancy by the Tenant of the Premises. Should a “Claims-Made” policy be purchased, such policy shall survive the
expiration of this Lease and remain in full force and effect for a further six (6) years.
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(b)
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Fire Insurance and Extended Coverage Endorsement (including coverage for leakage from fire protected devices from all other types of water damage) on a Replacement Cost
basis, in respect of the Premises which shall include but not be limited to all exterior windows, doors, demising walls, electrical fixtures, mechanical, plumbing fixtures and sprinkler drops and heads and ceiling/flooring and all trade fixtures,
furniture, equipment, inventory and all Leasehold Improvements constructed by or on behalf of the Tenant and such other property in or about the Premises as the Landlord or its mortgagees may from time to time reasonably require.
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- 22 -
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(c)
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Where the Tenant intends to or does use, store, distribute, treat, manufacture, transport, generate, process, package, reprocess, recycle, sell, offer for sale, dispose
of or import into the Province any Hazardous Substance as defined in Article 13.18 of this agreement, third party liability insurance for environmental liability in amounts and containing terms and conditions in accordance with industry standards
shall be carried by the Tenant.
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(d)
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Any other form or forms of insurance as the Landlord or the Landlord’s mortgagees reasonably requires from time to time including but not limited to Business
Interruption Insurance in amounts and for perils against which a prudent tenant would protect itself in similar circumstances.
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6.16
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Access and Maintenance
The Tenant covenants to permit the Landlord and all persons authorized by it at all reasonable times,
upon twenty-four (24) hours
prior written notice other than in cases reasonably deemed to be an emergency,
during the Term to enter the Premises to erect, build, use and maintain pipes, ducts and conduits, including communications services in and through the Premises and,
further, the Landlord shall have the right to enter the Premises at all reasonable times to examine the same and to make such repairs, alterations, improvements or additions as the Landlord may
reasonably
deem necessary or desirable or as the
Landlord may be required to make by law or in order to repair and maintain the Building, and the rent reserved shall not abate while any such work is being undertaken by the Landlord. The Landlord will exercise reasonable diligence so as to minimize
the disturbing or interruption of the Tenant’s operations. The Landlord or its agents shall have the further right to enter upon the Premises at all reasonable times
subject to twenty-four (24) hours prior notice to the Tenant excepting
emergencies,
to show them to prospective purchasers, encumbrancers, or assignees and during the six months prior to the expiration of the Term, the Landlord may show the Premises to prospective tenants and to permit free access to the Premises
by janitorial, cleaning personnel, watchmen and security personnel.
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The Tenant agrees with the Landlord that in
the event that the Tenant’s business is of such a nature as to require it to remain open other than the normal business hours of the Building (and if requested by Tenant) or to necessitate additional security measures or maintenance work or
Tenant-requested Common Area HVAC operation exceeding that normally required in the operation of the Building, then the Tenant shall pay to the Landlord, as Additional Rent, any such additional charges arising out of the additional security
measures, maintenance work or Common Area HVAC operation
within thirty (30) days of
receipt of an invoice from the Landlord for such charges.
The Tenant acknowledges the Building’s standard hours of operation are Monday to Friday
from 6:00 am to 9:00 pm and Saturday from 6:00 am to 1:00 pm (excluding statutory holidays). At the Commencement of this Lease, the cost for after hours HVAC shall be $30.00 per hour for air with chiller and fans and $5.00 per hour for fans only,
both subject to annual adjustment.
The Landlord shall have the right, but not the obligation, at all times during the
Lease Term to inspect the Premises and conduct such tests and investigations to evaluate the indoor air quality in the Premises and/or the Building. The Landlord’s entry may be made at any time either during or after Tenant’s business
hours.
- 23 -
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6.17
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Notice of Accident
The Tenant covenants to give the Landlord
reasonably
immediate notice of any accidents or defects in the water pipes, plumbing,
heating, ventilation and air-conditioning apparatus, electrical wiring or fixtures, and the Tenant will make good any damage caused by the misuse of the Premises by the Tenant, its servants or agents, or any other person who may be permitted by the
Tenant to enter the Premises.
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6.18
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Mechanics’ Liens
The Tenant covenants to pay promptly for labor, materials and construction and
except in cases of negligence or wilful misconduct by the
Landlord
, to indemnify and save harmless,
subject to the Indemnification Obligations of each party
, the Landlord against claims arising from Mechanics’ or other liens for any work done or materials provided or services rendered for
improvements or alterations made, by the Tenant to the Premises.
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If a Mechanics’ or other lien arises, the
Landlord has the right to pay the outstanding amount and charge the Tenant said amount as Additional Rent.
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6.19
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Surrender
To deliver up to the Landlord at the end of the Term, or earlier termination thereof, the Premises broom clean and in good and tenantable repair,
destructions as herein provided for and reasonable wear and tear only excepted.
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Notwithstanding the above, it
is agreed that the Tenant shall not have the obligation to remove existing Tenant’s Improvements (except fixtures and equipment that is specific to the Tenant) or to restore the Premises to base building or original condition at the termination
of the Lease and the Landlord agrees to accept the Premises in the condition and configuration in which they are structured at that time, normal reasonable wear and tear considered. Tenant covenants to maintain the Premises in a commercially
reasonable condition. However, the Tenant will have the right to remove fixtures, telephone switches, security systems, furniture and equipment so long as any damage caused as a result of such removals is repaired as required.
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6.20
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Tenant’s Work
To perform Tenant’s work to the satisfaction of the Landlord and with prior written approval of the Landlord as specified in Schedule
“C”.
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6.21
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Heat, Vent and/or Air-Conditioning Premises
If the Premises are served by a separate heating, ventilating and/or air-conditioning system, the Tenant covenants to
pay the
reasonable
gross cost of maintaining, operating, repairing and replacing the said separate system or systems located in the Premises.
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6.22
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Other Charges
The Tenant shall pay to the Landlord, as Additional Rent, at the times and in the manner provided in this Lease or, if not so provided as
reasonably required by the Landlord, all amounts (other than that payable under Articles 4.01 and 4.02) which are payable by the Tenant to the Landlord under this Lease.
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- 24 -
ARTICLE 7.00 LANDLORD COVENANTS
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7.01
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Quiet Enjoyment
Provided all conditions of the Lease are met and all Rent is paid, the Landlord covenants for quiet enjoyment and possession of the Premises
during the Term subject to the terms and conditions of this Lease.
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7.02
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Landlord’s Insurance
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(a)
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The Landlord, acting reasonably and as a prudent owner of a similar centre, shall carry such insurance on the Centre for the account and benefit of the Landlord as the
Landlord from time to time considers useful, expedient or beneficial.
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(b)
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Notwithstanding the provisions of Article 7.02(a) and notwithstanding any contribution by the Tenant to insurance premiums as provided for in this Lease, such policies
are for the benefit of the Landlord only and not for the benefit of the Tenant and do not bar a claim or action against the Tenant by the Landlord or in the name of the Landlord (whether such claim is subrogated or not) in respect of any loss or
damage which was insured against or which ought to have been insured against pursuant to this Article 7.00.
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7.03
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Heating and Air-Conditioning
The Landlord covenants to heat and provide air-conditioning to the Premises during normal business hours twenty four (24) hours a
day, but in the event that the apparatus or any part thereof used in heating or air-conditioning the Premises at any time becomes incapable of heating or air-conditioning them or becomes damaged or destroyed, the Landlord shall have a reasonable
time within which to repair the damage or replace or repair the apparatus and the Tenant shall have no claim whatsoever upon the Landlord for damages due to the failure or loss of any such service
during that reasonable
time. In the event the
Tenant’s work as outlined in Schedule “C” hereto or any other additions or alterations to the Premises undertaken by the Tenant interfere with or in any way materially affect the proper operations of the heating and air-conditioning
systems serving the Premises, the Tenant shall bear the expense of any alterations to the heating and air-conditioning equipment for the purpose of better serving the Premises.
Notwithstanding anything to the contrary herein, the Landlord
covenants heat and air-conditioning to the Premises shall be available on a twenty-four hour, seven day basis subject to Article 6.16 herein.
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7.04
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Electricity and Water
The Landlord covenants if applicable to the Building, to provide electricity to the Premises and water to the washrooms in the Common Areas
of the floor(s) on which the Premises are located, but should the Landlord make default in so doing the Tenant shall have no claim whatsoever upon the Landlord for damages due to the failure or loss of such services at any time unless failure or
loss shall have been due to the wilful act or neglect of the Landlord.
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7.05
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Maintenance
The Landlord covenants to maintain the exterior, roof structure and foundation of the Building in good condition in order that the Tenant will be
able to carry out the purpose for which this Lease is granted.
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7.06
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Janitorial Services
The Landlord covenants to provide janitorial services, including window washing, as reasonably required to keep the Premises in a clean and
wholesome condition, provided that the Tenant shall leave the Premises in a reasonably tidy condition at the end of each business day.
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- 25 -
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7.07
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Elevator Service
Landlord covenants to furnish, except when repairs are being made, automatic passenger elevator service and permit the Tenant, the employees and
customers of the Tenant, and all other persons having business with the Tenant, to have the free use of such elevator service in common with others, but the Tenant and such employees and customers and all other persons using the same shall do so at
their sole risk and Landlord
shall not
be held responsible for any damages or injury to any person while
using the same, unless such damages or injury arise from Landlord’s negligence or wilful misconduct.
The use of the elevators
for the purpose of delivery must adhere to the guidelines as outlined in Schedule “F” (Rules and Regulations).
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7.08
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Access to Tenant It is agreed that the Tenant, its employees, and invitees shall have the right, twenty-four (24) hours per day, seven (7) days per week
throughout the Term and Renewal Terms to have access to the Premises and parking facilities for the Building.
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The Tenant shall occupy the Premises on such lawful days and such lawful hours as the Tenant in its sole discretion shall determine.
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7.09
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Security The Landlord shall provide the following security features:
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-
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card readers in all elevator cabs (limiting floor access);
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-
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after-hours card access on main lobby access doors; and
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-
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security monitoring 24 hours a day, 7 days a week.
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Notwithstanding the above, the Landlord, at Tenant’s direct expense and option, agrees to arrange for the Building security to provide the Tenant with an escort service for its staff, based on
costs and schedule to be mutually agreed. The Tenant shall have the option to install a security system specific to the Premises, subject to Landlord’s approval not to be unreasonably withheld.
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7.10
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Landlord’s Work
To perform Landlord’s work as specified in Schedule “C”.
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7.11
|
Repairs
The Landlord will, in a first class manner and as would a prudent owner of a similar centre:
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(i) operate, maintain, repair, replace, clean, supervise and insure all Common Areas of the Centre for which the Tenant shall pay its
proportionate share, and
(ii) make, at its sole cost and expense, all repairs or replacements to the structural portions of
the Buildings comprising the Centre and to such structural portions of the Centre comprising and forming part of the Premises.
Notwithstanding the foregoing, the Landlord will maintain and repair the Building including without limitation the exterior wall,
foundation, roof, parking areas and any landscaped areas in a first class condition. The Landlord will at all times respect the Tenant’s secure areas within the Premises and shall at all times coordinate with the Tenant the timing and means of
undertaking such repairs inside the Premises except for events reasonably deemed an emergency by the Landlord.
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7.12
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Right to Alter
Notwithstanding anything herein contained, the Landlord reserves the right without liability to the Tenant and without it constituting an eviction
to alter the Common Areas and the entrances and exits thereto.
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7.13
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Lettering Only at the Commencement of this Lease,
the Landlord
shall
provide and install,
at Landlord’s expense
,
all letters or numbers
on or beside doors to the Premises; all such letters and numerals shall be in the Building standard graphics, and no others shall be used or permitted on the Premises. In addition, the Landlord shall maintain a directory board in the lobby of the
Building and provide reasonable identification of the Tenant at Tenant’s
reasonable
expense.
The Tenant acknowledges requests to change or add to Tenant’s lettering under this Article, during the Term, shall be at the
Tenant’s sole expense.
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ARTICLE 8.00 RESPONSIBILITY FOR DAMAGE
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8.01
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(a)
Landlord’s Liability Except in cases of negligence or wilful misconduct by the Landlord,
the Landlord and its agents shall not be liable or
responsible in any way for any loss of or damage or injury to any property belonging to the Tenant or to employees of the Tenant or to any other person while such property or person is on the Premises or in the Building or in or on the Lands and
Buildings owned by the Landlord whether or not such property has been entrusted to employees of the Landlord
by permission of the Tenant
and, without limiting the generality of the foregoing,
except in cases of negligence or wilful
misconduct by the Landlord
, the Landlord shall not be liable for any damage to any such property or to any
such
persons resulting from any failure of the heating, electrical, plumbing, air-conditioning, sprinkler, or other mechanical
systems or resulting from steam, water, rain, or snow which may leak from any part of the Building or from the pipes, appliances, or plumbing works of the same or from dampness, or damage or injury from any other cause whatsoever and in no event
will the Landlord be liable for any consequential damage suffered by the Tenant.
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Notwithstanding the
foregoing, except in cases of negligence or wilful misconduct by Tenant and subject to the Indemnification Obligations of each party, Landlord shall indemnify and save harmless the Tenant from and against all third party liability, claims, damages,
or expense due to or arising out of (i) any negligence or wilful misconduct of the Landlord or those for whom in the circumstances Landlord is responsible in law, in or about the Premises, Common Areas and Service Areas, or (ii) any breach
by the Landlord of any provision of this Lease, and including liability for injury or damage to the personal property of the Landlord’s employees or those for whom in the circumstances Landlord is responsible in law.
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(b)
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Cancellation of Insurance
If any insurance policy upon the Centre or any part thereof shall be cancelled or shall be threatened by the insurer to be cancelled,
or the coverage thereunder reduced in any
material
way by the insurer, by reason of the use and occupation of the Premises or any part thereof by the Tenant or by any assignee or sub-tenant of the Tenant,, or by anyone permitted by the Tenant
to be on the Premises, and if the Tenant fails
to take reasonable steps
to remedy the condition giving rise to cancellation, threatened cancellation or reduction of coverage within forty-eight (48) hours after notice thereof by the
Landlord, the Landlord may, at its option, either:
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(i) re-enter the Premises forthwith by leaving upon the
Premises a notice in writing of its intention so to do and thereupon the provisions of Article 10.01 shall apply, or
(ii)
enter upon the Premises and remedy the condition giving rise to such cancellation, threatened cancellation or reduction, and the Tenant shall forthwith pay the
reasonable
costs thereof to the Landlord, which costs may be collected by the
Landlord as Additional Rent and the Landlord shall not be liable for any damage or injury caused to any property of the Tenant or of others located on the Premises as a result of any such re-entry or entry, as the case may be.
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(c)
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The Tenant covenants and agrees to bring to the immediate attention of the Landlord notice of any occurrence or other action which might give rise to a claim or
possible claim under any insurance policy obtained by the Landlord under this Lease.
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8.02
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Tenant’s Liability Except in cases of negligence or wilful misconduct by the Tenant, the Tenant and its agents shall not be liable or responsible in any way for
any loss of or damage or injury to any property belonging to the Landlord or to employees of the Landlord or to any other person while such property or person is on the Premises or in the Building whether or not such property has been entrusted to
employees of the Tenant by permission of the Landlord.
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Notwithstanding the forgoing, and unless
caused by the negligence or wilful misconduct of the Landlord or by those for whom the Landlord is in law responsible,
and subject to the Indemnification Obligations of each party, the
Tenant shall indemnify and save harmless the Landlord
from and against all
third party
liability, claims, damages, or expense due to or arising out of
(i)
any negligence or wilful misconduct of the Tenant or those for whom in the circumstances Tenant is responsible in law, in or
about the Premises, Common Areas and Service Areas, or
(ii)
any breach by the Tenant of any provision of this Lease, and including liability for injury or damage to the personal property of the Tenant’s employees or those for whom
in the circumstances Tenant is responsible in law.
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8.03
|
Insurable Interest / Indemnity
Regardless of any contribution by the Tenant to insurance premiums as provided for in this Lease, no insurable interest is
conferred upon the Tenant under policies carried by the Landlord, nor do such policies protect, defend or indemnify the Tenant in any way. The Landlord shall in no way be accountable to the Tenant regarding the use of any insurance proceeds arising
from any claim, and the Landlord shall not be obliged on account of such contributions to apply such proceeds to the repair or restoration of that which was insured.
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Where the Tenant may desire to receive indemnity by way of insurance for any property, work
or thing whatsoever, the Tenant shall insure same for its own account and
except as described elsewhere in this Lease,
shall not look to the Landlord’
s policies
for reimbursement or recovery in the event of loss or damage from any
cause, whether or not the Landlord has insured same and recovered therefor.
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8.04
|
Waiver of Subrogation
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(a)
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All policies written on behalf of the Tenant must contain a waiver of subrogation rights which the Tenant’s insurer may have against the Landlord and against those
for whom the Landlord is in law responsible, whether any such damage is caused by the act, omission or negligence of the Landlord or by those for whom the Landlord is in law responsible.
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(b)
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All such policies must also contain a severability of interest clause, a cross-liability clause and shall be primary and shall not call into contribution any other
insurance available to the Landlord or the Landlord’s mortgagee.
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8.05
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Form of Policy
All policies shall be taken out with insurers
maintaining at least an A.M. Best rating of at least A
-. The Tenant agrees that certificates
of
insurance will
be delivered to the Landlord within seven days after the placing of the required insurance.
Tenant shall
notify the Landlord in writing not less than sixty (60) days
after
any material change in terms,
cancellation or other termination thereof. The Tenant agrees that if the Tenant fails to take out or to keep in force any such insurance referred to in Article 6.15, and the Tenant does not rectify the situation within forty-eight (48) hours
after written notice by the Landlord to the Tenant the Landlord shall have the right, without assuming any obligation in connection therewith, to effect such insurance to protect the interests of the Landlord only at the sole reasonable cost of the
Tenant and all outlays by the Landlord shall be immediately payable by the Tenant to the Landlord as Additional Rent and shall be due on the first day of the next month following said payment by the Landlord without prejudice to any other rights and
remedies of the Landlord under this Lease or in law.
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ARTICLE 9.00 DAMAGE BY FIRE OR OTHER CASUALTY
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9.01
|
Damage and Abatement
If during the Term the Building or the Premises are destroyed by any cause whatsoever or partially destroyed by any cause
so as to render the Premises wholly unfit for operating, or incapable of access, or if the Building or the Premises shall be so badly damaged that, in the opinion of the Landlord, repairs cannot be completed within one hundred and twenty
(120) days of the occurrence of such damage, then this Lease, at the option of the Landlord, shall cease and become null and void from the date of such damage or destruction and the Tenant shall thereupon immediately surrender the Premises and
all interest therein to the Landlord, and the Tenant shall pay rent within this Term only to the date of such
damage and destruction
and in any such case, the Landlord may re-enter and repossess the Premises discharged from this Lease and may
remove all parties therefrom. If the Building or the Premises shall be repairable as aforesaid within one hundred and twenty (120) days from the happening of said damage, and, in the sole,
commercially reasonable
opinion of the
Landlord’s architect,
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the Premises cannot be used for the Tenant’s business until repaired, the rent shall abate until the repairs have been completed. If the destruction is such that, in the sole,
commercially reasonable
opinion of the Landlord’s architect, the Premises may be partially used by the Tenant while the repairs are being undertaken, then the rent shall abate in proportion that the part of the Premises rendered unusable
bears to the whole of the Premises; EXCEPT THAT if the part rendered unusable exceeds one-half of the area of the Premises there shall be a total abatement of rent until the repairs have been made unless the Tenant with the permission of the
Landlord uses the undamaged part in which event the Tenant shall pay proportionate rent for the part so used. The Landlord’s decision, Landlord acting in a commercially
reasonable manner
, that the repairs are completed and the Premises
are ready for operating shall be conclusive. There shall be no abatement of rent if the damage shall have been caused by or due to negligence of the Tenant, its employees, agents or invitees or if the cause of the damage originates in the Premises
unless such damage shall be caused by or due to the negligence of the Landlord, its employees, agents or invitees.
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9.02
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Destruction and Surrender
Notwithstanding Article 9.01, in the event of total or partial destruction of the Building, and whether or not the Premises are
destroyed to such an extent or the damage or destruction is of such a nature that, in the sole,
commercially reasonable
opinion of the Landlord the Building should be totally or partially demolished, whether to be reconstructed in whole or in
part or not at all, then the Landlord may at its option not later than sixty (60) days from the date of the damage or destruction give notice to the Tenant that this Lease is terminated effective on the date of destruction. If the Tenant is
able to effectively use the Premises after the damage or destruction, such effective date shall not be less than thirty (30) days from the date of sending the notice by the Landlord. If the Tenant is unable to effectively use the Premises after
the damage or destruction, the date given in the notice shall be the date of destruction. Upon such termination, the Tenant shall immediately surrender the Premises and all its interest therein to the Landlord and the rent shall abate and be
apportioned to the date of the surrender.
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9.03
|
Limitation of Tenant’s Ability to Recover
In none of the cases referred to in this Article shall the Tenant have any claim upon the Landlord for any damages
sustained by it unless such damage or destruction shall have been the result of any wilful act or negligence of the Landlord, its employees or agents.
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ARTICLE 10.00 DEFAULT
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10.01
|
Remedies of the Landlord on Default by the Tenant and Provisions For Entry
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(a)
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If the rental reserved in this Lease is not paid within
five (5) days of the
day appointed for its payment or in case of the non-payment of
any other sums which the Tenant under any provision of this Lease has agreed to pay, or in case the Premises are vacated or become vacant or remain unoccupied for five days or are not used for the purpose provided in
Article 6.01, or
a
receiver of all or a part of the Tenant’s assets or undertaking be appointed, or if a writ of execution is issued against the goods, fixtures or equipment of the Tenant, or in case the Tenant becomes bankrupt or insolvent or makes an assignment
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for the benefit of its creditors, repudiates the Lease, or having become bankrupt or insolvent takes the benefit of any Act that be in force for bankrupt or insolvent debtors, or makes a
proposal, or shall not observe, perform and keep all and every one of the covenants, agreements, provisions, stipulations and conditions herein contained to be observed, performed and kept by the Tenant, or if the Tenant shall make a bulk sale of
its
goods, the
full amount of the then current month’s Minimum Rent, unamortized Leasehold Allowances, Leasehold Loans or real estate commissions paid by the Landlord and all other rentals and the next six months’ Minimum
,
A
dditional and all other rentals shall immediately become due and payable, and the Landlord may immediately claim the same together with any arrears then unpaid and any other amounts owing to the Landlord by the Tenant under reserve of and
without prejudice to all other rights, remedies and recourses of the Landlord including the right to distrain for such rent and accelerated rent and, at the option of the Landlord, the Term shall immediately become forfeited and
determined.
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(b)
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If the Landlord obtains possession of the Premises as a result of the Tenant’s abandonment of same or by a decree from a court of competent jurisdiction, this
shall not be construed as an election to terminate this Lease unless Landlord provides Tenant with a written notice.
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(c)
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If at any time an action is brought for recovery of possession of the Premises, for the recovery of rental or any other amount due under the provisions of this Lease,
or because of a breach by act or omission of any other covenant herein contained on the part of the Tenant, and
the Tenant’s
breach is established, the Tenant shall pay to the Landlord all reasonable expenses incurred therefor.
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If at any time an action is brought for recovery of possession of the Premises, for the recovery of rental or
any other amount due under the provisions of this Lease, or because of a breach by act or omission of any other covenant herein contained on the part of the Landlord, and the Landlord’s breach is established, the Landlord shall pay to the
Tenant all reasonable expenses incurred therefor
.
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(d)
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Intentionally deleted.
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(e)
|
Intentionally deleted.
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(f)
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The Tenant hereby agrees, that for the purposes of this Lease, and any other Lease between the Tenant and the Landlord, in the event that the Tenant commences any
proceeding under or seeks protection under the Companies Creditors Arrangement Act (“CCAA”), the Landlord shall be considered to be a separate class of creditors distinct from any other class of creditors in any compromise, arrangement,
classification or scheme proposed under the CCAA.
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10.02
|
Non-Waiver of Default
The waiver or acquiescence of the Landlord of any default by the Tenant under any clause of this Lease or the regulations shall not be
deemed to be a waiver of such clause or any subsequent or other default thereunder.
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ARTICLE 11.00 TRANSFERS BY LANDLORD
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11.01
|
Sale, Conveyance and Assignment
Nothing in this Lease shall restrict the right of the Landlord to sell, convey, assign or otherwise deal with the Building or
Centre, subject only to the rights of the Tenant under this Lease.
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11.02
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Effect of Sale, Conveyance or Assignment
A sale, conveyance or assignment of the Building or Centre shall operate to release Landlord from liability from and
after the effective date thereof upon all of the covenants, terms and conditions of this Lease, express or implied, except as such may relate to the period prior to such effective date and the Tenant shall thereafter look solely to the
Landlord’s successor in interest in and to this Lease. This Lease shall not be affected by any such sale, conveyance or assignment, and the Tenant shall attorn to the Landlord’s successor in interest thereunder.
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11.03
|
Subordination
This Lease is and shall be subject and subordinate in all respects to any and all mortgages and deeds of trust now or hereafter placed on the
Building or Buildings or Land, and to all renewals, modifications, consolidations, replacements and extensions thereof.
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11.04
|
Attornment
If the interest of the Landlord is transferred to any person (herein called “Purchaser”) by reason of foreclosure or other proceedings for
enforcement of any such mortgage or deed of trust, or by delivery of a deed in lieu of such foreclosure or other proceedings, the Tenant shall immediately and automatically attorn to Purchaser.
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11.05
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Execution of Instruments
The subordination and attornment provisions of this Article 11.00 shall be self-operating and no further instrument shall be
required. Nevertheless the Tenant, on request by and without cost to the Landlord or any successor in interest, shall execute and deliver any and all instruments further evidencing such subordination and (where applicable hereunder) attornment and
appoint the Landlord as its agent/attorney for the purpose of executing such document and for registering postponements of Lease.
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ARTICLE 12.00 HOLDING OVER
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12.01
|
Month-to-Month Tenancy
If with the Landlord’s written consent the Tenant remains in possession of the Premises after the expiration or other termination of
the Term, the Tenant shall be deemed to be occupying the Premises on a month-to-month tenancy only, at a monthly rental equal to the Rent as determined in accordance with Article 4.00 or such other rental (such as market rent) as stated in such
written consent, and such month-to-month tenancy may be terminated by the Landlord or Tenant on the last day of any calendar month by delivery of at least 30 days advance notice of termination to the other.
Notwithstanding the foregoing, in the
event the Tenant and the Landlord are actively negotiating the renewal of Term of the Lease, the Landlord agrees the Tenant may hold over for a period of up to six (6) months, under the same terms and conditions including the then current
Minimum Rent.
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12.02
|
Tenancy at Sufferance
If without the Landlord’s written consent the Tenant remains in possession of the Premises after the expiration or other termination
of the Term, the Tenant shall be deemed to be occupying the Premises upon a tenancy at sufferance only, at a monthly rental equal to two times the Rent determined in accordance with Article 4.00 or market rent; whichever is higher. Such tenancy at
sufferance may be terminated by the Landlord at any time by notice of termination to the Tenant, and by the Tenant on the last day of any calendar month by at least 30 days’ advance notice of termination to the Landlord.
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12.03
|
General
Any month-to-month tenancy or tenancy at sufferance hereunder shall be subject to all other terms and conditions of this Lease except any right of
renewal and except any rights of first refusal on adjacent space and nothing contained in this Article 12.00 shall be construed to limit or impair any of the Landlord’s rights of re-entry or eviction or constitute a waiver thereof.
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ARTICLE 13.00 MISCELLANEOUS
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13.01
|
Expropriation
If at any time during the Term of this Lease, the whole or any part of the Building shall be acquired or condemned by expropriation, this Lease and
the Term hereby granted may, at the option of the Landlord, be terminated and the Term and the estate hereby vested in the Tenant and any and all other rights of the Tenant hereunder shall thereupon immediately cease and expire and the Rent shall
abate and be apportioned to the date of termination. The Tenant shall forthwith pay to the Landlord the rent and all other amounts which may be due to the Landlord up to the date of termination and shall immediately surrender the Premises to the
Landlord. The Tenant shall have no claim upon the Landlord for the value of the unexpired Term of this Lease. The parties shall each be entitled to separately advance their claims for compensation for the loss of their respective interests in the
Premises and the parties shall each be entitled to receive and retain such compensation as may be awarded to each respectively. If an award of compensation made to the Landlord specifically includes an award for the Tenant, the Landlord will account
therefor to the Tenant.
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13.02
|
Relocation
The Landlord and the Tenant hereby covenant and agree that the Landlord,
acting in a commercially reasonable manner
, shall have the option at
any time during the Term of this Lease, and upon ninety (90) days prior written notice to the Tenant, to relocate the Tenant to Alternate Premises of similar size and condition as the existing Premises (the “Alternate Premises”).
All Leasehold Improvements and moving costs required to bring Alternate Premises to a similar condition as the existing Premises shall be done at the sole cost and expense of the Landlord. The Landlord covenants to arrange the relocation of
the Tenant’s property and equipment at a time and in such a manner as not to substantially interfere with the Tenant’s business operations. If the Alternate Premises are larger in area, the Tenant shall pay rent based on the square footage
of this Lease, outlined in Clause 1.01 (a) herein. In the event that the Landlord and the Tenant cannot agree on the size, location or condition of Alternate Premises, then the Landlord and/or the Tenant shall have the right, sixty
(60) days prior to the date upon which the relocation was to take place, to advise the other party of its intention to terminate this Lease on the date originally intended for the relocation
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13.03
|
Regulations Form Part of Agreement
The regulations for the operation of the Building, annexed hereto as Schedule “F”, form part of this Lease and are
binding upon the parties hereto.
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13.04
|
Further Regulations
The Landlord shall have the right to make such other and further reasonable regulations as in its judgement may from time to time be
necessary for the safety, security, care and cleanliness of the Premises or of the Building and for the preservation of good order therein and such regulations shall be binding upon the parties hereto as if incorporated in this Lease.
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13.05
|
Entire Agreement and Survival This Lease and Schedules hereto constitute the entire agreement and no modification except as by written agreement between the Landlord
and the Tenant and neither party is bound by any representation, warranty, promise, agreement or inducement not embodied herein.
Those sections which by their nature would reasonably be interpreted to survive termination or expiration of this
Lease shall so survive.
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The Landlord has made no express representations or warranties and disclaims any
implied representations or warranties relating to the condition of the Building, Premises, or any part thereof, including, without limitation, the building systems (including the HVAC system), the indoor air quality within the Building and the
environmental condition of the Building. The Landlord shall not be liable for any latent or patent defects therein.
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13.06
|
Interpretation
Words importing the singular number only shall include the plural, and words importing firms and corporations shall include persons. Unless the
context otherwise requires, the word “Landlord” and the word “Tenant” whenever used herein shall be construed to include their respective successors and permitted assigns, and if the Tenant is not a corporation shall include
heirs, executors, and administrators.
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13.07
|
Loading and Delivery
The delivery and shipping of merchandise, supplies, fixtures, and other materials or goods of whatsoever nature to or from the Premises and
all loading, unloading and handling thereof shall be done only at such times, in such areas, by such means, and through such elevators, entrances, malls, and corridors as are designated by and co-ordinated with the Landlord. The Landlord accepts no
liability and is hereby relieved and released by Tenant in respect of the operation of delivery facilities, or the adequacy thereof, or of the acts or omission of any person or persons engaged in the operation thereof, or in the acceptance, holding,
handling, delivery or dispatch, or failure of any acceptance, holding, handling or dispatch, or any error, negligence or delay therein. Landlord may from time to time make and amend regulations for the orderly and efficient operation of the delivery
facilities and may require the payment of reasonable and equitable charges for delivery services and demurrage provided by the Landlord. (Refer to Schedule “F”, Item 1.14.)
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13.08
|
Temporary Obstruction
When necessary by reason of accident or other cause or in order to make any repairs or alterations or improvements in or relating to the
Premises or to other portions of the Centre, the Landlord may cause such reasonable and temporary obstruction of Common Areas as may be necessary and may, for such time as is reasonably necessary, interrupt or suspend the supply to the Premises of
heating, air-conditioning, electricity, water, elevator service and other services where necessary and until said repairs, alterations or improvements shall have been completed. There shall be no abatement in rent because of any such obstruction,
interruption or suspension provided that such repairs, alterations or improvements are made as expeditiously as is reasonably possible.
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13.09
|
Right to Alter / Demolish
The Landlord reserves the right to add or permit to be added additional Buildings and Lands to the Centre at any future time or times
and shall not be liable to the Tenant for any interference or inconvenience so caused, provided any additional construction is carried out as expeditiously as is reasonably possible.
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Notwithstanding anything herein contained to the contrary, the Landlord and the Tenant hereby covenant and agree that the Landlord shall
have the right to demolish or substantially renovate or redevelop the Building at any time during the term of this Lease. It is further agreed between the parties that if the Landlord intends to proceed with the demolition or substantial renovation
or redevelopment of the Building, and if the said demolition and/or renovation and/or redevelopment of the Building shall directly affect the Premises, then the Landlord shall deliver to the Tenant written notice of its intention to perform the
same, and said notice shall stipulate a date, not less than ninety (90) days from the date of said notice, upon which date this Lease shall terminate with the same force and effect as if this Lease had expired by its own terms on that day, and
upon which date the Tenant shall deliver the Premises to the Landlord, and all of the Tenant’s rights under the Lease shall be cancelled and terminated as of that date.
All materials used in connection with the alteration or refurbishment of the Premises, including, without limitation, paint, carpet, wall or window coverings, carpet glues, and other chemicals, shall be
subject to Landlord’s prior written approval. Any such approval shall not be deemed a representation or warranty that the materials so approved are in compliance with laws (including indoor air quality laws) or that same do not affect the
indoor air quality in the Premises.
Also, the Tenant must ensure the insurance carried by the contractor names the Landlord as
additional insured.
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13.10
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Merger
The voluntary or other surrender of this Lease by the Tenant or the cancellation of this Lease by mutual agreement of the Tenant and the Landlord shall
not be considered a merger, and shall, at the Landlord’s option, either terminate all or any subleases and subtenancies or operate as an assignment to the Landlord of all or any subleases or subtenancies. The Landlord’s option hereunder
shall be exercised by notice to the Tenant and all sublessees or sub-tenants in the Premises or any part thereof known to the Landlord.
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13.11
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Applicable Law
This Lease shall be governed by and interpreted in accordance with the laws of the Province of Nova Scotia. The parties agree that the courts of
such province shall have jurisdiction to determine any matters arising hereunder, except to the extent, if any, expressly provided to the contrary herein, and the parties hereby attorn to the jurisdiction of the courts of such province.
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13.12
|
Binding Effect
It is further agreed between the parties hereto that the signing of this Lease by the Tenant does not constitute a binding agreement until such
time as this Lease shall have been accepted by the Landlord, through execution by its proper officers.
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13.13
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Commissions The Landlord agrees to pay Partners Global Corporate Real Estate Inc. (“Tenant’s Consultant), a Consultant’s Fee, comprising the sum of
THREE DOLLARS ($3.00) per square foot of rentable area of the Premises. The Consultant’s Fee plus Harmonized Sales Tax shall be payable upon the earlier of execution of the Lease Document or the date the Tenant occupies the Premises for
business purposes
.
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13.14
|
Force Majeure
Notwithstanding anything to the contrary contained in this Lease, if the Landlord hereto shall be bona fide delayed or hindered in or prevented
from the performance of any term, covenant or act required under the said Lease, by reason of strikes, labour troubles, inability to procure materials, or services, failure of power, restrictive governmental laws and regulations, riots,
insurrection, sabotage, rebellion, war, act of God, or other reason whether of a like nature or not, not the fault of the party delayed in performing work or doing acts required under the terms of this Lease, then performance of such Term, covenant
or act shall be excused for the period of delay and the period for the performance of any such Term, covenant or act shall be extended for a period equivalent to the period of such delay.
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13.15
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Registration Tenant shall register lease in short form only.
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13.16
|
Limitation of Landlord’s Liability Except in cases of gross negligence or wilful misconduct, i
f at any time during the Term the Landlord is a partnership,
joint venture or co-tenancy, the Tenant shall look solely to the assets of such partnership or joint venture or the co-tenants’ interest in the Centre, whichever shall be the case, for the collection or satisfaction of any money or judgement
which the Tenant may recover against the Landlord, and the Tenant shall not look for the collection or satisfaction of any such money or judgement to the personal assets of any person who shall at any time be a partner, joint venturer or co-tenant
in or under such partnership, joint venture or co-tenancy.
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13.17
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Limitation on Length of Term
This Lease is entered into subject to the express condition that it is to be effective to create any interest in land only if the
provisions of any statute relating to the severance of land or interest in land by conveyance or otherwise (as it may from time to time be amended) are complied with. The Landlord and the Tenant agree, as a separate and distinct agreement, that if
pursuant to any statute consent is requisite to the validity of this Lease, either party may apply for such consent and until unconditional consent has been obtained, the Term of this Lease or any renewal thereof shall not extend beyond the period
permitted without consent pursuant to any such statute, with no further right on the part of the Tenant to extend the Term, notwithstanding any other provision of this Lease.
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- 36 -
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13.18
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Environment Landlord covenants, warrants and represents, to its commercially reasonable knowledge, the Premises and the Building are free of any friable
asbestos-containing materials.
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Landlord covenants, warrants and represents, to its commercially
reasonable knowledge, the Premises and the Building (including the land there under) do not contain any environmental contaminants (“Toxic Contamination”) of any kind (including PCBs, except for PCBs that are totally contained within light
fixtures and exterior transformers).
Without limiting the generality of the obligations of the Landlord as set out
elsewhere in this Lease, the Landlord and Tenant agree that the Tenant is subject to the obligations of the Tenant set out in this Article (the “Environmental Obligations”).
In this Article:
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(a)
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“Hazardous Substance” means any product of waste, contaminant, pollutant, dangerous substance, potentially dangerous substance, noxious substance, toxic
substance, hazardous waste, flammable, explosive, radioactive material, chlorofluorocarbons (CFC’s), radon gas, urea formaldehyde foam insulation, asbestos, PCBs, gasoline, fuel oil, and any other substances or materials, and includes any
Container (as hereinafter defined), declared or defined, at any time and from time to time, to be or to potentially be hazardous, toxic, contaminants or pollutants in or pursuant to any applicable federal, provincial, municipal or quasi-governmental
law, statute, regulation, order, by-law or requirement in force from time to time (collectively, in this Article, “Legislation”) including, without limitation, environmental, land use, building, occupational, or health and safety
Legislation, Legislation in respect to demolition of buildings, excavation of soil, building materials and component fixtures and fittings, and storage and disposal of waste or effluent, and Legislation with respect to the maintenance, conversion
and replacement of Containers.
Notwithstanding the foregoing however, the definition of “Hazardous Substance” shall not include those items which a reasonable tenant of a like nature would use in the ordinary course of business, or in
the ordinary maintenance of such a business;
and
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(b)
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“Container” means any equipment, plant, pump, tank, container, receptacle, and any manner, method or procedure, which generates, manufactures, refines,
treats, transports, stores, contains, uses, handles, disposes of, transfers, produces or processes Hazardous Substances; and
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(c)
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“Remove” means to remove any Hazardous Substance from all or part of the Leased Premises and includes, without limitation, the removal, cleanup, treatment,
transportation, storing, containment, handling, disposal, transfer and/or processing thereof, and “Removed” and “Removals” have similar meanings.
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- 37 -
The Tenant shall not use or permit or suffer the use, directly or indirectly, of all or part
of the Leased Premises for any acts or omissions (“Activities”) that are not in compliance with all Legislation and permits granted thereunder. It shall be the responsibility of the Tenant to obtain all permits necessary for the use of the
Hazardous Substances on the Leased Premises.
The Tenant shall:
(i) Ensure that all construction work which is the responsibility of the Tenant under this Lease will comply with all Legislation and
without limiting the generality thereof will ensure that anyone working with Hazardous Substances is, where necessary, duly qualified, accredited and registered with all bodies having jurisdiction thereover; and
(ii) Ensure that all construction work which is the responsibility of the Tenant under this Lease, will comply with all Legislation; and
(iii) Remove at its sole cost and risk any Hazardous Substances not stored in a Container kept in accordance with all
Legislation. If any such Hazardous Substance is not removed forthwith by the Tenant, the Landlord shall be entitled but shall not be obligated, to remove same on the Tenant’s behalf and the Tenant shall reimburse the Landlord for the
reasonable
cost thereof together with administrative costs equal to fifteen (15%) percent of such costs to the Landlord. The Tenant shall also notify the Landlord if the Tenant receives notice of any violation or alleged violation of any
Legislation or that any administrative order is made or is proposed to be made against the Tenant or the Landlord or in respect of any part of the Leased Premises or the Centre in which the Leased Premises is located with respect to any Hazardous
Substance and otherwise ensure that the entire premises comply with all Legislation with respect to Hazardous Substances.
In
the event of a material violation of Legislation of a significant release of a noxious substance on or from the Leased Premises, or of the discovery of an environmental condition requiring response which violation, release, or environmental
condition is due to the negligence, wilful misconduct, or illegal action of the Tenant, its agents, employees, or invitees, the Landlord shall (in all cases, acting reasonably) have the right to enter the Leased Premises, to supervise and approve
any actions taken by the Tenant to address the material violation, release or environmental condition; and in the event the Tenant fails to lawfully address such violation, release, or environmental condition, the Landlord may perform, at the
Tenant’s reasonable expense and without unreasonable interference with the Tenant’s business activity, any lawful actions necessary to address the material violation, significant release, or environmental
condition.
The
provisions set out in this Clause shall survive the expiration or earlier termination of the Term of this Lease.
The Tenant will cooperate with the Landlord and will, at any
reasonable
time, allow Landlord and Landlord’s representatives
reasonable
access to any Tenant’s records with respect to the Premises for environmental inspection purposes. The Tenant will make
reasonably
available its personnel to respond to
reasonable
interview questions posed by
Landlord, Landlord’s representatives, or an environmental consultant.
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13.19
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Recycling
The Tenant covenants and agrees, at its sole cost and expense, to comply with all present and future laws, orders, and regulations of all provincial,
federal, municipal, and local governments, departments, commissions, and boards regarding the collection, sorting, separation, and recycling of waste products, garbage, refuse, and trash. Tenant shall sort and separate such waste products, garbage,
refuse, and trash into such categories as provided by law.. Each separately sorted category of waste products, garbage, refuse, and trash shall be placed in separate receptacles reasonably approved by the Landlord. Such separate receptacles may, at
the Landlord’s option, be removed from the Premises in accordance with a collection schedule prescribed by law. Also, Landlord,
upon reasonable notice to Tenant and provided Tenant fails to respond to such notice within three
(3) business days
, shall sort and separate all waste products, garbage, refuse and trash and charge the Tenant all
reasonable
costs involved in such recycling.
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The Landlord reserves the right to refuse to collect or accept from the Tenant any waste products, garbage, refuse, or trash that is not
separated and sorted as required by law, and to require the Tenant to
reasonably
arrange for such collection at the Tenant’s sole cost and expense, utilizing a contractor
reasonably
satisfactory to the Landlord.
Except in cases
of the Landlord’s negligence or wilful misconduct,
the Tenant shall pay all
reasonable
costs, expenses, fines, penalties, or damages that may be imposed on the Landlord or the Tenant by
sole
reason of the Tenant’s failure
to comply with the provisions of this section 13.19, and, at the Tenant’s sole cost and expense
and subject to the Indemnification Obligations of each party,
shall indemnify, defend, and hold the Landlord harmless (including legal fees
and expenses) from and against any actions, claims, and suits arising from such noncompliance, utilizing counsel reasonably satisfactory to the Landlord.
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13.20
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No Exclusive
The Tenant does not have the benefit of an exclusive-use restriction and nothing in the Lease will be implied to give the Tenant the benefit of one,
even where other tenants in the Building or the Centre may compete with the Tenant’s business.
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13.21
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Shorter Statute of Limitations Except with regards to any indemnification obligations herein,
any claim, demand, right, or defense by
a party
that arises
out of this Lease or the negotiations that preceded this Lease shall be barred unless the
party
commences an action thereon, or interposes a defense by reason thereof, within
two years
after the date of
discovery of
the
inaction, omission, event, or action that gave rise to such claim, demand, right, or defense.
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Each party
acknowledges and understands, after having consulted with its legal counsel, that the purpose of the above paragraph is to shorten the period within which the
party
would otherwise have to raise such claims, demands, rights, or defenses under
applicable laws.
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13.22
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No Presumption against Drafter
The Landlord and the Tenant understand, agree, and acknowledge that this Lease has been freely negotiated by both parties; and
that, in any controversy, dispute, or contest over the meaning, interpretation, validity, or enforceability of this Lease or any of its terms or conditions, there shall be no inference, presumption, or conclusion drawn whatsoever against either
party by virtue of that party having drafted this Lease or any portion thereof.
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13.23
Indemnifier
Deleted in its entirety.
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- 39 -
ARTICLE 14.00 NOTICE
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(a)
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Any written notice or demand to be given by the Tenant to the Landlord pursuant to this Lease shall be served upon the Landlord personally or sent by registered mail or
by courier service to the Landlord, Attention: The President, 115 King Street, Stellarton, Nova Scotia, B0K 1S0, or to the address as designated by the Landlord from time to time in writing with a copy to the Comptroller and the Property
Administration Office.
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(b)
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Any written notice or demand to be given by the Landlord to the Tenant pursuant to this Lease shall be served upon the Tenant personally or sent by
registered mail or by courier service to the Tenant at the Premises or to the Tenant at such other address as the Tenant may designate from time to time in writing.
In any event, a copy of such notice or demand shall also be simultaneously
sent by registered mail to the Tenant, Attention: General Counsel, 411 108
th
Ave NE, Ste 1400, Bellevue, WA 98004.
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(c)
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Any notice served hereunder by registered mail or by courier service shall, except for delays caused by interruption of postal or courier service through strikes or
lockouts, be deemed delivered on the second business day following mailing or delivery to the courier service.
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Signing Page Immediately Follows.
IN WITNESS WHEREOF
the parties hereto have executed this indenture by affixing their corporate seals by their authorized officers in that behalf, or by the Tenant’s signature hereto, as at the
date first above written.
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SIGNED, SEALED AND DELIVERED
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in the presence of
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CROMBIE DEVELOPMENTS LIMITED
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(the “Landlord”)
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Witness
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- 40 -
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DS DISTRIBUTION CANADA LIMITED
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(the “Tenant”)
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Witness
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- 45 -
- 46 -
SCHEDULE “C”
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1.01
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The Premises shall be turned over to the Tenant on an “as-is, where-is” basis with the following leasehold improvements performed and completed by the
Landlord on or before March 31, 2011:
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(a)
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Existing Architect & Engineering Drawings & Specifications: “Ás-is, Where-is”.
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(b)
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HVAC:
Primary system distributed and zoned consistent with the Premises in accordance with Tenant’s final design criteria and of adequate capacity to
fulfil the solar loads, people loads of one person per 100 square feet, lighting load of 1.5 watts per usable square foot, and equipment power loads of 3.0 watts per usable square foot (excluding power requirements for any of the Building’s
equipment). Separate zoning should also be provided for each area with different thermal characteristics. System shall have an economizer cycle. System must meet these temperature requirements: Summer 75 degrees F (+/- 2 degrees) with 55%
relative humidity, Winter 72 degrees F (+/- 2 degrees) with 30% relative humidity; Fresh outdoor air ventilation to provide minimum 20 CFM per person. System shall also be distributed and zoned to provide separate 24/7 cooling to Tenant’s
server room based on Tenant’s requirements to be provided and approved by the Landlord, such approval not to be unreasonably withheld. Water for cooling to be separately metered at the Tenant’s sole expense and responsibility, and paid for
by the Tenant.
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Washroom’s:
The Landlord shall upgrade the men’s and women’s washrooms
on the floor,
to the Landlord’s standard base building finishes.
Ceiling:
The Landlord shall supply and
install ceiling tiles throughout the Premises to replace any of those existing that are damaged or broken
as of the date of actual occupancy.
Lighting:
The Landlord shall supply and install building standard lighting fixtures throughout the Premises to replace any of those existing that are damaged or broken
as of the date of actual
occupancy
.
Window Coverings:
Building standard roller blinds with 95% reduction of light penetration, to be
supplied and installed
by Landlord
on all exterior windows.
Fire & Safety Systems:
Landlord to provide
and install all required fire hose cabinets and all other life safety systems in accordance with Building Codes
as it presently exists.
Corridors & Elevators:
Complete common area corridors and elevator lobby upgrades based on a standard to be mutually agreed upon, both parties acting reasonably.
Handicap Access:
The main
level and exterior access to the Building shall be fully handicap accessible
as it presently exists.
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2.01
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Save and except the Landlord’s Work outlined in Article 1.01 of this Schedule “C”, the Tenant Shall Supply to the Premises:
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(a)
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All internal partitioning, including decorating.
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(b)
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All electrical and telephone outlets, light switching and the necessary wiring from the electrical room. Minimum light switching 1 switch for each 900 square feet.
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(c)
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All special air-conditioning, heating and ventilation requirements over and above the Building standard including all operational costs associated therewith.
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(d)
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All plumbing and mechanical changes, subject to the prior written approval of the Landlord, not to be unreasonably withheld.
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(e)
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All other special requirements, such as telephone conduit and service, additional or relocation of lighting fixtures and wiring made necessary by the Tenant’s
plan, all subject to final approval of the Landlord, not to be unreasonably withheld.
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(f)
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Supply and installation of electrical and water meters to computers or other specialized equipment.
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SCHEDULE “D”
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(a)
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The Tenant shall pay the Landlord as Additional Rent the “Tenant’s Proportionate Share of taxes”. The “Tenant’s Proportionate Share
of taxes” shall be defined as the proportion thereof equal to the product obtained by multiplying such taxes by a fraction the numerator of which is the floor area of the Premises and the denominator of which is the aggregate of all Rentable
Space in the Building of which the Premises form a part.
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(b)
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If taxes increase by reason of any installation made in or upon, or any alterations made in or upon the Premises by the Tenant, the Tenant shall pay the amount of such
increase as Additional Rent.
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(c)
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The Landlord shall determine the appropriate percentage of municipal taxes and fire protection rates payable by the Landlord in respect of the Building and the Lands
described in Schedule “B” of the Lease.
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SCHEDULE “E”
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(a)
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The Tenant agrees to pay to the Landlord, as Additional Rent, a proportionate share determined in the manner prescribed in this Clause of the Operating Costs of the
Building, which the Landlord deems to be applicable to the operation of the Building.
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(b)
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“Operating Costs”
shall, for the purpose of this Clause, include commercially reasonable amounts paid or allocated by the Landlord or by others on behalf
of the Landlord for the operation of the Building and for complete maintenance, repair and janitorial services for the Building or components therein and Land or components thereon provided that if the Building is less than one hundred percent
(100%) occupied during any part of a calendar year, Operating Costs shall mean the amount obtained by adjusting the actual Operating Costs for such calendar year to a one hundred percent (100%) Building occupancy level, such adjustment to
be made by adding to the actual Operating Costs during such calendar year such additional costs as would have been incurred if the Building had been one hundred (100%) percent occupied. Without limiting the generality of the foregoing,
Operating Costs shall include (in each case, reasonable costs), without duplication; the costs of all repairs required in the maintenance of the Building, electricity not otherwise chargeable to the Tenant, air-conditioning and window cleaning, all
fire, casualty, liability and other insurance, the amount paid under service contracts with independent contractors, salaries, wages and other remuneration and the costs of benefits paid to employees of the Landlord engaged in administering,
operating and maintaining the Building the fair market rental value, prevailing from time to time, of space occupied by the Landlord’s agents or employees for administrative, supervisory or management purposes relating to the Building and the
Land and all other expenses paid or payable by the Landlord in connection with the operation of the Building but excluding taxes and capital expenditures, excepting those amounts expended of a capital nature, which in the Landlord’s opinion
will reduce energy consumption or improve efficiency for the purpose of reducing Operating Costs. Any provision for depreciation on or in respect of the Building, interest on debt or capital retirement of debt and any amounts directly chargeable by
the Landlord to any tenant or tenants of the Building or the proceeds realized by the Landlord from any insurance claims made by the Landlord in connection with repairs or rebuilding done by the Landlord, will be excluded in computing Operating
Costs.
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(c)
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There shall be included in Operating Costs, management and/or administration fees equal to fifteen percent (15%) of Clause 1:00 (b) above.
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(d)
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The Tenant’s Proportionate Share shall be the same proportion of the Operating Costs of the Building which the Landlord
reasonably
deems to be applicable to
the operation of the Building as the total floor area of the Premises bears to the total floor area of the Rentable Space in the Building.
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(e)
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Prior to the beginning of each calendar year or as soon thereafter as possible, the Landlord shall furnish the Tenant with a statement showing an estimate of Operating
Costs. The Tenant shall pay to the Landlord the Tenant’s Proportionate Share of the said estimated cost in equal monthly instalments on the first day of each month throughout the calendar year.
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(f)
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Within a reasonable period of time following the end of each calendar year, the Landlord shall furnish the Tenant with an audited statement of the actual Operating
Costs of the Building which the Landlord deems to be applicable to the operation of the Building thereof and the actual amount thereof payable by the Tenant, showing in reasonable detail all information relevant and necessary to the exact
calculation and determination thereof. If such amount is greater or less than the payment on account thereof made by the Tenant, adjustments will be made between the parties hereto within thirty (30) days after delivery of such statement.
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SCHEDULE “F”
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1.01
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REFUSE:
The Tenant shall keep the Premises free of rubbish and debris at all times and shall provide receptacles for waste and rubbish.
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1.02
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CLEANLINESS:
The Tenant shall leave the Premises in a reasonably tidy condition at the end of each business day to facilitate the performance by the Landlord of
the cleaning services referred to in the Lease.
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1.03
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FIRE PRECAUTIONS:
The Tenant shall at all times exercise and take reasonable precautions to protect the Premises against damage by fire or other cause.
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1.04
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OBSTRUCTIONS:
The Tenant shall not encumber or obstruct the hallways, passageways, stairways, elevators, emergency exits or other parts of the Common Areas of
the Building or allow the same to be encumbered or obstructed, or used for any purpose other than ingress to and egress from the Premises.
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1.05
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MERCHANDISE DISPLAY:
The Tenant shall not without prior consent in writing keep or display any merchandise in any area of the Building other that the Premises.
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1.06
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QUIET USE OF PREMISES:
The Tenant shall not cause or permit any unusual or objectionable noises or odours to emanate from the Premises of the Building. If the
Tenant desires telegraphic or telephonic connections, the Landlord will direct the electricians as to where and how the wires are to be introduced, and without such directions,
which will not be commercially
unreasonably withheld
, no
boring or cutting of wires will be permitted. No pipes or electric wires will be permitted which have not been ordered or authorized in writing by the Landlord,
provided that such authorization will not be commercially unreasonably withheld.
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1.07
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PROPER CONDUCT:
Any business or other activity carried on by the Tenant which may
reasonably
harm or tend to harm the business or reputation of the
Landlord, or reflect or tend to reflect unfavourably on the operation of the Building as a first class office building shall be immediately discontinued by the Tenant
reasonably soon after
the request of the Landlord.
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1.08
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WATER FIXTURES:
The toilets, wash basins and other plumbing fixtures shall not be used for any purpose other than those for which they were constructed, and no
sweepings, rubbish, rags, or other substances shall be thrown therein. All damages resulting from any misuse of the fixtures shall be borne by the Tenant who, or whose servants, employees, agents, visitors or licensees shall have caused the same.
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1.09
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BICYCLES, ANIMALS:
No bicycles, vehicles or animals or birds of any kind shall be brought into or kept in or about Building or Premises.
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1.10
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USE OF PREMISES:
The Premises shall not be used for lodging, for sleeping or for any illegal purpose, and no cooking (except by microwave) shall be done therein
without the written consent to the Landlord. No part of the Premises shall be used for manufacturing, for the storage of merchandise, or for the sale of merchandise, goods or property of any kind.
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1.11
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HAZARDOUS MATERIALS:
The Tenant shall not bring or keep upon the Premises any corrosive, inflammable, combustible, explosive, or other hazardous materials.
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1.12
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LOCKS:
The Tenant shall not place any additional locks or bolts of any kind upon any of the doors of the Premises or change any of the existing locks or
mechanisms thereof, as supplied by the Landlord.
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1.13
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BUILDING SECURITY:
The Landlord reserves the right to exclude from the Building, at all times except the normal business hours, all persons who do not present a
pass to the Building issued by the Landlord at the Tenant’s expense or upon instructions from the Tenant. Each tenant shall be responsible for all persons for whom such passes are issued and shall be liable to the Landlord for all those
persons. The Landlord may require such persons to register in books kept by the Landlord when entering and leaving. The Landlord shall be under no responsibility for failure to enforce this regulation.
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1.14
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TRANSPORTING OF GOODS:
The carrying in or out of safes, freight furniture or bulky matter of any description must take place during the hours which the Landlord
or its agents may
reasonably
determine from time to time. The Landlord reserves the right to inspect all freight to be brought into
or through the Building
and to exclude from the Building all freight which violates any of these
regulations, and all damage to the Building occasioned
by the Tenant’s handling of such violating freight
shall be repaired at the expense of the Tenant. Only hand trucks equipped with rubber tires and sideguards and such other
safeguards as the Landlord may require shall be used in the delivery of transportation of goods or materials in the Building.
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1.15
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SOLICITATION:
Canvassing, soliciting and peddling in the Building without the express permission of the Landlord is prohibited and each tenant shall cooperate to
prevent the same.
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1.16
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WORK REQUESTS:
The requirements of the tenants of the Building will be attended to only upon application at the office of the Landlord. Building service
employees shall not perform any work or do anything outside their regular duties, unless under special instruction from the Landlord.
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1.17
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WINDOW CLEANING:
The Tenant shall permit window cleaners to clean the windows of the Premises during normal business hours.
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1.18
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SALE OF FOOD ITEMS:
The Tenant shall not install or permit the installation or use of any
additional machine(s)
dispensing goods for sale in the Premises
of the Building or permit the delivery of any food or beverage to the Premises without the approval of the Landlord or in contravention of any regulations fixed or to be fixed by the Landlord. Only persons authorized by the Landlord shall be
permitted to deliver or to use the elevator in the Building for the purpose of delivering food or beverages to the Premises.
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1.19
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ENCUMBRANCES:
Tenants or other occupants shall not encumber the window sills, or any part of the Building or Premises with goods, packages, flower pots or any
other articles.
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1.20
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OBSTRUCTION OF HVAC UNITS:
The Tenant shall not place furniture, or other objects so as to impede the air circulation of the Heating Ventilation and Air-
conditioning System.
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1.21
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SMOKING:
The Tenant, employees and invitees, shall not be permitted at any time to smoke tobacco products anywhere in the Common Areas of the Building. Common
Area includes elevators, elevator lobbies, corridors, washrooms, stairwells, stair landings, interior and exterior building entrances and main building lobby.
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1.22
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HAZARDOUS WASTE:
The Tenant shall not store, warehouse, transport within the Premises any toxic, hazardous chemicals or substances without the prior knowledge
and approval of the Landlord. Such chemicals or substances are to be maintained and stored as per “Hazardous Waste and Disposal Act” and any other such precautions as may be now or in the future required by law; failure to strictly comply
with such requirements constitutes an event of default allowing the Landlord the right in the Landlord’s sole,
commercially reasonable
discretion, to exercise any remedy available under the Lease, including terminations of this Lease.
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SCHEDULE “G”
RENEWAL
Providing that the Tenant duly and regularly performs each and every of the covenants, provisos and agreements herein contained on the
part of the Tenant to be paid, done and performed and subject to receipt of the written request of the Tenant not less than twelve (12) months before the expiration of the said Term and provided that such covenants, provisos, agreements and
rents are determined by negotiation prior to the expiry herein, the Landlord will, on the expiration of the Term hereby demised, grant to the Tenant a renewal of Lease for
one (1)
term of
Five
(
5
) years on the
Landlord’s then current Lease form, subject to such covenants, provisos, agreements and rents as may be determined by negotiation between the parties.
Minimum Rent shall be determined by the then current fair market rate.
If the parties
cannot agree on the terms of the Renewal by the Termination Date this Renewal is null and void. Any broker services retained by the Tenant for the purpose of renewing this Lease shall be paid by the Tenant to the complete exoneration of the
Landlord.
SCHEDULE “H”
LEASEHOLD ALLOWANCE
The Landlord agrees to pay to the Tenant,
an amount equal to
($
20.00
)
Twenty dollars and zero cents
per square foot of the Floor Area of the Premises (excluding GST or any other tax
imposed including but not limited to any Harmonized Sales Tax levied under the Excise Tax Act of Canada) (
the “Leasehold Allowance”)
. Said amount to be used by the Tenant to pay for the construction of the leasehold improvements of
the Premises
outlined under the heading “Tenant’s Work” in Schedule “C”
herein, which when installed in the Premises become the property of the Landlord and the Tenant will not use said Leaseholds to secure financing
for the Tenant. Said amount shall be due and payable by the Landlord to the Tenant during the original Term of the Lease.
In the event the Tenant’s leasehold improvements do not require the full amount of the Leasehold Allowance, the excess
funds can be used to offset the payment of Minimum and Additional Rent from the Commencement Date until exhausted, upon written direction by the Tenant.
The Landlord has the right to offset the Leasehold Allowance against arrears on the
Tenant’s account. The following must be completed prior to payment being processed:
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(i)
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the Tenant has sent the Landlord receipted invoices for work done to the Premises;
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(ii)
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the applicable Mechanic’s Lien or Construction Lien period has ended, and no lien has been registered;
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(iii)
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the Tenant has sent an invoice to the Landlord for the Allowance amount and GST or any other tax imposed including but not limited to any Harmonized Sales Tax levied
under the Excise Tax Act of Canada.
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(iv)
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the Tenant’s Tax Registration number under the Excise Tax Act of Canada is on the invoice;
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(v)
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a Statutory Declaration is completed by the Tenant to confirm that the Tenant’s contractors have been paid;
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(vi)
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the Lease is fully executed by both parties;
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(vii)
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the Tenant is not in default under this Lease;
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(viii)
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the Tenant is open for business to the public;
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(ix)
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the Tenant’s account is paid up-to-date.
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(x)
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Tenant Work under Schedule “C” is complete and there are no construction deficiencies in the Premises.
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It is agreed and understood that the Tenant, at the Tenant’s option, shall have the right to complete its Tenant’s Improvements between
November 1, 2010 and March 31, 2011 or thereafter, subject to approval from Nova Scotia Power Incorporated, and upon completion, the Tenant, shall have the right to receive payment of the Leasehold Allowance subject to completion of items
(i) through (x) herein.
The Landlord, at the Tenant’s option, agrees to manage Tenant’s Improvements based on an
administration fee of 10%.
Exhibit 10.16
SECOND AMENDMENT TO INDUSTRIAL BUILDING LEASE
THIS SECOND AMENDMENT TO
INDUSTRIAL BUILDING LEASE (“
Second Amendment
”) is made to be effective the
18th
day of November, 2010, by and between US INDUSTRIAL REIT II, a Texas real estate investment trust (“
Landlord
”),
and DRUGSTORE.COM, INC., a Delaware corporation (“
Tenant
”).
W
I
T
N
E
S
E
T
H
WHEREAS
, Landlord and Tenant’s predecessor-in-interest, DS
Distribution, Inc., a Delaware corporation, entered into that certain Industrial Building Lease dated June 20, 2007, as amended by that certain First Amendment to Industrial Building Lease dated October 10, 2007 (collectively, the
“
Lease
”) pursuant to which Landlord agreed to lease to Tenant and Tenant agreed to lease from Landlord, certain Premises containing 85,080 Rentable Square Feet known as Suite 300 in the building located at 1130 Commerce
Boulevard, Logan Township, New Jersey (the “
Building
”); and
WHEREAS
, Landlord and Tenant
desire to extend the Lease Term for an additional period of twenty-four (24) months and to further modify the Lease as set forth herein.
NOW, THEREFORE
, in consideration of the mutual covenants and agreements set forth herein and in the Lease, Landlord and Tenant agree to amend the Lease as follows, said provisions to control
whenever inconsistent with the original provisions of the Lease, and the capitalized terms herein shall have the same definitions as set forth in the Lease unless stated otherwise herein:
1.
Expiration Date
. Section 1.9 of the Lease is hereby deleted in its entirety and replaced with the following:
“1.9
Expiration Date
. February 28, 2013.”
2.
Term
. The following language is hereby added to the end of Section 1.7 of the Lease:
“Effective March 1, 2011 (the “
Renewal Date
”), the Term is extended for the entire Premises for an additional twenty-four (24) months (the “
Renewal
Term
”) to expire on the Expiration Date.”
3.
Basic Rent
. The following language is hereby added to
the end of Section 1.12:
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Month(s)
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Approximate
Annual Rate (RSF)
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Monthly
Basic Rent
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Annual
Basic Rent
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03/01/2011 – 02/28/2013
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$
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4.58
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$
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32,472.20
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$
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389,666.40
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4.
Condition of
the Premises
. Tenant acknowledges that Landlord has no obligation to improve the Premises and Tenant ACCEPTS THE PREMISES “AS IS”, “WHERE IS” AND WITH ANY AND ALL FAULTS. LANDLORD NEITHER MAKES NOR HAS MADE ANY
REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED, WITH RESPECT TO THE QUALITY, SUITABILITY OR FITNESS THEREOF OF THE PREMISES, OR THE CONDITION OR REPAIR THEREOF. TENANT’S OCCUPYING THE PREMISES SHALL BE CONCLUSIVE EVIDENCE FOR ALL PURPOSES OF
TENANT’S ACCEPTANCE OF THE PREMISES IN GOOD ORDER AND SATISFACTORY CONDITION, AND IN A STATE AND CONDITION SATISFACTORY, ACCEPTABLE AND SUITABLE FOR THE TENANT’S USE PURSUANT TO THE LEASE.
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SECOND AMENDMENT TO INDUSTRIAL BUILDING LEASE
1130 Commerce Boulevard – DS Distribution, Inc.
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PAGE 1
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5.
Brokerage
. Except for The Flynn Company which represents Landlord and Studley
which represents Tenant (collectively, “
Broker
”), Tenant and Landlord each represent that it has not had dealings with a real estate broker, finder or other person with respect to this Second Amendment in any manner. Tenant
and Landlord each agree to indemnify and hold the other harmless of and from any and all loss, costs, damages or expenses (including, without limitation, all attorneys’ fees and disbursements) by reason of any claim of or liability to any
broker or person claiming through the indemnifying party and arising out of or in connection with the negotiation, execution and delivery of this Second Amendment. Broker will be compensated by Landlord pursuant to the terms of a separate agreement
between Landlord and Broker.
6.
Continued Effect
. Except as otherwise provided in this Second Amendment, all other
provisions of the Lease shall remain unmodified and in full force and effect.
7.
Counterparts
. This Second Amendment
may be executed in one or more counterparts, each of which shall constitute an original and all of which shall be one and the same agreement.
8. In the event of a conflict between this Second Amendment and any other provision of the Lease this Second Amendment shall control.
[SIGNATURES ON FOLLOWING PAGE]
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SECOND AMENDMENT TO INDUSTRIAL BUILDING LEASE
1130 Commerce Boulevard – DS Distribution, Inc.
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PAGE 2
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EXECUTED on the dates indicated below to be effective as of the date indicated above.
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LANDLORD
:
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US INDUSTRIAL REIT II,
a Texas real estate investment trust
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By:
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/s/
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Name:
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Title:
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Date:
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TENANT
:
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DRUGSTORE.COM, INC.,
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a Delaware corporation
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By:
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/s/
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Name:
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Title:
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Date:
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SIGNATURE PAGE
SECOND
AMENDMENT TO INDUSTRIAL BUILDING LEASE
1130 Commerce Boulevard – DS Distribution, Inc.
Exhibit 10.25
DRUGSTORE.COM, INC.
AMENDMENT TO DAWN LEPORE OFFER LETTER
This amendment (the “
Amendment
”) is made by and between Dawn Lepore
(“
Executive
”) and drugstore.com inc., a Delaware corporation (the “
Company
” and together with the Executive hereinafter collectively referred to as the “
Parties
”) on
December 31, 2010.
W
I
T
N
E
S
S
E
T
H:
WHEREAS
, the Parties previously entered into an offer letter, dated December 31, 2008 and as amended and
restated as of January 26, 2009 (the “
Offer Letter
”); and
WHEREAS
, the Company and
Executive wish to amend certain provisions of the Offer Letter in order to clarify certain payment terms for purposes of Section 409A of the Internal Revenue Code of 1986, as amended, (the “
Code
”) and to correct certain
provisions in accordance with IRS Notice 2010-6.
NOW, THEREFORE
, in consideration of the foregoing and for other good
and valuable consideration, Executive and the Company agree that the Offer Letter is hereby amended as follows:
1.
Section 409A
. The eighth (8
th
) through
tenth (10
th
) full paragraph of the Offer Letter are
hereby amended and replaced in their entirety as follows to, in an abundance of caution, correct the time of payment pursuant to Section VI.B and/or VII.C. of IRS Notice 2010-6:
“Notwithstanding anything to the contrary in this offer letter, no severance or benefits payable to you, if any, pursuant to
this offer letter that, when considered together with any other severance payments or separation benefits, are considered deferred compensation under Section 409A (together, the “Deferred Compensation Separation Benefits”)
shall be paid or otherwise provided until you have a “separation from service” within the meaning of Section 409A. Similarly, no severance payable to you, if any, pursuant to this offer letter that otherwise would be exempt
from Section 409A pursuant to Treasury Regulation Section 1.409A-1(b)(9) will be payable until you have a “separation from service” within the meaning of Section 409A. For purposes of this offer letter,
“Section 409A” means Code Section 409A, and the final regulations and any guidance promulgated thereunder and any state law equivalent.
Your entitlement to this severance package is subject to your execution of an effective release of claims substantially in the form attached hereto, except as the parties may otherwise agree or except as
required by law provided that such release of claims is effective within sixty (60) days following the termination date or such earlier date as required by the release of claims (such deadline, the “Release Deadline”), and your
continuing compliance with the Company’s proprietary information and inventions agreement. If the release does not become effective and irrevocable by the Release Deadline, you will forfeit any rights to severance or benefits under this offer
letter. In no event will severance payments or benefits be paid or provided until the release becomes effective and irrevocable. Any severance payments or benefits under this offer letter that would be considered Deferred Compensation Separation
Benefits will be paid on, or, in the case of installments, will not commence until, the ninetieth (90
th
) day following your separation from service, or, if later, such time as required by the following paragraph. Except as required by the
following paragraph, any installment payments of Deferred Compensation Separation Benefits that would have been made to you during the ninety (90) day period immediately following your
separation from service but for the preceding sentence will be paid to you on the ninetieth (90
th
) day following your separation from service and the remaining payments shall be made as provided in this offer letter. Each payment, installment and benefit payable under this offer letter is
intended to constitute a separate payment for purposes of Section 1.409A-2(b)(2) of the Treasury Regulations. These provisions are intended to comply with or be exempt from the requirements of Section 409A so that none of the Deferred
Compensation Separation Benefits to be provided hereunder will be subject to the additional tax imposed under Section 409A, and any ambiguities or ambiguous terms herein will be interpreted to so comply or be exempt.
Notwithstanding anything to the contrary in this offer letter, if you are a “specified employee” within the meaning of
Section 409A at the time of your termination (other than due to death), the Deferred Compensation Separation Benefits that are payable within the first six (6) months following separation from service will become payable on the first
payroll date that occurs on or after the date six (6) months and one (1) day following the date of your separation from service. All subsequent Deferred Compensation Separation Benefits, if any, will be payable in accordance with the
payment schedule applicable to each payment or benefit. Notwithstanding anything herein to the contrary, if you die following your separation from service but prior to the six (6) month anniversary of your separation from service, then any
payments delayed in accordance with this paragraph will be payable in a lump sum as soon as administratively practicable after the date of your death and all other Deferred Compensation Separation Benefits will be payable in accordance with the
payment schedule applicable to each payment or benefit.
Any amount paid under this offer letter agreement that satisfies the
requirements of the “short-term deferral” rule set forth in Section 1.409A-1(b)(4) of the Treasury Regulations will not constitute Deferred Compensation Separation Benefits.
Any amount paid under this offer letter agreement that qualifies as a payment made as a result of an involuntary separation from service
pursuant to Section 1.409A-1(b)(9)(iii) of the Treasury Regulations that does not exceed the Section 409A Limit will not constitute Deferred Compensation Separation Benefits. “Section 409A Limit” will mean two (2) times the
lesser of: (i) your annualized compensation based upon the annual rate of pay paid to you during your taxable year preceding the taxable year of your separation from service as determined under Treasury Regulation
Section 1.409A-1(b)(9)(iii)(A)(1) and any Internal Revenue Service guidance issued with respect thereto; or (ii) the maximum amount that may be taken into account under a qualified plan pursuant to Section 401(a)(17) of the Internal
Revenue Code for the year in which your separation from service occurred.”
2.
Defined Terms
. All capitalized terms used herein
which are not defined herein shall have the meanings given such terms in the Offer Letter.
3.
Full Force and Effect
. To the extent not
expressly amended hereby, the Offer Letter shall remain in full force and effect.
4.
Entire Agreement
. This Amendment and the Offer
Letter constitute the full and entire understanding and agreement between the Parties with regard to the subjects hereof and thereof. This Amendment may be amended at any time only by mutual written agreement of the Parties.
2
5.
Counterparts
. This Amendment may be executed in counterparts, all of which together shall
constitute one instrument, and each of which may be executed by less than all of the parties to this Amendment.
6.
Governing Law
. This
Amendment will be governed by the laws of the State of Washington (with the exception of its conflict of laws provisions).
IN WITNESS WHEREOF
, each of the Parties has executed this Amendment, in the case of the Company by its duly authorized officer, as
of the date set forth above.
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COMPANY
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DRUGSTORE.COM, INC.
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/s/ William Savoy
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By:
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William Savoy
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Title:
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EXECUTIVE
|
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DAWN LEPORE
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/s/ Dawn G. Lepore
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3
Exhibit 10.27
May 23, 2008
Robert Potter
2615 Ferndale Place NE
Renton WA 98056
Dear Rob:
In recognition of your achievements and dedication in helping to build our business, I
am very pleased to promote you to Vice President, Chief Accounting Officer effective May 29, 2008, reporting to me.
As Vice President,
Chief Accounting Officer, your new salary will be $200,000. In addition, you will be eligible to receive an annual target bonus of 35% of your annual salary, based on both company and individual performance. Depending on the level of company and
individual performance, you may receive between 0% and 125% of this target amount. Your bonus compensation for subsequent years will be determined by the Board of Directors and the CEO. Your compensation package will be reviewed annually.
Please note that your employment continues to be at-will employment, which means that you have the right to terminate your employment at any
time with or without cause or notice, and the Company reserves for itself the same right.
Congratulations, I look forward to a continued
successful working relationship.
Kindly indicate your consent to the terms of this offer letter by signing and returning a copy to Human Resources by May 30, 2008
Sincerely,
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/s/
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Dawn Lepore
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President, CEO and Chairman
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Agreed and accepted:
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/s/
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Date:
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6/10/08
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Robert Potter
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Exhibit 10.28
May 23, 2008
Tracy Wright
4421 240th Pl SE
Bothell WA, 98021
Dear Tracy:
In recognition of your achievements and dedication in helping build our business, I
am very pleased to promote you to Vice President, Chief Finance Officer effective May 29, 2008, reporting to me.
As Vice President,
Chief Finance Officer, your new salary will be $200,000. In addition, you will be eligible to receive an annual target bonus of 35% of your annual salary, based on both company and individual performance. Depending on the level of company and
individual performance, you may receive between 0% and 125% of this target amount. Your bonus compensation for subsequent years will be determined by the Board of Directors and the CEO. Your compensation package will be reviewed annually.
Please note that your employment continues to be at-will employment, which means that you have the right to terminate your employment at any
time with or without cause, and the Company reserves for itself the same right.
Congratulations, I look forward to a continued successful
working relationship.
Kindly indicate your consent to the terms of this offer letter by signing and returning a copy to Human Resources by May 30, 2008
Sincerely,
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/s/
|
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Dawn Lepore
|
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President, CEO and Chairman
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Agreed and accepted:
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/s/
|
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Date:
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6/30/08
|
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Tracy Wright
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Exhibit 10.29
DRUGSTORE.COM, INC.
CHANGE IN CONTROL AGREEMENT
This Change in Control Agreement (the “Agreement”) is made and entered into by and between
(“Executive”) and drugstore.com, inc. (the “Company”), effective as of January 26, 2009 (the
“Effective Date”).
RECITALS
1. It is expected that the Company from time to time will consider the possibility of an acquisition by another company or other change in control. The Board of Directors of the Company (the
“Board”) recognizes that such consideration can be a distraction to Executive and can cause Executive to consider alternative employment opportunities. The Board has determined that it is in the best interests of the Company and its
stockholders to assure that the Company will have the continued dedication and objectivity of Executive, notwithstanding the possibility, threat or occurrence of a Change in Control (as defined herein) of the Company.
2. The Board believes that it is in the best interests of the Company and its stockholders to provide Executive with an incentive to
continue his or her employment and to motivate Executive to maximize the value of the Company upon a Change in Control for the benefit of its stockholders.
3. The Board believes that it is imperative to provide Executive with certain severance benefits upon Executive’s termination of employment following a Change in Control. These benefits will provide
Executive with enhanced financial security and incentive and encouragement to remain with the Company notwithstanding the possibility of a Change in Control.
4. Certain capitalized terms used in the Agreement are defined in Section 6 below.
AGREEMENT
NOW, THEREFORE, in consideration of the mutual covenants
contained herein, the parties hereto agree as follows:
1.
Term of Agreement
. This Agreement will terminate upon the
date that all of the obligations of the parties hereto with respect to this Agreement have been satisfied.
2.
At-Will
Employment
. The Company and Executive acknowledge that Executive’s employment is and will continue to be at-will, as defined under applicable law.
3.
Severance Benefits
.
(a)
Involuntary Termination Following a Change in Control
. If upon or within twelve (12) months following a Change in Control
(i) Executive terminates his or her employment with the Company (or any parent, subsidiary or successor of the Company) for Good Reason (as defined herein) or (ii) the Company (or any parent, subsidiary or successor of the Company)
terminates Executive’s employment without Cause (as defined herein), and Executive signs and does not revoke the release of claims as required by Section 4, Executive will receive the following severance benefits from the Company:
(i)
Severance Payment
. Executive will receive a single lump sum severance payment (less applicable withholding taxes)
in an amount equal to twelve (12) months of Executive’s annual salary (the “Severance Period”) determined at a rate equal to the greater of (A) Executive’s annual salary as in effect immediately prior to the Change in
Control, or (B) Executive’s Base Salary (as defined herein).
(ii)
Bonus Payment
. Executive will
receive a lump sum cash payment (less applicable withholding taxes) in an amount equal to one hundred percent (100%) of Executive’s target annual incentive for the year of the Change in Control.
(iii)
Equity Awards
. One hundred percent (100%) of Executive’s then outstanding and unvested Equity Awards as of the
date of Executive’s termination of employment will become vested and will otherwise remain subject to the terms and conditions of the applicable Equity Award agreement.
(iv)
Benefits
. The Company agrees to pay for health continuation coverage premiums for Executive at the same level of health coverage and benefits as in effect for on the day immediately preceding
the date of termination; provided, however, that (1) Executive constitutes a qualified beneficiary, as defined in Section 4980(B)(g)(1) of the Internal Revenue Code of 1986, as amended (the “Code”); and (2) Executive elects
continuation coverage pursuant to the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended (“COBRA”), within the time period prescribed pursuant to COBRA. The Company will pay such COBRA premiums to provide for continuation
benefits on behalf of the Executive through the Severance Period. Executive will thereafter be responsible for the payment of COBRA premiums (including, without limitation, all administrative expenses) for the remaining COBRA period.
(b)
Timing of Severance Payments
. Unless otherwise required pursuant to Section 10 of this Agreement, the Company will pay
the cash severance payments to which Executive is entitled under this Agreement in a lump sum as soon as practicable following the date of termination, provided, however, that such payment will be delayed to the extent required by Section 4
and/or Section 10 of this Agreement. Except to the extent payment is delayed pursuant to Section 9(b), all cash severance payments under this Agreement will be paid no later than March 15 of the year following the year in which the
termination occurs.
-2-
(c)
Voluntary Resignation; Termination For Cause
. If Executive’s employment with
the Company terminates (i) voluntarily by Executive (other than for Good Reason) or (ii) for Cause by the Company, then Executive will not be entitled to receive severance or other benefits except for those (if any) as may then be
established under the Company’s then existing severance and benefits plans and practices or pursuant to other written agreements with the Company, including, without limitation, any Equity Award agreement.
(d)
Disability; Death
. If the Company terminates Executive’s employment as a result of Executive’s Disability, or
Executive’s employment terminates due to his or her death, then Executive will not be entitled to receive severance or other benefits except for those (if any) as may then be established under the Company’s then existing written severance
and benefits plans and practices or pursuant to other written agreements with the Company, including, without limitation, any Equity Award agreement.
(e)
Termination Apart from Change in Control
. In the event Executive’s employment is terminated for any reason, either prior to the occurrence of a Change in Control or after the twelve
(12) month period following a Change in Control, then Executive will be entitled to receive severance and any other benefits only as may then be established under the Company’s existing written severance and benefits plans and practices or
pursuant to other written agreements with the Company, including, without limitation, any Equity Award agreement.
(f)
Exclusive Remedy
. In the event of a termination of Executive’s employment upon or within twelve (12) months following a Change in Control, the provisions of this Section 3 are intended to be and are exclusive and in lieu of any
other rights or remedies to which Executive or the Company may otherwise be entitled, whether at law, tort or contract, in equity, or under this Agreement. Executive will be entitled to no benefits, compensation or other payments or rights upon
termination of employment following a Change in Control other than those benefits expressly set forth in this Section 3, except as may be provided in any Equity Award agreement.
4.
Conditions to Receipt of Severance
.
(a)
Release of Claims Agreement
. The receipt of any severance or other benefits pursuant to Section 3 will
be subject to Executive signing and not revoking a release of claims agreement in a form reasonably acceptable to the Company, and such release becoming effective and irrevocable within sixty (60) days of Executive’s termination or such
earlier deadline required by the release (such deadline, the “Release Deadline”). No severance or other benefits will be paid or provided until the release of claims agreement becomes effective and irrevocable, and any severance amounts or
benefits otherwise payable between the date of Executive’s termination and the date such release becomes effective shall be paid on the effective date of such release. Notwithstanding the foregoing, and subject to the release becoming effective
and irrevocable by the Release Deadline, any severance payments or benefits under this Agreement that would be considered Deferred Compensation Separation Benefits (as defined in Section 10(b)) shall be paid on the sixtieth (60
th
) day following Executive’s “separation from
service” within the meaning of Section 409A of the Code, or, if later, such time as required by Section 10(b). If the release does not become effective by the Release Deadline, Executive will forfeit all rights to severance payments
and benefits under this Agreement.
-3-
(b)
Other Requirement
. Executive’s receipt of any payments or benefits under
Section 3 will be subject to Executive continuing to comply with the terms of any form of confidential information agreement.
(c)
No Duty to Mitigate
. Executive will not be required to mitigate the amount of any payment contemplated by this Agreement, nor will any earnings that Executive may receive from any other source
reduce any such payment.
5.
Limitation on Payments
. In the event that the severance and other benefits provided for in
this Agreement or otherwise payable to Executive (i) constitute “parachute payments” within the meaning of Section 280G of the Code and (ii) but for this Section 5, would be subject to the excise tax imposed by
Section 4999 of the Code, then Executive’s severance benefits under Section 3 will be either:
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(a)
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delivered in full, or
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(b)
|
delivered as to such lesser extent which would result in no portion of such severance benefits being subject to excise tax under Section 4999 of the Code,
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whichever of the foregoing amounts, taking into account the applicable federal, state and local income taxes and the excise tax
imposed by Section 4999, results in the receipt by Executive on an after-tax basis, of the greatest amount of severance benefits, notwithstanding that all or some portion of such severance benefits may be taxable under Section 4999 of the
Code. Unless the Company and Executive otherwise agree in writing, any determination required under this Section 5 will be made in writing by the Company’s independent public accountants immediately prior to a Change in Control or a
“Big Four” national accounting firm selected by the Company (the “Accountants”), whose determination will be conclusive and binding upon Executive and the Company for all purposes. For purposes of making the calculations required
by this Section 5, the Accountants may make reasonable assumptions and approximations concerning applicable taxes and may rely on reasonable, good faith interpretations concerning the application of Sections 280G and 4999 of the Code. The
Company and Executive will furnish to the Accountants such information and documents as the Accountants may reasonably request in order to make a determination under this Section. The Company will bear all costs the Accountants may reasonably incur
in connection with any calculations contemplated by this Section 5. Any reduction in payments and/or benefits required by this Section 5 shall occur in the following order: (1) reduction of cash payments; (2) reduction of vesting
acceleration of Equity Awards; and (3) reduction of other benefits paid or provided to Executive. In the event that acceleration of vesting of Equity Awards is to be reduced, such acceleration of vesting shall be cancelled in the reverse order
of the date of grant for Executive’s Equity Awards. If two or more Equity Awards are granted on the same date, each Equity Award will be reduced on a pro-rata basis. In no event will Executive exercise any discretion with respect to the
ordering of any reduction of payments or benefits pursuant to this Section 5.
-4-
6.
Definition of Terms
. The following terms referred to in this Agreement will have
the following meanings:
(a)
Base Salary
. For purposes of determining the severance payment under this Agreement,
“Base Salary” will mean Executive’s annual salary as in effect on the last day of the calendar year immediately prior to the year in which the Change in Control occurs.
(b)
Cause
. For purposes of this Agreement, “Cause” will mean:
(i) Any act of personal dishonesty taken by Executive in connection with Executive’s responsibilities as an employee [and intended
to result in substantial personal enrichment of Executive];
(ii) Executive’s conviction of, or plea of
nolo
contendere
to, a felony;
(iii) Executive’s gross misconduct;
(iv) Executive’s continued failure to perform the duties and responsibilities of Executive’s position after there has been
delivered to Executive a written demand for performance from the Company which describes the basis for the belief that Executive has not substantially performed such duties and responsibilities and that Executive has not corrected such failure
within two (2) weeks of such written demand.
(c)
Change in Control
. For purposes of this Agreement, “Change
in Control” shall have the same meaning as defined in the Company’s 2008 Equity Incentive Plan.
(d)
Disability
. For purposes of this Agreement, “Disability” shall have the same meaning as that term is defined in the Company’s 2008 Equity Incentive Plan. Notwithstanding the foregoing however, should the Company maintain a
long-term disability plan at any time during Executive’s employment with the Company, a determination of Disability under such plan shall also be considered a “Disability” for purposes of this Agreement.
(e)
Good Reason
. For purposes of this Agreement and any Equity Award agreement, “Good Reason” means the occurrence of
any of the following, without Executive’s express written consent:
(i) A material reduction of Executive’s
authority, duties or responsibilities;
(ii) A material reduction in Executive’s base compensation;
(iii) A material change in the geographic location at which Executive must perform his or her services; provided that in no instance
will the relocation of Executive to a facility or a location of fifty (50) miles or less from Executive’s then current office location be deemed material for purposes of this Agreement;
provided, however
, that before Executive may resign for Good Reason, (A) Executive must provide the Company with written notice within ninety
(90) days of the initial event that Executive believes constitutes “Good Reason” specifically identifying the facts and circumstances claimed to constitute the grounds for Executive’s resignation for Good Reason and the proposed
termination date (which
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will not be more than forty-five (45) days after the giving of written notice hereunder by Executive to the Company), and (B) the Company must have an opportunity of at least thirty
(30) days following delivery of such notice to cure the Good Reason condition and the Company must have failed to cure such Good Reason condition.
Executive specifically acknowledges and agrees that the definition of “Good Reason” in this Section 6(e) shall operate with respect to all rights to severance and/or accelerated vesting of
any Equity Award paid upon a termination upon or after a Change in Control and shall supersede and replace in its entirety any other definitions of “Good Reason,” “Involuntary Termination,” or other similar terms that may exist
in any other employment agreement, offer letter, severance plan or policy, Equity Award agreement or Company stock incentive plan document.
7.
Successors
.
(a)
The Company’s Successors
. Any successor to
the Company (whether direct or indirect and whether by purchase, merger, consolidation, liquidation or otherwise) to all or substantially all of the Company’s business and/or assets will assume the obligations under this Agreement and agree
expressly to perform the obligations under this Agreement in the same manner and to the same extent as the Company would be required to perform such obligations in the absence of a succession. For all purposes under this Agreement, the term
“Company” will include any successor to the Company’s business and/or assets which executes and delivers the assumption agreement described in this Section 7(a) or which becomes bound by the terms of this Agreement by operation
of law.
(b)
Executive’s Successors
. The terms of this Agreement and all rights of Executive hereunder will inure
to the benefit of, and be enforceable by, Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees.
8.
Notice
.
(a)
General
. Notices and all other communications contemplated by this Agreement will be in writing and will be deemed to have been duly given when personally delivered or when mailed by U.S.
registered or certified mail, return receipt requested and postage prepaid. In the case of Executive, mailed notices will be addressed to him or her at the home address which he or she most recently communicated to the Company in writing. In the
case of the Company, mailed notices will be addressed to its corporate headquarters, and all notices will be directed to the attention of its President.
(b)
Notice of Termination
. Any termination by the Company for Cause or by Executive for Good Reason or as a result of a voluntary resignation will be communicated by a notice of termination to the
other party hereto given in accordance with Section 8(a) of this Agreement. Such notice will indicate the specific termination provision in this Agreement relied upon, will set forth in reasonable detail the facts and circumstances claimed to
provide a basis for termination under the provision so indicated, and will specify the termination date. The failure by Executive to include in the notice any fact or circumstance which contributes to a showing of Good Reason will not waive any
right of Executive hereunder or preclude Executive from asserting such fact or circumstance in enforcing his or her rights hereunder.
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9.
Arbitration
. The Company and Executive each agree that any and all disputes
arising out of the terms of this Agreement, Executive’s employment by the Company, Executive’s service as an officer or director of the Company, or Executive’s compensation and benefits, their interpretation and any of the matters
herein released, will be subject to binding arbitration. In the event of a dispute, the parties (or their legal representatives) will promptly confer to select a single arbitrator mutually acceptable to both parties. If the parties cannot agree on
an arbitrator, then the moving party may file a demand for arbitration with the Judicial Arbitration and Mediation Services (“JAMS”) in King County, Washington, who will be selected and appointed consistent with the Employment Arbitration
Rules and Procedures of JAMS (the “JAMS Rules”), except that such arbitrator must have the qualifications set forth in this paragraph. Any arbitration will be conducted in a manner consistent with the JAMS Rules, supplemented by the
Washington Rules of Civil Procedure. The parties further agree that the prevailing party in any arbitration will be entitled to injunctive relief in any court of competent jurisdiction to enforce the arbitration award.
The parties hereby agree to
waive their right to have any dispute between them resolved in a court of law by a judge or jury.
This paragraph will not prevent either party from seeking injunctive relief (or any other provisional remedy) from any court having jurisdiction
over the parties and the subject matter of their dispute relating to Executive’s obligations under this Agreement and the Company’s form of confidential information agreement.
10.
Code Section 409A
.
(a) Any amount paid under this Agreement that satisfies the requirements of the “short-term deferral” rule set forth in Section 1.409A-1(b)(4) of the regulations issued under
Section 409A of the Code (the “Treasury Regulations”) shall not constitute Deferred Compensation Separation Benefits for purposes of Section 10(b) below, and consequently shall be paid to Executive promptly following termination
as required by Section 3 of this Agreement. It is intended that all cash severance payments under this Agreement, if any, satisfy the short-term deferral rule.
(b) Notwithstanding anything to the contrary in this Agreement, no Deferred Compensation Separation Benefits (as defined in this Section 10(b)) will become payable under this Agreement until
Executive has a “separation from service” within the meaning of Section 409A of the Code, and any proposed or final regulations and guidance promulgated thereunder (“Section 409A”). Further, if Executive is a “specified
employee” within the meaning of Section 409A at the time of Executive’s separation from service (other than due to Executive’s death), and the severance payable to Executive, if any, pursuant to this Agreement, when considered
together with any other severance payments or separation benefits, are considered deferred compensation under Section 409A (together, the “Deferred Compensation Separation Benefits”), such Deferred Compensation Separation Payments
that are otherwise payable within the first six (6) months following Executive’s termination of employment will become payable on the first payroll date that occurs on or after the date six (6) months and one (1) day following
the date of Executive’s separation from service. All subsequent Deferred Compensation Separation Benefits, if any, will be payable in accordance with the payment schedule applicable to each payment or benefit. Notwithstanding anything herein to
the contrary, if Executive dies following his or her separation from service but prior to the six (6) month
-7-
anniversary of his or her separation from service, then any payments delayed in accordance with this paragraph will be payable in a lump sum as soon as administratively practicable after the date
of Executive’s death and all other Deferred Compensation Separation Benefits will be payable in accordance with the payment schedule applicable to each payment or benefit. Each payment and benefit payable under this Agreement is intended to
constitute a separate payment for purposes of Section 1.409A-2(b)(2) of the Treasury Regulations.
(c) Any amount paid
under this Agreement that qualifies as a payment made as a result of an involuntary separation from service pursuant to Section 1.409A-1(b)(9)(iii) of the Treasury Regulations that does not exceed the Section 409A Limit (as defined below)
shall not constitute Deferred Compensation Separation Benefits for purposes of Section 10(b) above. For purposes of this Section 10(c), “Section 409A Limit” will mean two (2) times the lesser of: (i) Executive’s
annualized compensation based upon the annual rate of pay paid to Executive during Executive’s taxable year preceding the Executive’s taxable year of Executive’s separation from service as determined under Treasury Regulation
1.409A-1(b)(9)(iii)(A)(1); or (ii) the maximum amount that may be taken into account under a qualified plan pursuant to Section 401(a)(17) of the Code for the year in which Executive’s separation from service occurs.
(d) The foregoing provisions are intended to comply with the requirements of Section 409A so that none of the severance payments and
benefits to be provided hereunder will be subject to the additional tax imposed under Section 409A, and any ambiguities herein will be interpreted to so comply. The Company and Executive agree to work together in good faith to consider
amendments to this Agreement and to take such reasonable actions which are necessary, appropriate or desirable to avoid imposition of any additional tax or income recognition prior to actual payment to Executive under Section 409A.
11.
Miscellaneous Provisions
.
(a)
Waiver
. No provision of this Agreement will be modified, waived or discharged unless the modification, waiver or discharge is agreed to in writing and signed by Executive and by an authorized
officer of the Company (other than Executive). No waiver by either party of any breach of, or of compliance with, any condition or provision of this Agreement by the other party will be considered a waiver of any other condition or provision or of
the same condition or provision at another time.
(b)
Headings
. All captions and section headings used in this
Agreement are for convenient reference only and do not form a part of this Agreement.
(c)
Choice of Law
. The validity,
interpretation, construction and performance of this Agreement will be governed by the laws of the State of Washington (with the exception of its conflict of laws provisions).
(d)
Integration
. This Agreement, together with the form of confidential information agreement and the standard forms of Equity Award agreement that describe Executive’s outstanding Equity
Awards (other than as such Equity Award agreements have been revised pursuant to this Agreement), represents the entire agreement and understanding between the parties
-8-
as to the subject matter herein and supersedes all prior or contemporaneous agreements whether written or oral. With respect to Equity Awards granted on or after the date of this Agreement, the
acceleration of vesting provisions provided herein will apply to such Equity Awards except to the extent otherwise explicitly provided in the applicable Equity Award agreement. No waiver, alteration, or modification of any of the provisions of this
Agreement will be binding unless in a writing and signed by duly authorized representatives of the parties hereto. In entering into this Agreement, no party has relied on or made any representation, warranty, inducement, promise, or understanding
that is not in this Agreement. To the extent that any provisions of this Agreement conflict with those of any other agreement between the Executive and the Company, the terms in this Agreement will prevail.
(e)
Severability
. In the event that any provision or any portion of any provision hereof becomes or is declared by a court of
competent jurisdiction to be illegal, unenforceable, or void, this Agreement will continue in full force and effect without said provision or portion of provision. The remainder of this Agreement shall be interpreted so as best to effect the intent
of the Company and Executive.
(f)
Withholding
. All payments made pursuant to this Agreement will be subject to
withholding of applicable income and employment taxes.
(g)
Counterparts
. This Agreement may be executed in
counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument.
-9-
IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the
Company by its duly authorized officer, as of the day and year set forth below.
Executive understands and acknowledges that
the definition of “Good Reason” contained in this Agreement shall supersede any and all such similar definitions contained in employment agreements, offer letters, severance policies and plans and Equity Award agreements to the extent such
other agreements provide for benefits contingent on a Change in Control, and that by executing this Agreement, Executive acknowledges such other arrangements have been amended accordingly.
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COMPANY
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DRUGSTORE.COM, INC.
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By:
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Dawn Lepore,
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President and Chief Executive Officer
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EXECUTIVE
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By:
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Title:
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-10-
Exhibit 21.1
SUBSIDIARIES
Beauty.com, Inc., a Delaware corporation
Custom Nutrition Services, Inc., a Delaware corporation
DS Pharmacy, Inc., a Delaware corporation
de~luxe Distributors, Inc., a Delaware corporation
DS Distribution Canada Ltd., a British Columbia, Canada company
Medco Online Sales, Inc., a Delaware corporation
RAD Online Sales, Inc., a Delaware corporation
Vision Direct Inc., a Texas corporation
Salu Beauty, Inc., a Delaware corporation
Salu Australia Pty Ltd., an Australia company
Skincarestore Australia Pty Ltd., an Australia company
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by
reference in the following Registration Statements:
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(1)
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Registration Statement (Form S-8, No. 333-83975) pertaining to the 1999 Employee Stock Purchase Plan and 1998 Stock Plan of drugstore.com, inc.,
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(2)
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Registration Statement (Form S-8, No. 333-58174) pertaining to the 1998 Stock Plan of drugstore.com, inc.,
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(3)
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Registration Statement (Form S-8, No. 333-85468) pertaining to the 1998 Stock Plan of drugstore.com, inc.,
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(4)
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Registration Statement (Form S-3, No. 333-130097) and related prospectus of drugstore.com, inc.,
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(5)
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Registration Statement (Form S-8, No. 333-153407) pertaining to the 2008 Equity Incentive Plan of drugstore.com, inc., and
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(6)
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Registration Statement (Form S-8, No. 333-167654) pertaining to the 2008 Equity Incentive Plan of drugstore.com, inc.
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of our reports dated March 18, 2011, with respect to the consolidated financial statements and schedule of drugstore.com, inc. and the effectiveness
of internal control over financial reporting of drugstore.com, inc., included in this Annual Report (Form 10-K) for the year ended January 2, 2011.
Seattle, Washington
March 18, 2011
Exhibit 31.1
CERTIFICATION
I, Dawn G. Lepore, certify that:
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1.
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I have reviewed this annual report on Form 10-K of drugstore.com, inc.;
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2.
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Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
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3.
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Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
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4.
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The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
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a)
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Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material
information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
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b)
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Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
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c)
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Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
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d)
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Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal
quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
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5.
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The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s board of directors:
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a)
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All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely
affect the registrant’s ability to record, process, summarize and report financial information; and
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b)
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Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial
reporting.
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/s/ Dawn G. Lepore
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Dawn G. Lepore
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President, Chief Executive Officer and
Chairman of the Board
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March 18, 2011
Exhibit 31.2
CERTIFICATIONS
I, Robert P. Potter, certify that:
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1.
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I have reviewed this annual report on Form 10-K of drugstore.com, inc.;
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2.
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Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
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3.
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Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
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4.
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The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
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a)
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Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material
information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
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b)
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Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
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c)
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Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
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d)
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Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal
quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
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5.
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The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s board of directors:
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a)
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All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely
affect the registrant’s ability to record, process, summarize and report financial information; and
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b)
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Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial
reporting.
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/s/ Robert P. Potter
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Robert P. Potter
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Vice President and
Chief Accounting Officer
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March 18, 2011
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the
Annual Report on Form 10-K of drugstore.com, inc. (the “Company”) for the period ending January 2, 2011, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Dawn G. Lepore, President,
Chief Executive Officer, and Chairman of the Board of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations
of the Company.
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/s/ Dawn G. Lepore
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Dawn G. Lepore
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President, Chief Executive Officer, and
Chairman of the Board
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A signed original of this written statement required by Section 906 has been provided to drugstore.com, inc. and will be retained by drugstore.com, inc. and furnished to the Securities and Exchange
Commission or its staff upon request.
March 18, 2011
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the
Annual Report on Form 10-K of drugstore.com, inc. (the “Company”) for the period ending January 2, 2011, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert P. Potter, Vice
President and Chief Accounting Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
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/s/ Robert P. Potter
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Robert P. Potter
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Vice President and
Chief Accounting Officer
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A signed original of this
written statement required by Section 906 has been provided to drugstore.com, inc. and will be retained by drugstore.com, inc. and furnished to the Securities and Exchange Commission or its staff upon request.
March 18, 2011
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