Drugstore.com 10-K 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Amendment No. 1)
For the fiscal year ended January 2, 2011
For the transition period from to
Commission File Number: 0-26137
(Exact Name of Registrant as Specified in its Charter)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ 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 ¨ No x
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 ¨
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 ¨ No ¨
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 registrants 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):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
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 registrants most recently completed second fiscal quarter.
As of March 4, 2011, the number of shares of the registrants common stock outstanding was 105,911,293.
drugstore.com, inc. (also referred to as the Company, we, or our) is filing this Amendment No. 1 on Form 10-K/A to amend our Form 10-K for the fiscal year ended January 2, 2011, originally filed with the Securities and Exchange Commission (or SEC) on March 18, 2011, for the purpose of providing the information required by Part III that we intended to be incorporated by reference from our proxy statement relating to our 2011 annual meeting of shareholders, which will not be filed within the requisite time period allowing such incorporation by reference.
Except as otherwise expressly stated herein, this Amendment No. 1 does not reflect events occurring after the date of the original Form 10-K, and does not modify or update the disclosures contained in the Form 10-K in any way other than as required to reflect the amendments discussed above and reflected below. Accordingly, this Amendment No. 1 should be read in conjunction with the original Form 10-K and our other filings made with the SEC on or subsequent to March 18, 2011.We have also included as exhibits the certifications required under Section 302 of The Sarbanes-Oxley Act of 2002. Because no financial statements are contained within this Amendment, we are not including certifications pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
Directors and Executive Officers
Board and Committee Meetings
The board of directors meets regularly during the year and holds special meetings and acts by unanimous written consent whenever circumstances require. The board held six meetings (including special meetings) and took action by unanimous written consent once during our fiscal year ended January 2, 2011. In fiscal year 2010, no incumbent director attended fewer than 75% of the aggregate number of board meetings and meetings of board committees on which she or he served
Our non-management directors meet without management present each time the full board convenes for a regularly scheduled meeting. If the board of directors convenes a special meeting, the non-management directors meet in executive session if circumstances warrant.
The board of directors had three standing committees during 2010: the audit committee, the compensation committee, and the nominating committee. These committees are responsible to the full board. In January 2009, the board established a special equity awards committee, which reports to the compensation committee.
The audit committee operates pursuant to a written charter and is responsible for:
The audit committee is currently composed of Messrs. Bennet, Savoy, and Stanger (chair). The board of directors has determined that, in addition to qualifying as an independent director under current NASDAQ rules, each of Messrs. Bennet, Savoy, and Stanger meet the independence and financial literacy requirements for audit committee members under the applicable rules of the Securities and Exchange Commission and NASDAQ. The board of directors has determined that each of Messrs. Stanger and Savoy is an audit committee financial expert within the meaning of applicable SEC rules.
The audit committee met six times during fiscal year 2010. The audit committee charter can be found on our website under Corporate Governance at http://investor.drugstore.com.
The compensation committee operates pursuant to a written charter and is responsible for:
The compensation committee may delegate certain of its responsibilities to a subcommittee of the compensation committee. Any such subcommittee must report regularly to the compensation committee on any actions that it takes on behalf of the committee. With respect to executive officers other than the chief executive officer, the compensation committee considers the recommendation of the chief executive officer, whose recommendation is based on management objectives and her evaluation of the executive officers performance.
The compensation committee is also responsible for selecting, retaining, and replacing compensation and benefits consultants and other outside consultants to provide independent advice to the committee, as it deems necessary or appropriate.
The compensation committee is currently composed of Messrs. Killeen and Savoy (chair). In addition to qualifying as an independent director under NASDAQ rules, each member of the compensation committee meets the definition of non-employee director for the purposes of Rule 16b-3 under the Securities Exchange Act of 1934.
The compensation committee met nine times during fiscal year 2010 and took action by unanimous written consent on one other occasion. In addition, the compensation committee met periodically and informally with the Companys CEO throughout fiscal year 2010. The report of the compensation committee is set forth on page 29. The compensation committee charter can be found on our website under Corporate Governance at http://investor.drugstore.com.
The nominating committee operates pursuant to a written charter and is responsible for:
The nominating committee may, in its discretion, retain a third-party search firm to assist it in identifying and evaluating potential candidates.
The nominating committee considers director candidates recommended by either of its members, by other board members, by management, and by stockholders, as well those identified by any third-party search firm it may retain. From time to time, the committee has engaged a third-party search firm to assist in identifying or evaluating potential director nominees. The nominating committee has not established any special qualifications or minimum criteria for director nominees. In searching for and evaluating potential candidates for director nominees, the nominating committee takes into account such factors as it deems appropriate. These factors may include, but are not limited to, the experience, education, background, and expected contributions of such director candidates and the current directors, any potential conflicts of interest, including financial relationships, the diversity of the board of directors, and the evolving needs of drugstore.com. The nominating committees process for identifying and evaluating nominees for directors includes, but is not limited to, the following:
The nominating committee evaluates director candidates recommended by stockholders in the same way that it evaluates candidates recommended by its members, other board members or other persons. Stockholder recommendations for director candidates should be sent by certified or registered mail to: Nominating Committee, c/o Secretary, drugstore.com, inc., 411 108th Avenue NE, Suite 1400, Bellevue, Washington 98004. The recommendation must provide the following information for each candidate recommended:
The nominating committee charter can be found on our website under Corporate Governance at http://investor.drugstore.com.
Amazon.com, our largest stockholder, designated Geoffrey R. Entress to serve as its nominee on the board of directors. The nominating committee has not received a director nominee recommendation from any other stockholder (or group of stockholders) that beneficially owns more than 5% of our common stock.
The nominating committee currently consists of Messrs. Killeen and Savoy (chair). The board of directors has determined that Messrs. Killeen and Savoy are independent within the meaning of the NASDAQ rules. The nominating committee did not meet separately during fiscal year 2010.
Special Equity Awards Committee
The special equity awards committee does not have a written charter, but operates pursuant to a specific delegation of authority from the board of directors and is responsible for approving grants of restricted stock awards and restricted stock units under our 2008 Equity Incentive Plan to eligible recipients who are not our executive officers, non-employee directors, contractors, or subject to Section 16 of the Securities Exchange Act of 1934. The special equity awards committee currently consists of Mr. Savoy and Ms. Lepore.
Stockholder Communications with the Board of Directors
Stockholders may communicate directly with the board of directors or any board member by writing to them care of: Secretary, drugstore.com, inc., 411 108th Avenue NE, Suite 1400, Bellevue, Washington 98004. The outside of the envelope should prominently indicate that the correspondence is intended for the board of directors or for a specific director. The Secretary will forward all such written communications to the director to whom it is addressed or, if no director is specified, to the entire board of directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act and related rules of the SEC require our directors, executive officers, and any persons holding more than 10% of our common stock to file with the SEC and NASDAQ reports regarding their initial ownership of our stock and any subsequent changes in that ownership. SEC regulations require directors and executive officers to provide us with copies of all Section 16(a) reports they file.
To our knowledge, based solely on a review of the Section 16(a) reports furnished to us and written representations that no other reports were required to be filed pursuant to Section 16(a) and the related rules of the SEC, during fiscal year 2010, our officers, directors and holders of more than 10% of our common stock filed all Section 16(a) reports on a timely basis.
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 108th Avenue NE, Suite 1400, Bellevue, Washington 98004, or by calling (425) 372-3200.
The following table sets forth the total compensation awarded to, earned by, or paid to our non-employee directors for services rendered to drugstore.com during fiscal year 2010.
Ms. Lepore, our president, chief executive officer and chairman of the board, receives compensation as an employee of drugstore.com but receives no additional compensation for her service as director. For details of our arrangements with Ms. Lepore, see the section entitled Executive Compensation. We reimburse all directors for certain expenses they incur in connection with attendance at board and committee meetings.
In 2010, the board engaged HR Strategies, Inc. to conduct a market survey of cash and equity compensation paid to directors by comparable companies. The companies comprising the peer group were selected on the basis of their similarity to us in terms of revenue, market capitalization, business strategy, and industry. The peer group included: Expedia, Inc., Monster Worldwide, Inc., priceline.com Incorporated, InfoSpace, Inc., IAC/InteractiveDataCorp, Gaiam, Inc., Systemax, Inc., Shutterfly, Inc., GSI Commerce, Inc., 1-800-FLOWERS, Inc., Blue Nile, Inc., and Overstock.com, Inc.
Based on the recommendations of HR Strategies, we increased the cash compensation that we pay to our non-employee directors, effective beginning in 2011. The following table sets forth the annual cash compensation paid in 2010, and payable in 2011, to our non-employee directors for their service as members of the board of directors and as chairs of our various board committees.
Non-employee directors are also eligible to receive equity grants under our 2008 Plan. Each year for his service during the one-year term following his election (or re-election) at our annual stockholders meeting, we have granted each of our non-employee directors an option to purchase 30,000 shares of our common stock. The exercise price of the option is the market price per share on the date of grant. These options vest in full on the first anniversary of the date of grant. In addition, we have generally granted options to new non-employee directors at the time they first join our board of directors.
Compensation Committee Interlocks and Insider Participation
The members of the compensation committee during fiscal year 2010 were Jeffrey M. Killeen and William D. Savoy. Neither was an officer or employee of drugstore.com or any of its subsidiaries at any time during fiscal year 2010, and neither of them has ever been an officer of drugstore.com or any of its subsidiaries. In addition, none of the executive officers of drugstore.com served on the compensation committee of any entity or as a director of an entity that employs any of the members of the compensation committee.
Compensation Discussion and Analysis
The compensation committee of our board of directors is responsible for approving and evaluating executive compensation and our policies and programs with respect to compensation for our chief executive officer, our chief finance officer, our chief accounting officer and our other executive officers.
Objectives of Our Compensation Programs
We aim to offer compensation packages designed to attract, retain and motivate outstanding executives, to encourage and reward the achievement of sustainable, long-term stockholder value and other corporate goals and to align our executives financial interests with the Companys strategic business plans and the interests of our stockholders. Our compensation policy is to offer a package that includes a competitive salary and benefits, a cash bonus program dependent primarily on attainment of the Companys performance goals but that also considers the executive officers individual performance (as described further below), and equity compensation that provides a longer-term incentive while encouraging and facilitating our employees ownership of our common stock in order to align the interests of our executive officers more closely with those of our stockholders at large.
We endeavor to balance the fixed and variable components of our named executive officers compensation packages. By putting an appropriate portion of the executives compensation at risk, we seek to build and maintain a strong management team and incent that team to achieve financial and strategic goals. At the same time, we attempt to provide a sufficient fixed salary and reasonable, incremental bonus criteria so as to discourage unreasonable risk-taking. We also seek to provide an appropriate mix of cash and equity compensation in order to encourage our named executive officers to focus on, and to deliver, long-term, sustainable stockholder returns.
What Our Compensation Program Is Designed to Reward
Our compensation policy for our named executive officers is designed to reward each executives contribution to the Company through the attainment of corporate and individual objectives as well as general job performance.
In measuring the executive officers individual job performance and his or her contribution to the Company, the compensation committee considered numerous factors including our growth and financial performance as reflected in our net revenue, net income (loss), gross margins, adjusted EBITDA (defined as earnings before interest, taxes, depreciation and amortization, adjusted to exclude the impact of stock-based compensation), and 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). It also considered nonfinancial factors such as improvement in the Companys strategic position, expansion into new technologies and markets, including mobile and social media, the performance of the Companys individual units, the development of a strong executive and managerial team, and improving customer satisfaction and employee engagement results.
Each year, working with the board of directors, the chief executive officer sets her own individual strategic priorities or objectives. With the assistance of the chief executive officer, our other executive officers also set individual performance objectives, which management and the compensation committee closely monitored and evaluated. Our approach is to set stretch goals while still rewarding the effort required to achieve incremental gains and successes. The objectives of Ms. Lepore and our other executive officers are discussed in more detail below under Performance Objectives.
Competitive Positioning and the Compensation Committees Outside Advisor
The compensation committee receives and reviews competitive positioning data in the course of its annual compensation review but does not establish a specific target percentile or range or benchmark for the total compensation of our executive officers. We do however consider the compensation practices of comparable companies and how each of our executive officers compensation compares to his or her peers as one of a number of factors when setting the amount of each compensation component for our executive officers. As a general guideline, rather than an absolute benchmark, the compensation committee typically concentrates its consideration of data on compensation that falls between the 65th and 75th percentile for each executive officers peers at comparable companies. Although the compensation committee may consider this comparative data, it is not the sole item of consideration. Rather, this data provides only a reference point and is one among many of the considerations that the compensation committee takes into account in determining compensation for the executive officers. As a result, the total compensation of our executive officers, as well as individual elements of compensation for these individuals, may be within, below, or above this market range for their positions.
Other factors the compensation committee considers in designing each executive officers compensation package include:
No single factor above was determinative in setting compensation for fiscal 2010, nor was the impact of any factor on the determination of compensation quantifiable.
For purposes of comparing our named executive officers against the competitive market, as well as to assess the relative competitiveness of our executive compensation program, the compensation committee developed, with the assistance of its compensation consultant, Applied HR Strategies, Inc., a peer group of twelve e-commerce companies. This peer group data is used to assess our current compensation levels and to provide a reference for the compensation committee in the course of its deliberations on compensation forms and amounts.
The peer group used for this analysis was the same group, and chosen on the same basis, discussed above under Director Compensation. To analyze the compensation practices of the peer group companies, Applied HR Strategies gathered data from the peer groups public filings, the Culpepper Executive Compensation, Senior Division Executive, and Top Merchandising Executive Surveys, the Watson Wyatt Executive Compensation Survey, and the consultants own proprietary data.
Applied HR Strategies provided advisory services regarding total compensation for our chief executive officer, our other executive officers, and our outside directors, as well as long-term incentive compensation for all eligible employees. For more information on the analysis provided, please see the relevant discussions under Elements of Our Compensation Program and How We Determine Amounts in Light of Our Compensation Objectives Salary, Bonus, and Equity Awards, below. Fees for services related to the long-term incentive compensation consulting were not allocated between our executive officers and other employees, but total fees did not exceed $120,000.
Compensation Review Cycle
The compensation committee reviews the base salary levels of our executive officers, as well as their annual cash incentive opportunities and equity awards each year, or more frequently as warranted, with salary adjustments generally effective and final bonus amounts determined during the first quarter. In recent years, the compensation committee has granted equity awards to our executive team in the fourth quarter. The compensation committee reviews our chief executive officers compensation in the fourth quarter and our other executive officers early in the first quarter. Each executive officer conducts a written self-evaluation, including an assessment of their performance against objectives established in the prior year. In the case of the chief executive officer, the compensation committee reviews and evaluates the self-assessment along with the other factors discussed above under What Our Compensation Program Is Designed to Reward and Competitive Positioning and the Compensation Committees Outside Advisor and Performance Objectives. The chief executive officer reviews the other executive officers self-assessments as part of her evaluation of their performance prior to providing her input and making her recommendations to the compensation committee. Typically, as part of this annual performance evaluation, each of our executive officers, including our chief executive officer, like all of our employees, are assigned ratings. This rating is used to determine in part any adjustments to base salary and the size of any cash or equity incentive awards, as discussed in more detail below under Elements of Our Compensation Program and How We Determine Amounts in Light of our Compensation ObjectivesSalary. However, during the annual assessment of fiscal 2010 performance, the individual performance of our executive officers, including our chief executive officer, were evaluated but ratings were not assigned.
In assessing the performance of our chief executive officer, Dawn Lepore, the compensation committee reviewed the individual strategic priorities that she, together with the board of directors, established for her in the first quarter of 2010. For 2010, Ms. Lepore targeted:
Ms. Lepore assessed the performance of each of our other named executive officers against the individual objectives each of them had worked with Ms. Lepore to establish in the first quarter of 2010.
In 2010, Yukio Morikubo, our vice president, strategy and general counsel, focused on:
The goals for Robert Potter, our vice president, chief accounting officer, included:
The objectives of Tracy Wright, our vice president, chief finance officer, included:
Achievements and Performance Assessment
The compensation committee assessed each of our named executive officers achievements during 2010 in light of their performance objectives as a whole, rather than assigning a measure of achievement to each individual objective, but did not assign each officer an individual performance rating as in the past, due to the decision (described below) not to factor ratings into the determination of fiscal 2010 bonuses. The performance assessments then served as a factor in determining various components of such officers compensation, as discussed in greater detail below under Elements of Our Compensation Program and How We Determine Amounts in Light of Our Compensation Objectives Salary, Bonus, and Equity Awards. Ultimately, for fiscal 2010, the compensation committee determined to pay bonuses under the plan based primarily on Company performance against the applicable metrics (described below). As part of the compensation committees process in determining that this was the appropriate route, the compensation committee assessed the individual performance of the named executive officers, as described below. In doing so, the compensation committee concluded that performance was at a sufficiently high level across the entire named executive officer team, and therefore, given the business considerations described below under Elements of Our Compensation Program and How We Determine Amounts in Light of Our Compensation Objectives Bonus, our goals of incentivizing and rewarding performance would be met for fiscal 2010 without assigning a specific rating or differentiating based on individual performance.
With respect to Ms. Lepore, the compensation committee noted her contributions towards the Companys financial targets, which in turn were an integral part of her own objectives, including the fact that total net sales, normalized to adjust for the difference between a 53-week fiscal year 2009 and a 52-week fiscal year 2010, grew 24% in fiscal year 2010 and ongoing adjusted EBITDA increased over 75% in the face of continued pressure from cost-conscious consumers and a notable increase in the use by customers of discounts and promotions. The compensation committee felt Ms. Lepores leadership, strategic decision making, and focus on operational excellence and solid execution were primary reasons why the Company grew both top and bottom line in a very difficult economic environment.
The compensation committee cited Ms. Lepores leadership and reputation as instrumental in the renegotiations with Medco, the Salu Beauty integration, and furthering the negotiations in 2010 with Walgreen Co., or Walgreens, as well as in building and retaining a strong management team and promoting a stable organization and stimulating culture.
In assessing Mr. Morikubos performance, the compensation committee credited Mr. Morikubo as the principal organizational leader in many strategic complex initiatives, including the completion of the Salu acquisition and subsequent
integration, the Medco renegotiation, the sale of the Companys pharmacy assets, the progress made during 2010 towards the agreement with Walgreens, and other key drivers of the Companys success in 2010. Mr. Morikubo met his goal of maintaining high service levels for our internal clients, and showed tremendous leadership in managing multiple legal matters and processes, including internal audit and corporate governance, while continuing to control external legal costs.
Mr. Potters stewardship of the various accounting functions resulted in substantially improved inventory management practices. In addition, he negotiated preferred credit terms with the Companys banks in an extremely tight credit market, effectively managed the Companys cash position, and improved our practices relating to vendor payments. His overall leadership helped maintain high standards in managing our risk and compliance. His sound management resulted in a successful external audit and effective internal controls.
The compensation committee acknowledged Ms. Wrights leadership and her essential contributions to our disciplined long-range planning and budgeting process, resulting in more accurate forecasting and timelier reporting. In addition, the compensation committee noted that Ms. Wright played pivotal financial and business roles in our acquisition and partnership initiatives, including the integration of Salu Beauty, renegotiation with Medco, the pharmacy asset sale, and her continued investor relations efforts to improve investor confidence in the Company. In addition, the compensation committee recognized the additional responsibilities that Ms. Wright assumed after the resignation of our vice president, human resources in the fourth quarter of 2010.
Elements of Our Compensation Program and How We Determine Amounts in Light of Our Compensation Objectives
Elements of 2010 compensation for our named executive officers included: salary, bonus, and equity incentive awards. Executive officers received total compensation packages in line with their responsibilities, experience, expertise and performance.
We paid base salaries intended to attract and retain highly capable executives by providing adequate fixed cash compensation. The compensation committee determines the salaries of our executive officers annually. In the case of the chief executive officer, all of the independent directors participated in the determination of her 2010 salary. In setting each named executive officers 2010 salary, the compensation committee evaluated the responsibilities of the executive, his or her general job performance (as discussed above in What Our Compensation Program is Designed to Reward and Performance Objectives), and the competitive positioning approach described above under Competitive Positioning and the Compensation Committees Outside Advisor. We then considered the performance of the Company and the individuals performance against objectives to recommend annual or other increases, if any, to base salary. As discussed above, in most years, but not at the end of fiscal 2010, our executive officers, including our chief executive officer, like all of our employees, are rated. A higher rating or overall performance assessment, as applicable is generally rewarded with a higher pay increase, though the precise impact of this is not quantifiable, as the rating or overall performance assessment, as applicable is one of several factors the compensation committee considers.
For our executive officers other than our chief executive officer, the compensation committee also considered the recommendation of our chief executive officer, whose recommendation was based on managements objectives and her evaluation of the executive officers experience and potential performance. Our executive officers, other than our chief executive officer, are rarely involved in determining compensation other than to provide information regarding Company or individual performance. The compensation committee instead relies on its outside consultant, as discussed above under Competitive Positioning and the Compensation Committees Outside Advisor.
In September 2009, the compensation committee engaged Applied HR Strategies to conduct a competitive review of our chief executive officers cash compensation in light of her target cash and equity incentives, including an analysis of the peer group and data from discussed above under Competitive Positioning and the Compensation Committees Outside Advisor. Based on the consultants recommendations and the compensation committees assessment of Ms. Lepores performance, Company performance and the other factors discussed above under What Our Compensation Program is Designed to Reward, Performance Objectives and Competitive Positioning and the Compensation Committees Outside Advisor, in December 2009, the compensation committee increased her annual base salary for 2010 from $500,000 to $550,000, representing a 10% increase.
In January 2010, the compensation committee engaged its compensation consultant to assess cash compensation paid to our other executive officers. In March 2010, based on the consultants recommendations and other factors discussed above with respect to our other executive officers, the compensation committee increased the base salaries of our other executive officers as follows:
In April 2011, based on the performance assessment of our executive officers, changes in the executive officers duties, and other factors related to the Companys expected performance and operations for 2011, the compensation committee increased Mr. Morikubos 2011 base salary by 5% to $290,000 and Ms. Wrights base salary by 7% to $230,000. The base salary of Ms. Lepore and Mr. Potter remained the same.
A significant portion of the variable component of our executive compensation package was made up of a cash incentive bonus. In February 2010, the compensation committee approved an incentive bonus plan under which our executive officers were eligible to receive cash bonuses for fiscal year 2010, 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 individuals performance. Each of these prongs of the 2010 bonus plan is described in more detail below. The Company paid bonuses under the plan in two installments: a mid-year payment based on performance for the first half of the year and a final payment based on full-year performance. The compensation committee implemented the mid-year bonus payment in order to align employees incentives more closely with our quarterly as well as full-year results.
Initial Target Bonus Amounts
Each executive officer is assigned an initial target bonus percentage, determined using the criteria and analysis discussed above under What Our Compensation Program is Designed to Reward and Competitive Positioning and the Compensation Committees Outside Advisor.
In February 2010, the compensation committee evaluated our executive officers initial target bonus level in light of his or her position and responsibilities (as discussed above under What Our Compensation Program is Designed to Reward and Performance Objectives) and the compensation committees compensation consultants competitive positioning information (as discussed under Competitive Positioning and the Compensation Committees Outside Advisor) including the September 2009 and January 2010 assessments. Ms. Lepores initial target bonus as a percentage of her base salary remained unchanged from her 2009 level at 150%. Mr. Potters and Ms. Wrights initial target bonuses also remained unchanged from their 2009 level at 35%. The compensation committee increased Mr. Morikubos initial target bonus from 35% for 2009 to 40% for 2010, based on the consultants recommendations and in recognition of Mr. Morikubos increased responsibilities and efforts in connection with the Companys strategic initiatives.
Company Performance Component of Bonus
Each year, our compensation committee establishes an incentive bonus plan to promote the achievement of Company financial performance objectives based on various financial thresholds. We attempt to provide annual cash incentive bonuses under the plan for our named executive officers and other eligible employees that reflect the Companys belief that a significant portion of the compensation of each executive should be contingent on Company performance as well as the individual contribution of each executive. We determine the financial thresholds for the bonus plan in conjunction with our annual planning and budgeting process, which generally begins in the fall of the prior fiscal year. Management develops, and our board of directors oversees and approves, our financial plans and budget, including our expected and targeted net revenue and adjusted EBITDA figures. Adjusted EBITDA is a non-GAAP financial measure defined as earnings before interest, taxes, depreciation, and amortization of intangible assets and non-cash marketing expense, adjusted to exclude the impact of stock-based compensation expense. Management believes that adjusted EBITDA, as defined, provides useful information to the Company and to investors by excluding certain items that may not be indicative of the Companys core operating results, and we have historically relied on adjusted EBITDA measures, management believes it provides consistency in the Companys financial reporting.
We base our financial plans, budget and related guidance, and accordingly our bonus plan financial thresholds, on the basis of (i) the Companys performance for the prior fiscal year, (ii) estimates of sales revenue for the plan year based on recent market conditions, trends and competition and other factors that, based on historical experience, we expect to affect the level of sales that can be achieved, (iii) historical operating costs and cost savings that management believes we can realize, (iv) competitive conditions that we expect to face, and (v) additional expenditures beyond prior fiscal years. As a result of this approach to setting plan financial thresholds, the proportion of each named executive officers total cash compensation that is represented by incentive based income may increase in those years in which our actual results are stronger relative to our projections.
In earlier years, where our focus was on overall growth, the bonus plan assumed a relatively equal weighting between our net revenue and adjusted EBITDA thresholds. More recently, while we continued to promote growth, the compensation committee wanted management to ensure that our growth was profitable, so we adjusted the weighting of the two measures so that the thresholds were based more on profitability measurements. For 2010, the Company performance component of the bonus plan was based 40% on net revenues and 60% on adjusted EBITDA. We endeavored to set financial thresholds that challenged our executives to meet or exceed the Companys expected performance for the year, but that offered some recognition of the executives contribution in the event the Company substantially performed but fell short of specific expectations. The compensation committee also felt that rewarding incremental achievement would promote thoughtful, strategic risk management and discourage excessive risk-taking. At the time our compensation committee established these financial thresholds, the compensation committee believed that these financial thresholds would be difficult to achieve but could be achieved with significant effort on the part of our executives.
Under the Company performance component of the 2010 bonus plan, if we achieved 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 failed to meet a minimum net revenue threshold of $425 million and a minimum adjusted EBITDA threshold of $15 million, to 140%, if we vastly exceeded our guidance for the year by meeting or surpassing a net revenue threshold of $560 million and an adjusted EBITDA threshold of $27 million. The Company performance component of the plan generally was structured to pay out 100% of the named executive officers initial target bonus amounts if we met the high end of our initial full year targets for both net revenue of approximately $530 million and adjusted EBITDA of approximately $22 million for the year. The compensation committee reserved the right to exercise discretion in determining the final amounts to be paid under the bonus plan.
In August 2010, based on managements and the compensation committees assessment of Company performance results for the first half of the year, we paid a mid-year bonus equal to 65% of the named executive officers initial target bonus percentage of his or her year-to-date salary earned as of June 30, 2010.
In January 2011, the compensation committee determined that based on the Companys full-year 2010 net revenues of approximately $456.5 million and adjusted EBITDA of approximately $20 million, the terms of the bonus plan provided for a payout based on Company performance of approximately 40% of employees respective initial target bonus amounts. However, the compensation committee exercised the discretion reserved by it under the plan and elected not to pay any additional amounts under the bonus plan at year-end but rather to keep full-year bonus amounts under the plan equal only to the mid-year payment, or approximately 32% of employees respective initial target bonus amounts based on their full-year salaries. The compensation committee then allocated the remaining 8% available under the initial terms of the bonus plan to a limited number of top-performing employees, including certain of our executive officers as well as non-officer employees.
Individual Performance Component of Bonus
The individual performance component of each named executive officers actual 2010 bonus was initially structured, at the beginning of fiscal 2010, to be a function of (i) his or her initial target bonus based his or her position and responsibilities (as discussed above under What Our Compensation Program is Designed to Reward and Competitive Positioning and the Compensation Committees Outside Advisor) and (ii) an individual performance adjustment determined through the individual performance review process described above under Compensation Review Cycle.
Under this component of the bonus plan, a named executive officers ultimate bonus amount, that is, his or her initial target bonus amount multiplied by the Company performance payout factor, typically is then adjusted again by a multiplier of 0% to 130%, based on his or her individual job performance and, if one is assigned, overall rating. No ratings were assigned to the executive officers based on fiscal 2010 performance (as discussed above under Compensation Review Cycle and Performance Objectives and as discussed below). 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.
Use of Compensation Committee Discretion
In determining the actual final individual performance adjustment for each officer, the compensation committee exercised discretion, considering not only the officers achievements, but other factors, such as the aggregate amount of bonuses paid under the plan, the impact of that amount on the Companys financial results, the extent to which the officers contributions were reflected in the Company performance component of the bonus, internal equity among our executive officers, and the impact of other events on an officers total compensation. For 2010, the compensation committee determined
that notwithstanding any differentiation in individual performance of our named executive officers, because performance was at a sufficiently high level across the entire named executive officer team, our goals of incentivizing and rewarding performance would be met without assigning individual performance ratings or basing the executive officers final bonus amounts on a multiplier based on individual performance.
Instead, the compensation committee exercised the discretion reserved to it under the bonus plan to start with the premise that all but a small number of employees would be awarded a final bonus amount equal to their mid-year payment. The amount of the mid-year payment was initially calculated based on Company performance during the first half of the year, which justified a 65% payout at the time, but was eventually supported by full-year results, which justified a markedly lower payout of 40%, as noted above under Company Performance Component of Bonus. Given this, the compensation committee elected not to make any additional payment based on full-year results or, except for a select group of employees, individual performance. This resulted in most employees and certain executive officers receiving a bonus based on a 32% Company performance adjustment and a 100% individual performance adjustment. Then, the compensation committee allocated the remaining 8% available under the bonus plan to make additional bonus payments to certain top-performing non-officer employees based on individual performance and to Ms. Lepore, Mr. Morikubo, and Ms. Wright based on a number of factors, including the general and informal assessment of their contributions to the Company and the amount of profits disgorged by them in 2010 pursuant to Section 16(b) of the Securities Exchange Act of 1934, as amended, related to inadvertent short-swing sales of drugstore.com common stock.
In connection with the issuance of restricted stock to its employees, and the Companys related tax withholding obligations at the time that restricted stock vests, the Company adopted a practice of having its designated broker sell on behalf of the Companys employees a sufficient portion of the vesting shares to cover the associated tax withholding obligation. Under this practice, our officers sold stock in October 2009 and April 2010. Then, in June 2010, having overlooked the automatic sales required by the Companys tax withholding practices, the officers purchased shares of our common stock in open-market transactions. The Company promptly identified the matching transactions under Section 16(b) and notified the affected officers, and the officers returned the profits from these sales to the Company. After these events, as a result of this disgorgement and to remedy the effective preclusion of officers open-market purchases of Company stock, the compensation committee modified the Companys tax withholding practices for all officers to eliminate these automatic sales. Because of the inadvertent nature of the short-swing transactions, and in order to encourage managements ownership of Company stock, in January 2011, the compensation committee elected to award additional bonus amounts out of the available bonus plan funds to the executive officers after taking into account a number of considerations including each executive officers overall contributions to the Company as well as the amount of the previously disgorged profits.
The following table shows each officers mid-year bonus paid in August 2010 and equal to 65% of the officers initial target bonus percentage of his or her year-to-date salary as of June 30, 2010, or approximately 32% of his or her full year salary, and any additional discretionary amount approved in January 2011, and paid in February 2011, as described above:
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 similar two-pronged assessment to the 2010 bonus plan: (i) Company performance, as demonstrated by our achievement of certain net revenue and adjusted EBITDA objectives; and (ii) the individuals performance.
The compensation committee again assigned each officer 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.
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 targets for the year. The compensation committee again 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 officers 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 officers 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.
The other significant component of our executives variable compensation was equity compensation in the form of restricted stock units that we granted under our 2008 Plan. Historically, we have also granted our executive officers stock options under our 1998 Stock Plan (the 1998 Plan) and stock options, restricted stock, and stock appreciation rights under our 2008 Plan.
We seek to align the long-term interests of our named executive officers with those of our stockholders. Accordingly, we granted each executive a significant stock option when he or she joined drugstore.com and/or when we promoted him or her to his or her current position. In addition, the compensation committee evaluates stock-based compensation annually (as part of the review process described above under Compensation Review Cycle), considering executive officers responsibilities and performance (as discussed above under What Our Compensation Program is Designed to Reward and Performance Objectives and, generally, under Competitive Positioning and the Compensation Committees Outside Advisor). In June 2009, the compensation committee engaged Applied HR Strategies specifically to assess its Company-wide long-term incentive compensation program and to assist it with its ongoing approach to long-term incentive awards. The compensation committee sought advice from the compensation consultant to develop an equity program to address the challenges faced by stock-based compensation expensing requirements, the need to reduce overall equity usage, and the continued focus on shareholder alignment, while at the same time balancing the need for executive retention and motivation.
Historically, the Company granted stock options as its primary form of equity award. Working with its consultant, in 2009, the compensation committee determined that it would shift from stock options to a more balanced mix of restricted stock and stock-settled stock appreciation rights. Restricted stock would foster stock ownership more immediately, provide an effective long-term incentive to management for their efforts, while ensuring more retentive value and providing some protection to our executives from uncertainty in the current economic climate. Restricted stock would also have less of a dilutive effect for our stockholders. Stock appreciation rights offer the long-term incentive benefits of stock options and aligned our executives financial interests with our stockholders even more closely than restricted stock, but with a less dilutive effect than stock options. By settling these rights in stock rather than cash, the Company can also preserve its cash for other strategic purposes.
We manage our equity incentive award use carefully, and continue to monitor and adapt that usage as necessary in light of changes in the regulatory and competitive landscape. The compensation committee carefully monitors our total dilution, burn rate and stock-based compensation expense to ensure that we maximize stockholder value by granting only the appropriate number of equity awards necessary to attract, reward and retain employees. Working with compensation consultants in recent years, we have worked to ensure that our equity compensation program is competitive in light of the markets in which we compete for talent and, at the same time, in the best interest of our stockholders.
In 2010, the compensation committee elected to issue restricted stock units in lieu of restricted stock awards. Unlike restricted stock, which is issued and outstanding at the time of grant regardless of the vesting schedule of the award, the shares underlying restricted stock units are not issued until they vest, so the dilutive effect of the awards is delayed. In addition, holders of restricted stock units have no voting rights with respect to the underlying shares until they vest and the shares are issued, thus eliminating the empty vote issue that arises when a restricted stockholder votes shares to which they do not yet have full economic rights. At the same time, in order to reduce dilution, burn rate, and stock-based compensation expense further, the compensation committee decided to shift from a mix of restricted stock units and stock appreciation rights to restricted stock units only.
Based on market analysis conducted by its consultant in June 2009, the compensation committee approved equity award guidelines to determine the size of equity awards approved by the compensation committee or any subcommittee authorized by the compensation committee. Under these guidelines, the Company seeks to grant to each of our named executive officers an annual package of long-term incentive awards valued at a percentage of that executives base salary. For our chief executive officer, the compensation committee sought to grant a package of awards with an aggregate face value equal to approximately 300% of her base salary, which the compensation committee determined was appropriate for her position and responsibilities based on the market analysis and other advice provided by the consultant. The compensation committee exercised some discretion on the basis of her individual performance and potential (evaluated as discussed above
under What Our Compensation Program is Designed to Reward and Performance Objectives) to determine the final number of shares subject to the awards. For our other named executive officers, the compensation committee granted the annual awards described below valued at 140% of their respective base salaries, which the compensation committee determined was appropriate for his or her position and responsibilities, based on the market analysis and other advice provided by the consultant, and then adjusted the final number of shares on the basis of their individual performance and potential in the discretion of the compensation committee. In determining the actual number of restricted stock units to issue, the compensation committee applied the formula described above using a stock price of $2.00 per share rather than the actual stock price on the date of grant in order to lessen the impact of stock price volatility.
On November 12, 2010, the compensation committee granted to Ms. Lepore 300,000 restricted stock units subject to the terms and conditions of our 2008 Plan and a restricted stock unit agreement. These restricted stock units are subject to the terms and conditions of our 2008 Plan and a restricted stock unit agreement and will vest over four years in eight equal installments on each six-month anniversary of the grant date, subject to continued service through each vesting date.
Consistent with the terms of Ms. Lepores previous equity awards, all unvested restricted stock units will vest in the event of a change in control (as defined in the 2008 Plan). In addition, if we terminate her employment without cause (as defined in Ms. Lepores restricted stock unit agreement) or if she terminates her employment for good reason (as defined in the agreement), she will receive 12 additional months of vesting credit with respect to her restricted stock units.
On November 12, 2010, the compensation committee also granted restricted stock units to our other named executive officers, as follows:
These restricted stock units are subject to the terms and conditions of our 2008 Plan and restricted stock unit agreements and will vest over four years in eight equal installments on each six-month anniversary of the grant date, subject to continued service through each vesting date. Pursuant to the terms of each of these executive officers change in control arrangements (discussed more fully below in the section entitled Post-Employment Compensation), if we terminate his or her employment without cause (as defined in the applicable change in control agreement) or if the executive officer terminates his or her employment for good reason (as defined in the applicable change in control agreement), the restricted stock units will vest in full.
Our named executive officers are provided with the opportunity to participate in our health and welfare benefit program, as well as the opportunity to participate in our Section 401(k) plan, on substantially the same terms and conditions as most of our other employees. In addition, we cover insurance premiums on long-term disability and group term life insurance policies for the benefit of each of our executive officers, which benefits are over and above those available for our other employees generally.
Post-Employment Compensation Agreements
We generally do not enter into severance agreements with our executive officers (other than the change in control agreements discussed below), other than our chief executive officer, as discussed below. From time to time, in the discretion of management, we may make payments to an executive in the event of his or her termination without cause. In such cases, no benefits are available or have accrued prior to the executives employment separation, and at no time does such executive have any right to severance payments. We enter into separation arrangements with certain executives at the time of their termination without cause in order to protect us, because we generally make these payments in consideration of a general release of future claims against drugstore.com. These separation agreements may also include non-compete, non-solicitation, non-disparagement, and confidentiality agreements by the executives.
Under the terms of our offer letter to Ms. Lepore, we will make certain payments and provide certain rights and benefits to Ms. Lepore in the event we terminate her employment without cause or she terminates her employment for good reason. The payments, rights and benefits are more fully described below in the section entitled Post-Employment Compensation.
We believe that this severance protection is specifically appropriate for our chief executive officer to ensure that our most senior executive can remain focused on the Companys goals and objectives and the best interests of stockholders, rather than potential personal economic exposure even during the most distracting circumstances of a period of transition or succession.
Change in Control Arrangements
We have change in control arrangements with our chief executive officer documented in both an offer letter with her and individual equity agreements, pursuant to which all of her outstanding equity will become immediately vested and exercisable in the event of a change in control, as discussed in more detail below under Post-Employment Compensation. In addition, in connection with its regular review of our corporate governance practices, in January 2009, our board of directors , based on the recommendation of our compensation committee, approved the terms of change in control arrangements for certain of our other officers, including Messrs. Potter and Morikubo and Ms. Wright, which entitles each of them to certain payments, rights and benefits in the event that we terminate his or her employment without cause (as defined in the agreement) or he or she terminates his or her employment for good reason (as defined in the agreement) upon or within twelve months following a change in control of drugstore.com. Although the terms of these arrangements were approved in 2009, the actual change in control agreements evidencing these terms were not entered into at that time. On January 28, 2011, our compensation committee, recognizing that the earlier agreed upon terms were not entirely consistent with the compensation committees intent, approved, and in February 2011, the Company and the individuals entered into, change in control agreements that reflected modified terms regarding equity treatment. The modified term was to include in the agreement full acceleration of the vesting and exercisability of the executive officers then-outstanding equity awards upon a qualifying termination occurring upon or within twelve months following the change in control. The payments and rights are more fully described below in the section entitled Post-Employment Compensation.
We believe that our severance and change in control arrangements and agreements generally offer significant protections and promote important goals that are critical to our long-term financial success. The agreements create incentives for our executive officers to obtain the highest possible value for our stockholders in an acquisition and allow our executive officers to continue to focus their attention on our operations and strategic objectives without the distraction of a risk to their own financial security during periods when we need their focused attention to succeed. The agreements are intended to retain qualified executives who could have other job alternatives that may appear to provide them with more financial security absent an agreement. Accordingly, the compensation committee believed that it was in the best interest of the Company and its stockholders to improve the Companys ability to retain its executives through any potential transaction.
Ms. Lepores change in control arrangement is a single-trigger arrangement, such that her equity accelerates on the closing of a transaction regardless of whether her employment is terminated. The compensation committee believed this is appropriate for two reasons. First, Ms. Lepore has separate severance protection as discussed above under Severance Agreements. Second, having the change in control protection tied directly to her equity is intended to ensure that our chief executive officers personal financial interest is aligned with that of our stockholder base and encourages her to secure the highest possible price in any change in control transaction. This alignment is further heightened because Ms. Lepores equity constitutes a more significant portion of her total compensation than it does for other executive officers.
Our other executive officers change in control agreements are double-trigger arrangements, such that the benefits are received only if the executives employment is terminated upon or within a limited time period following a change in control. The compensation committee believed that given the structure of our executive officers overall compensation, these arrangements offer appropriate financial security to our senior management to meet the objectives discussed above.
In addition, our 2008 Plan provides that in a change in control where the successor corporation, or the parent or subsidiary of the successor corporation, refuses to assume or substitute for the award, outstanding awards under the plan would become immediately vested and exercisable.
As part of our executive officers compensation, as previously described, we granted restricted stock units under our 2008 Plan. In the event of a change in control, any of Ms. Lepores awards that are unvested will become immediately vested, as discussed in more detail below in the section entitled Post-Employment Compensation. In addition, if any of our other executive officers are terminated in qualifying termination upon or within 12 months following a change in control, any of their unvested awards will become immediately vested, as discussed in more detail below in the section entitled Post-Employment Compensation.
We have considered the total potential cost of the change in control protection afforded to our executive officers and have determined that it is reasonable and not excessive given the importance of the objectives described above.
Our current insider trading policy and guidelines limit the timing and types of transactions in our common stock or other securities by our Section 16 officers, including stock option and stock appreciation right exercises, whether or not the executive subsequently sells any shares purchased. Our policy and guidelines seek to promote compliance with applicable securities laws, to prevent insider trading violations and allegations of insider trading violations, and to preserve the reputation and integrity of drugstore.com and others associated with us. In addition to the prohibitions generally applicable to all of our employees on trading in our securities while in possession of material nonpublic information or passing on such information to others, the policy and guidelines specifically require our Section 16 officers:
Accounting and Tax Considerations
Our stock option grant policies have been affected by the implementation of Financial Accounting Standards Board Accounting Standards Codification Topic 718 (ASC Topic 718, formerly called SFAS No. 123(R)). Under ASC 718, we estimate the portion of unvested stock options that we expect to be forfeited for failure to vest, and we recognize compensation costs only for those equity awards expected to vest.
We are subject to Section 162(m) of the Internal Revenue Code of 1986, as amended, which limits the deductibility of certain compensation payments to certain of our executive officers in excess of $1 million. Section 162(m) also provides for certain exceptions to the limitations on deductibility, including compensation that is performance based within the meaning of Section 162(m)(4)(c). Based on fiscal year 2010 compensation levels and the exception for performance-based compensation, no limits on the deductibility of compensation applied to any officer of drugstore.com.
In addition, Section 409A of the Internal Revenue Code imposes additional significant taxes in the event that a named executive officer, director or service provider receives deferred compensation that does not meet the requirements of Section 409A. To assist in preventing the imposition of additional tax under Section 409A, we have structured our 2008 Plan and our equity compensation awards in a manner intended to comply with the applicable Section 409A requirements. In addition, in 2008, we amended the terms of certain options granted under our 1998 Plan, including Ms. Lepores 2004 option, to comply with these 409A requirements.
2010 Summary Compensation Table
The following table sets forth the total compensation awarded to, earned by, or paid to our chief executive officer and our other executive officers for services rendered to drugstore.com during fiscal years 2008, 2009, and 2010. We refer to the listed persons as our named executive officers.
We do not enter into employment agreements with our executive officers. We do however have offer letters, and in many cases, promotion offer letters, that set forth the officers initial salary and option grants. Thereafter, the compensation committee evaluates our executive officers annually and determines any adjustments to salary and additional option grants, as discussed above in the section entitled Compensation Discussion and Analysis.
2010 Grants of Plan-Based Awards
The following table sets forth the restricted stock units granted to our named executive officers during fiscal year 2010, the fair value of these awards as of their grant date, and the estimated future payouts under our non-equity incentive plan.
We granted the restricted stock units indicated in the above table to our named executive officers under our 2008 Plan. Generally, those awards vest over four years in eight equal installments on each six-month anniversary of the vesting commencement date.
Outstanding Equity Awards at Fiscal Year-End
The following table shows outstanding equity awards held by the named executive officers as of January 2, 2011.
Option Exercises and Stock Vested
The following table shows shares of restricted stock held by our named executive officers that vested in 2010. None of our named executive officers exercised any options during 2010.
Post-Employment Agreements with Executive Officers
We have severance or change-of-control agreements with our chief executive officer and our other executive officers, as discussed below. Our 1998 Plan did not provide for automatic acceleration of vesting in the event of a change of control, though it authorizes the plan administrator to provide for such terms on a case-by-case basis. As discussed above, the 2008 Plan authorizes the plan administrator to determine how awards are treated in the event of a change of control, but specifically provides for acceleration of vesting in the event awards are not assumed or substituted by the successor corporation.
Offer Letter and Change of Control Arrangements with Dawn Lepore
drugstore.com has entered into an offer letter with Dawn Lepore, its chief executive officer, originally dated September 21, 2004, and most recently amended on April 8, 2011. The offer letter provides for certain severance benefits in the event drugstore.com terminates Ms. Lepores employment without cause or if Ms. Lepore terminates her employment for good reason, in each case as defined in her offer letter. Upon a qualifying termination and conditioned on Ms. Lepore executing a release of claims against drugstore.com, Ms. Lepore will receive the following benefits:
Each of Ms. Lepores equity awards from drugstore.com will fully accelerate upon a change in control.
Ms. Lepores receipt of these benefits will be subject to her compliance with our confidentiality agreement and her execution of a release of claims in the form customarily used by drugstore.com in connection with the termination of an executive officers employment.
The table below reflects the amount of compensation to Ms. Lepore assuming that her employment was terminated by drugstore.com without cause, she resigned for good reason, or a change of control was completed on January 2, 2011. Please note that the amounts indicated below are hypothetical estimates. Amounts, if any, to be received by Ms. Lepore in connection with any actual future termination of her employment or consummation of a change of control may differ in material respects from the amounts set forth below.
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 board of directors approved in January 2009. On January 28, 2011, our compensation committee, recognizing that the earlier agreements were not entirely consistent with the committees 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 officers 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 officers 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 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 officers receipt of the greatest after-tax amount.
Each executive officers 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 officers employment.
For purposes of the change in control agreements, change in control has the definition provided in our 2008 Plan and means:
For purposes of the change in control agreements, cause means:
For purposes of the change in control agreements, good reason means any of the following uncured events:
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 table below reflects the amount of compensation to each executive had his or her employment been terminated by drugstore.com without cause or the executive resigned for good reason following a change in control of drugstore.com and provided the executive signed and did not revoke a release of claims. The table assumes that the change in control was completed on January 2, 2011, and that the executive terminated employment on January 2, 2011. Please note that the amounts indicated below are hypothetical estimates. Amounts, if any, to be received by the executive in connection with any actual future termination of her employment in connection with a change of control may differ in material respects from the amounts set forth below.
COMPENSATION COMMITTEE REPORT
The compensation committee of the board of directors has reviewed and discussed the Compensation Discussion and Analysis with management. Based on such review and discussions, the compensation committee recommended to the board of directors that the Compensation Discussion and Analysis be included in this Amendment No. 1 to our annual report on form 10-K.
Jeffrey M. Killeen
William Savoy (chair)
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information regarding securities issuable under our equity compensation plans as of January 2, 2011.
Security Ownership of Certain Beneficial Owners and Management
The following table shows certain information as of March 31, 2011 regarding beneficial ownership of our common stock by (a) each person who, to drugstore.coms knowledge, beneficially owned more than five percent of the outstanding shares of our common stock as of that date, (b) each of our Named Executive Officers (as defined in Item 402 of Regulation S-K promulgated by the SEC), (c) each member of our board of directors, and (d) all directors and executive officers as a group.
Transactions with Related Persons
We have entered into the transactions described below with our executive officers, directors and holders of 5% or more of our common stock and their affiliates.
Agreements with Executive Officers and Directors
We have entered into indemnification agreements with our directors and officers. These agreements require us to indemnify these individuals to the fullest extent permitted by Delaware law.
Agreements with Amazon.com
Amazon.com is our largest stockholder, owning approximately 12.1% of our outstanding stock as of March 31, 2011. Pursuant to the Voting Agreement, in November 2006, Geoffrey R. Entress, was appointed to serve as Amazons designee on our board of directors. 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.
Policies and Procedures for Approving Related Person Transactions
On an annual basis, each of our directors and officers must complete a director and officer questionnaire that requires disclosure of any transaction, arrangement, or relationship with the Company during the last fiscal year in which the director or executive officer, or any member of his or her immediate family, had a direct or indirect material interest. In addition, this questionnaire directs the directors and officers to certify that they will update us throughout the year regarding any revisions or additions to the information provided in the questionnaire. Our board of directors will review and consider any transaction, arrangement, or relationship that a director or officer discloses in his or her questionnaire in making independence determinations with respect to directors and resolving any conflicts of interest that may be implicated.
Our code of business conduct and ethics requires all directors and employees either to avoid participating in any outside activity that might create a conflict of interest or, if such avoidance is impossible, to disclose fully any information regarding a potential conflict and to refrain from participating in any of our decisions that might raise the conflict. All officers must obtain the prior written consent of our legal team before entering into any outside employment or business venture. In addition, our code requires that all of our contracts be reviewed and approved by our legal and finance teams before they are signed, regardless of the type or dollar amount of the contract.
As required under SEC rules, transactions that we determine to be directly or indirectly material to us or to a related person are disclosed in our Proxy Statement. In addition, the audit committee of our board of directors reviews and approves or ratifies any related person transactions, including those that we are required to disclose, based on the relevant circumstances, including:
In the event that any member of the audit committee has a direct or indirect interest in any such transaction, he or she will recuse himself or herself from the deliberations of the committee regarding that particular transaction. If the audit committee does not approve any related person transaction, it may take such action as it may deem necessary or desirable in our best interests and in the best interest of our stockholders.
The board of directors has determined that Messrs. Bennet, Killeen, Savoy, and Stanger are independent within the meaning of rules of the NASDAQ Stock Market. The audit committee, compensation committee, and nominating committee are composed entirely of independent directors.
Fees of Independent Registered Public Accounting Firm
The following table sets forth the fees paid to date for services rendered by Ernst & Young LLP during fiscal years 2010 and 2009.
Audit Committee Preapproval of Auditor Services
The audit committee is responsible for the appointment, compensation, retention, and oversight of, and for the preapproval of all audit, audit-related, tax and nonaudit services to be provided by, our independent registered public accounting firm.
The audit committee has adopted guidelines for preapproval of services to be provided by our independent registered public accounting firm. The audit committee preapproves services as follows:
In deciding whether to preapprove any services proposed to be provided by the independent registered public accounting firm, the audit committee considers the following: (i) whether the proposed services are consistent with SEC rules on auditor independence; (ii) whether the independent registered public accounting firm is qualified to provide effective and efficient service; (iii) whether such service would enhance our ability to manage or control risk or improve audit quality or would otherwise be beneficial to drugstore.com; and (iv) the relationship between fees for audit and nonaudit services. The audit committee will not approve the provision by the independent registered public accounting firm of any audit or nonaudit service that it believes, individually or in the aggregate, may impair the independence of the independent registered public accounting firm.
(a)(1) and (a)(2): No financial statements or schedules are filed with this report on Form 10-K/A.
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 May 2, 2011.