Healthcentral
Com · 10-Q · For 3/31/01
(Securities
and Exchange Commission)
On January
29, 2001, XOR, Inc. filed an action in Adams County, Colorado
District Court against HealthCentral.com. The complaint alleges
breach of contract, unjust enrichment and promissory estoppel.
The complaint alleges monetary damages of approximately $1.3
million. The Company has responded with an answer and counter
claim for breach of contract and plans to vigorously defend
against this claim. The Company's financial statements reflect
the software capitalization of $0.5 million related to XOR.
The Company has not accrued any amount related to the resolution
of this matter.
|
Filed On 4/2/01 3:56pm ET · SEC File 0-27567 · Accession Number 929624-1-545
As Of Filer Filing As/For/On Docs:Pgs Issuer Agent
4/02/01 Healthcentral Com 10-K405 12/31/00 17:267 Donneley R R & S..Inc/FA
Annual Report -- [X] Reg. S-K Item 405 · Form 10-K
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10-K405 Form 10-K 84 550K
2: EX-3.5 Amended and Restated Bylaws of the Company 28 123K
3: EX-3.8 Certificate of Designation 7 37K
4: EX-4.3 Registration Rights Agreement 12 60K
5: EX-4.4 Registration Rights Agreement 12 60K
6: EX-10.33 Lease 12 57K
7: EX-10.34 Lease Agreement 36 136K
8: EX-10.35 Lease 45 172K
9: EX-10.36 Employment Agreement 5 27K
10: EX-10.37 General Assignment 2 13K
11: EX-10.38 General Assignment 3 14K
12: EX-10.39 Common Stock Repurchase Agreement 6 23K
13: EX-10.40 Amendment I 3 15K
14: EX-10.41 Severance and Change Agreement 9 46K
15: EX-21.1 Subsidiaries of the Company 1 7K
16: EX-23.1 Consent of Independent Accountants 1 7K
17: EX-23.2 Consent of Independent Public Accountants 1 7K
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
Form 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period from to
Commission File Number: 000-27567
HEALTHCENTRAL.COM
(Exact name of registrant as specified in its charter)
[Download Table]
Delaware 94-3250851
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
HealthCentral.com
6005 Shellmound Street, Suite 250
Emeryville, CA 94608
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (510) 250-2500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
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 than the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES [X] NO [_]
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]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $12,150,729 as of February 28, 2001 based
upon the closing sale price on the Nasdaq National Market reported for such
date. Shares of Common Stock held by each officer and director and by each
person who owns 5% or more of the outstanding Common Stock have been excluded
in that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
There were 50,661,038 shares of the registrant's Common Stock issued and
outstanding as of February 28, 2001.
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
HEALTHCENTRAL.COM
[Download Table]
Page
----
PART I
Item 1. Business....................................................... 1
Item 2. Properties..................................................... 18
Item 3. Legal Proceedings.............................................. 18
Item 4. Submission of Matters to a Vote of Security Holders............ 19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder 19
Matters.......................................................
Item 6. Selected Financial Data........................................ 21
Item 7. Management's Discussion and Analysis of Financial Condition and 22
Results of Operations.........................................
Item 7a. Qualitative and Quantitative Disclosures About Market Risk..... 43
Item 8. Financial Statements and Supplementary Data.................... 43
Item 9. Changes in and Disagreements with Accountants on Accounting and 43
Financial Disclosure..........................................
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8- 44
K.............................................................
Signatures............................................................... 47
PART I
In addition to historical information, this Annual Report on Form 10-K
contains forward-looking statements. These forward-looking statements involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to, those discussed in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Risk Factors That May Affect Future Results and Market Price of
Stock." Readers are cautioned not to place undue reliance on these forward-
looking statements, which reflect management's opinions only as of the date
hereof. The Company undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements.
Item 1. Business
Company Overview
HealthCentral.com is a leading provider of online healthcare-related e-
commerce and content to consumers through our network of websites, which
includes WebRx.com, ComfortLiving.com, Vitamins.com, DrugEmporium.com,
HealthCentral.com and RxList.com, and through our Vitamins.com mail order and
retail operations. We derive revenue from e-commerce, mail order and other
product sales, which consists of prescription and non-prescription drugs,
over-the-counter health and beauty aid products, nutraceuticals, vitamins,
minerals, supplements, back care products, baby care products, maternity care
products, allergy care products and other specialty health and wellness
products. We also derive revenue from the sale of the Dr. Dean Edell Eyewear
brand eyeglasses to our distributor.
We believe our stores and catalog offerings provide an easy way for
consumers to shop for the healthcare products they use everyday by providing a
complete source of healthcare products along with a wide range of health-
related content. Our goal is to become the leader in healthcare related e-
commerce. We intend to accomplish this goal through:
. WebRx.com, our online health superstore, which offers a selection of more
than 25,000 SKU's of health, beauty, and personal care products, plus a
full service pharmacy and a complete vision center at competitive prices;
. Comfort Living.com, our online specialty store, which features personal
and home products that are designed to address a particular health
condition. These products are distinctive in quality and not widely
available from other retailers. They are intended to make some aspect of
the user's life easier, better, more enjoyable or more comfortable.
Typical product lines include ergonomically correct chairs, products for
back and pain relief, allergy and asthma relief products and beds and
mattresses;
. Vitamins.com, our online vitamin store, which offers approximately 4,000
products representing over 100 health-related national brands as well as
the Vitamins.com brand. Product offerings include vitamins, minerals,
nutraceuticals, herbs, homeopathic products, body building supplements
and other healthcare products;
. Our Vitamins catalog, a monthly publication which offers approximately
8,000 products including nutraceuticals and other healthcare products;
. Our six Vitamins.com retail stores, which operate in the Maryland and
Virginia suburbs of the Washington, DC area. These stores generally stock
approximately 5,000 products;
. Comprehensive information on over-the-counter and prescription drugs
coupled with in-depth health-related content to help customers make
better informed purchases of health related products; and
. Quality customer service assistance, which is designed to attract and
retain customers, along with systems designed to safeguard client
confidentiality.
1
We also design, host and maintain healthcare institutions' websites for
healthcare content and e-commerce. These co-branded and private label websites
enable our institutional clients to build needed brand loyalty to retain and
attract members and patients. We receive both development fees for building
customized websites and an annual license fee for our content and interactive
tools. Our largest clients are currently Blue Shield of California, Tenet
Healthcare Corporation, Women's Capital Corporation, Catholic Healthcare West,
St. Vincent's Hospital, Henry Ford Health System and Scripps Clinic.
HealthCentral.com is a Delaware corporation. Our principal executive
offices are located at 6005 Shellmound Street, Suite 250, Emeryville,
California 94608. Our telephone number at that location is (510) 250-2500. The
websites of the HealthCentral.com network are www.healthcentral.com,
www.webrx.com, www.rxlist.com, www.vitamins.com, www.drugemporium.com and
www.comfortliving.com.
Recent Events
Acquisition of Certain Assets and Liabilities of Comfort Living, Inc. and
Certain Assets of more.com. On December 14, 2000, we acquired all of the
assets and properties and assumed certain liabilities associated with
more.com's Comfort Living subsidiary, and certain related more.com assets,
including its website, www.comfortliving.com, inventory and a leased 18,000
square foot warehouse and distribution center in Gaithersburg, Maryland.
Acquisition of DrugEmporium.com. On September 14, 2000, we completed an
asset purchase agreement with Drug Emporium, Inc. and its online drugstore
subsidiary, DrugEmporium.com. Under the terms of the asset purchase agreement,
we acquired substantially all of the assets of DrugEmporium.com, including a
leased 60,000 square foot distribution and a prescription fulfillment center
in Louisville, Kentucky. In connection with this acquisition, we also entered
into a 10-year services agreement with Drug Emporium, under which we receive
in-store promotional and advertising support and access to Drug Emporium's
electronic purchasing system and in-store order pickup capabilities at certain
Drug Emporium retail stores. Drug Emporium recently filed for Chapter 11
bankruptcy protection in connection with a buyout by Snyder's Drug Stores.
Acquisition of Vitamins.com, Inc. On June 16, 2000, we acquired
Vitamins.com, a retailer that provides dietary supplements and related health
and wellness products. Through the acquisition of Vitamins.com, we acquired
Internet, mail order and brick-and-mortar retailing operations.
Dr. Dean Edell Eyewear License Agreement. On April 11, 2000, we acquired
the exclusive licensing rights to "Dr. Dean Edell Eyewear" through 2006.
Simultaneously, we entered into a distribution agreement with Cable Car
Eyewear to sell the Dr. Dean Edell Eyewear to brick-and-mortar pharmacies and
grocery chains. This agreement requires minimum purchases of products by Cable
Car Eyewear from us for the years 2000 through 2006; we are in negotiations
with the distributor regarding changes to the existing agreement that may
result in inventory values not being realized. In addition, we entered into a
supply agreement with Invision Optical Products through 2006 to source the
Dr. Dean Edell Eyewear products and supply us with these products, and we are
in negotiations with the supplier regarding changes to the existing agreement.
As a result of the DrugEmporium.com and Comfort Living asset purchases, we
have been able to purchase products directly from manufacturers and
wholesalers, thus we were able to eliminate many of our third party
fulfillment partnerships which we believe will result in improved product
margins. These acquisitions have also allowed us direct access to vendor
promotions and rebates. In October, 2000 we consolidated our Long Island City,
New York fulfillment operation into our Louisville, Kentucky fulfillment
center. This consolidation resulted in reduced operating costs, improved
inventory controls and greater economies of scale. We plan to further
consolidate our warehouse operations by closing our Gaithersburg, Maryland
facility on or before June 2001. Further, the acquisitions of
ComfortLiving.com, Vitamins.com and the Dr. Dean Edell Eyewear brand have
allowed us to expand our product lines, gain access to additional online and
offline customers and establish multiple high margin categories throughout our
health superstore and our mail order and retail businesses. We are in the
process of reviewing pharmacy operations and, as a result, may make changes in
the future.
2
Industry Background
The Internet has become an increasingly popular source for healthcare
information and products. In a November 2000 survey performed by Pew Internet
and American Life Project (www.pewinter.org), 52 million American adults, or
55% of those people with Internet access have used the Web to search for
health or medical information. The number of people retrieving health-related
information is projected to grow. This growth in demand for online health
information has been driven by consumers seeking to make better personal
healthcare decisions.
As consumers become more educated about their personal healthcare, they are
also increasingly purchasing healthcare products online. According to June
2000 data from the research firm International Data Corporation, U.S. sales of
pharmaceutical, health, and beauty products over the Internet will increase
from less than $250 million in 1999 to more than $18 billion in 2004. The
study, "U.S. Online Prescription and Nonprescription Pharmaceutical, Health,
and Beauty Market: Forecast and Analysis," predicts that the majority of
revenue, 80% or $14.8 billion, will come from online sales of prescription
drugs, and Unity Marketing estimates that 89% of U.S. adults were expected to
take vitamins in 2000.
HealthCentral.com Solution
Through our network of websites, mail order operations, brick-and-mortar
stores, interactive and convenient shopping tools and customer service center,
HealthCentral.com offers a global solution to satisfy the growing demand for
healthcare products and health-related content.
WebRx Health Superstore
Our WebRx Health Superstore is a full service online store that combines
the convenience and privacy of online shopping with tremendous product
selection and reasonable prices. WebRx features the health-related products
that people use everyday, such as over-the-counter remedies, beauty aids,
cough, cold and pain relief medications. WebRx also features a full service
pharmacy with a licensed pharmacist to provide information about prescription
medications concerning correct use and dosage, generic alternatives, potential
side effects and drug interactions. Our pharmacy department is able to
crosscheck each prescription received for allergies, therapeutic overlap,
overuse/underuse and drug interactions with other drugs or foods. We are in
the process of reviewing pharmacy operations and, as a result, may make
changes in the future.
Vitamins, Minerals, Supplements & Herbs
In order to address lifestyle changes and the growing needs of an aging
population, we offer a large selection of vitamins, nutritional and dietary
supplements, herbs, homeopathic products, minerals and natural health, sports
and fitness products. These products may be purchased through three different
distribution channels:
. Vitamins.com. Our Vitamins.com Internet website offers over 4,000
products, representing over 100 health-related national brands. Customers
may seek out products in four different ways--by specific product,
product category, health concern or brand name. We carry both national
brands and private label brands such as Vitamins.com and Drug Emporium.
. Vitamins Mail Order. The Vitamins.com catalog is a full-color publication
distributed monthly by mail to catalog shoppers. It typically contains
between 90 and 100 pages and offers approximately 8,000 products. Each
issue features up to 100 products at special prices of up to 30% off of
regular catalog prices and up to 50% off of manufacturers' suggested
retail prices.
. Vitamins Retail Stores. We operate six Vitamins.com or Vitamin Superstore
brick-and-mortar stores in the Maryland and Virginia suburbs of
Washington, D.C. These retail stores generally stock approximately 5,000
products and are strategically located in high-traffic, high volume
retail centers. We believe our stores are substantially larger than the
stores of our major retail competitors. The stores are designed to
3
be comfortable and welcoming and provide the atmosphere typical of an
upscale bookstore or other specialty store.
Specialty Health Products
ComfortLiving.com is an Internet retailer specializing in non-consumable,
durable products, which are designed to address personal care, pain relief and
comfort. The products are organized around three key themes:
. Healthy environment--products used primarily in the home and office to
improve personal comfort, air and water quality, or the overall
environment, such as specialty products for allergy and asthma sufferers,
air and water conditioners, purifiers and filters, and ergonomic supplies
and furniture;
. Home healthcare--special use or hard-to-find products designed for use in
the home by people with particular assisted living and healthcare needs,
such as adjustable beds, therapeutic mattresses, lift chairs and
ergonomic supports; and
. Baby care and maternity--health, safety and comfort products for the
expecting mother or new parents and their children.
Vision Center
Through our vision center, customers can purchase a wide variety of eye
care products, such as contact lenses, contact solution and Dr. Dean Edell
Eyewear nonprescription reading glasses.
Interactive and Convenient Shopping Tools
To enhance the shopping experience, the WebRx.com site has a virtual
shopping bag that keeps a running tab of selected items and prices, allowing
shoppers to quickly purchase their needed healthcare products. The shopping
bag remains to the right of their screen while the customer browses so that
consumers do not have to click to a different page to select each product. To
quickly find a particular item, shoppers can use our search engine, browsing
the entire inventory by key word, such as the product name, brand name or
description. Shoppers may also develop their own shopping lists on the site to
be saved and used again. The customer can then add or subtract items as they
continue to shop with us in the future. We also offer a convenient and easy-
to-use Auto Reorder service, which allows customers to order products that
will be shipped automatically at any time intervals they choose. Customers can
also create and store multiple shopping lists to eliminate the task of
searching for the same products.
Personalized Level of Customer Service
Our customers can have their general questions about account information,
ordering products and shipping status addressed by HealthCentral.com customer
care representatives. Our customer service representatives provide responses
to customer inquiries by e-mail or telephone and are available seven days a
week, from the hours of 8:00 a.m. to 10:00 p.m., Eastern Time, from Monday
through Friday, and from 9:00 a.m. to 5:00 p.m., Eastern Time, on Saturday and
Sunday. We offer our customers various shipping options, including next-day,
two-day or standard delivery through UPS or the United States Post Office.
Informative, Trustworthy and Engaging Health Information Content
In the Winter 2000 Scorecard, HealthCentral.com website was ranked as the
number one overall health content site on the Internet by Gomez, the Internet
quality measurement firm. Our reputation in this regard is built on the
provision of comprehensive and engaging information from medical professionals
who have established a high degree of trust with consumers through traditional
media. Currently our original content comes from established media sources
such as Dr. Dean Edell, one of the leading physician broadcasters in the
United States for the past twenty years. In addition, RxList.com, our internet
drug index, provides fast and
4
reliable information to both the consumer and the medical professional. The
RxList.com database stores information regarding approximately 4,400
pharmaceuticals and other medicines in addition to Taber's Medical
Encyclopedia of more than 53,000 medical terms.
Our Strategy
Our strategy is to become the world's leading healthcare e-commerce
company. We intend to accomplish our strategy through multiple revenue
streams, high margin products, expansive product lines and the acquisition of
qualified customers at a relatively low cost while maintaining and cultivating
a relationship with our existing consumer customers:
Multiple Revenue Streams. Our strategy is to develop multiple revenue
streams from our e-commerce websites, catalog sales, Dr. Dean Edell Eyewear
sales, and sponsorship and advertising fees.
High Margin Products. We intend to focus on high price, high margin
products such as those offered at ComfortLiving.com and on high margin, high
volume products such as the vitamins, minerals and supplements sold through
our Vitamins.com website and mail order business.
Expansive Product Lines. We will continue to look for high margin, high
volume products to expand our range of consumer products and services.
Large Customer Base. In order to grow and maintain a large customer base,
we encourage repeat purchases with our emphasis on customer service. We are
also targeting to acquire new customers at a relatively low cost through
segmented emails, affiliate marketing programs, healthcare newsletters, and
engaging and informative content.
Maintain and Cultivate a Relationship of Trust with Consumers. Through our
affiliations with trusted media personalities such as Dr. Dean Edell we enjoy
a privileged and trusted status with those consumers who seek our
HealthCentral.com network based on their experience with those personalities.
We hold that level of trust in high regard and seek to maintain it by
providing consumers with reliable content and by keeping individual consumer
information confidential.
Customers
Consumer
In January 2001, the HealthCentral.com websites had the following traffic
levels, according to DoubleClick and internally generated reports.
ComfortLiving.com traffic levels were reported by WebTrends and reflect
pageviews, visits and unique visitors for the month of February 2001. "Total
unique visitors" is calculated as the sum of the unique visitors to each
individual site, thus, total unique visitors may be overstated due to
potential multiple counting.
[Download Table]
Pageviews Visits Unique Visitors
---------- --------- ---------------
ComfortLiving.com.................... 1,063,871 342,573 165,431
HealthCentral.com.................... 5,562,525 905,900 600,066
RxList.com........................... 5,939,491 1,014,770 709,722
WebRx.com*........................... 6,410,933 1,380,907 900,139
TOTAL................................ 18,976,820 3,644,150 2,375,358
--------
* Includes WebRx.com, Vitamins.com and DrugEmporium.com.
5
Technology
Our HealthCentral.com network of websites employs hardware and software
architectures, which are hosted on third-party web hosting services. We are in
the process of integrating all of our applications, services and databases into
the HealthCentral.com network architecture.
Physical Architecture. We employ a server architecture in a mixed LINUX,
Solaris, UNIX and Windows NT environment. Our HealthCentral.com network sites
and online stores, as well as our institutional clients' websites, are
protected by industry standard firewalls. All sensitive data is stored on
separate, private networks that are not directly accessible from the Internet.
In addition, there are security systems that include video surveillance of
critical servers 24 hours a day. There are also well-defined audit mechanisms
in place. We have implemented a broad array of website management, search
engine, customer support, order processing and fulfillment systems using a
combination of commercially available, licensed technologies and selected
proprietary technologies. The front ends of our online stores are built on
industry standard technologies, including the Sun Solaris operating system and
an Oracle database. These technologies are integrated using a variety of
proprietary computer programs, the majority of which are written in server side
Java, HTML, JavaScript and Pearl. These programs handle user interface, product
search, ordering, order tracking and customer communications.
HealthCentral.com subcontracts the hosting of its servers to several
different hosting companies. These hosting companies have agreed to provide
Internet connections to multiple Internet access points, a secure physical
environment, climate control, redundant power and 24-hour-a-day, seven-day-a-
week monitoring services. We believe that all facilities have adequate capacity
for expansion to support.
The continued, uninterrupted operation of the HealthCentral.com websites,
mail order and retail stores and our transaction processing systems is
essential to our business. We employ system administrators to monitor and
manage the website, network operations, inventory and fulfillment and
transaction processing systems to enable their continued operation and
reliability. The systems include redundant hardware on critical components and
have been designed to survive a variety of failures with minimal downtime.
Software Architecture. We employ three-tier software architectures,
consisting of a user interface layer, an engine layer and a database layer,
which allow customization, updating and repair of each layer without
interfering with the operation of the other layers. Our database servers are
Oracle on Sun Solaris for high end applications and MS SQL servers for low-end
applications.
Sales and Marketing
Our current sales and marketing strategy is targeted to drive qualified
customers to our network of e-commerce websites at a low cost. Our online
marketing efforts are focused on identifying first time customers and repeat
purchasers, who are typically Internet users aged 35 to 54, with an emphasis on
women. We reach these groups through:
. Segmented e-Mails
We have a large customer base that totaled 1.3 million customers as of
January 2001. We rely heavily on segmented e-mails as a way to cost
effectively market to our existing customer base, which we believe
results in improved customer retention and repeat purchases. We attempt
to maximize repeat purchases through our online Auto Reorder feature. We
also acquire or rent opt-in e-mail lists to market through e-mail-based
communications. Additionally, through our Vitamins catalog, we employ a
frequency reward program based upon repeat purchases, which reinforces
our online marketing efforts through branded giveaway items in our
product packaging.
. Co-Marketing Initiatives with Affiliates
We enter into co-marketing agreements with affiliate websites that
typically target women's interests, parenting and family, travel planning
and senior-oriented sites. We share revenue with affiliates for directing
traffic that results in purchases to our site.
6
. Healthcare Newsletters
We target healthy people and people who suffer from chronic conditions by
offering over 70 different topic specific newsletters (i.e., fitness,
diabetes, nutrition, hypertension, etc.) to our customers via email. This
e-mail program is effective and relatively inexpensive to administer, and
each newsletter contains e-commerce promotions.
. Search Engine Optimization
The marketing efforts of our ComfortLiving.com site include search-engine
optimization, an efficient and cost effective technique by which we
strive to direct Internet shoppers searching for brand name products and
special needs to our site.
. Advertising and Sponsorships
Our advertising campaigns target online consumers and are designed to
promote repeat purchases as well as result in the acquisition of new
customers. We employ DoubleClick, Inc. to conduct advertising sales for
our HealthCentral.com and RxList.com websites. Under the terms of the
agreement, we cannot sell advertising, with certain exceptions, for our
HealthCentral.com website through alternate avenues; however, the
agreement is terminable by either party on 90 days notice. We directly
develop and generate sponsorship revenues for our e-commerce websites
through strategic partnerships and selected relationships with key
vendors and pharmaceutical companies.
Competition
The online e-commerce markets in the health, beauty, wellness, personal care
and pharmacy categories are fragmented and intensely competitive. This
competition has resulted in price discounting and failure to build brand
loyalty. Our competitors in these areas can be divided into several groups:
. chain drugstores, such as CVS, Eckerd and Walgreen's, and independent
drug stores, including their websites;
. mass market retailers, such as Kmart, Target and Wal-Mart, including
their websites;
. supermarkets and warehouse clubs such as Kroger, Safeway and Sam's Club;
. online retailers of health, beauty, personal care and/or pharmaceutical
products, such as drugstore.com, Rx.com and CVS.com;
. mail-order pharmacies and prescription benefits managers, such as Advance
PCS, Express Scripts and Merck-Medco, including their websites;
. internet-portals and online service providers that feature shopping
services, such as America Online, Yahoo!, Excite and Lycos;
. health and specialty stores such as General Nutritional Centers,
Brookstone and Gazoontite, including their websites; and
. cosmetics departments at major department stores, including their
websites.
Each of these competitors operates within one or more of the health, beauty,
wellness, personal care and pharmacy product categories. In addition, nearly
all of our competitors have, or have announced their intention to have, the
capability to accept orders for products online. In particular, Walgreen's,
CVS, Albertson's and Wal-Mart accept prescription refill or other orders on
their websites. Additionally, larger, better-established and better-financed
entities may acquire, invest in or form joint ventures with online competitors
or suppliers as the use of the Internet increases.
Many of these competitors have substantial competitive advantages over us,
such as:
. greater name recognition;
7
. larger customer and user bases;
. substantially greater financial, technical and other resources;
. larger production and technical staffs;
. the ability to offer a wider array of online products and services; and
. more diversified content offerings.
We believe that we compete on the basis of product selection and variety,
convenience, customer service and satisfaction, quality of search tools, speed
of fulfillment for products ordered and price. We believe that the key
competitive factors in this industry are:
. brand recognition;
. the ability to attract and retain customers;
. breadth and depth of product offerings;
. product pricing;
. the availability and quality of information on nutrition, health and
wellness topics; and
. the quality and responsiveness of customer service.
We also believe that these competitive factors are significant to our
traditional brick-and-mortar retail business, as well as our mail order
operations.
In the market for health content, there are currently over 15,000 Internet
websites that provide health-related information. As a result, our industry is
fragmented and competition is extremely intense. Our HealthCentral.com and
RxList.com websites compete directly for users, advertisers, e-commerce
merchants and other partners with numerous Internet and non-Internet
businesses, including:
. health-related websites targeted at consumers, such as WebMD, drkoop.com,
DiscoveryHealth.com, InteliHealth, and Medscape.com;
. online portal companies, such as America Online, Excite, Inc., Lycos
Corporation, Microsoft Network, and Yahoo!;
. hospitals, HMOs, managed care organizations, insurance companies and
other healthcare providers and payors that offer healthcare information
through the Internet; and
. consumer affinity groups, such as the American Association of Retired
Persons and SeniorNet, which offer online healthcare-related content to
special demographic groups.
Intellectual Property Rights
Our intellectual property rights are important to our business. We rely on
a combination of copyright, trade secret, trademark and trade dress laws,
confidentiality procedures and contractual provisions to protect our
proprietary rights. We have obtained federal trademark registrations for the
trademarks and logos "HealthCentral," "WebRx" and "RxList" as well as other
trademarks. We have a 15-year agreement with Dr. Edell, in which he has
granted us the exclusive right to the use of his name in connection with our
business and exclusive commercialization rights to his services over the
Internet, except for the publication of radio transcripts and Internet
broadcasts of his radio program. Under this agreement, all content that Dr.
Edell creates for our HealthCentral.com network is owned by us. Enterprise Web
Services, or EWS, developed some elements of HealthView, the Personal Health
Record and the general architecture of the HealthCentral.com consumer website
during its participation in a project funded by a grant from the National
Institute of Standards and Technology. Under the terms of the grant, EWS owns
the intellectual property it developed for the project and granted a
nonexclusive, nontransferable license to the U.S. government of that
intellectual property.
8
Our policy is to enter into confidentiality and invention assignment
agreements with all employees and consultants, and nondisclosure agreements
with all potential business partners. These protections, however, may not be
adequate to protect our intellectual property rights. In addition, we may be
sued by third parties alleging, with or without merit, that we have violated
their intellectual property rights. See "Risk Factors--Any failure to protect
our intellectual property rights impair our ability to establish our brands"
and "--We may be sued by third parties for infringement of their proprietary
rights."
Government Healthcare Regulation
General. Numerous state and federal laws regulate our health business, as
described below. Generally, the laws and regulations governing the healthcare
industry are just beginning to be tested in relation to e-commerce in
healthcare products, such as prescription drugs on the Internet, and in the
provision of healthcare information. The laws may be interpreted in such a way
that we may not be permitted to conduct our business as described. The
requirement that we comply with new legislation or regulations, or any
unanticipated application or interpretation of existing laws or regulations,
may decrease the growth in the use of the Internet, which could in turn
decrease the demand for our products, services and information offered through
our HealthCentral.com network, increase our cost of doing business or
otherwise harm our business. See "Risk Factors--Extensive and changing
government regulation of the healthcare industry is expensive to comply with
and exposes us to the risk of substantial governmental penalties."
Regulation of the Practice of Medicine. The practice of medicine is
generally defined by state law and varies from state to state. Often it is
defined as engaging in, with or without compensation, diagnosis or treatment
of a physical or mental condition. The practice of medicine requires a license
under state law and, depending on state law, engaging in the practice of
medicine without a license can be a civil or criminal violation. Many states
have laws prohibiting corporations from engaging in the practice of medicine
or employing or contracting with licensed medical professionals for the
provision of medical services. We have endeavored to structure our websites
and, in particular our personal health evaluation tools and our descriptions
of various healthcare products, to avoid the implication that we are in any
way practicing medicine in violation of state licensing requirements or in
violation of state corporate practice of medicine prohibitions. For example,
we have included within our websites disclaimers and other notices that we
have deemed appropriate to advise users that the information provided is not
intended to be a substitute for consultation with a licensed physician.
However, the application of this area of the law to Internet services such as
ours is still in its infancy with no clear guidance from federal or state
regulatory agencies regarding their interpretation of services such as ours. A
key element of our strategy is to encourage consumers to identify us with Dr.
Dean Edell, a physician licensed in the state of California. Confusion by
consumers regarding the limitations on information received from Dr. Edell and
the need to consult with their own physician with respect to their medical
condition is possible. Also, we have not conducted a state by state survey of
medical personnel licensing requirements and policies. Accordingly, a state
regulatory authority and/or one or more licensed physicians or physician
advocacy groups or consumers may now or in the future allege that one or more
elements of our business requires a license to practice medicine, that we are
in violation of corporate practice of medicine prohibitions, and/or that our
disclaimers are ineffective as to particular consumers who claim to rely upon
advice or information provided by us. Any application of practice of medicine
regulations to our business could harm our business or require us to change
our business model. Further, liability based on a determination that we are
engaged in the practice of medicine without a license may cause us to be
excluded from coverage under the terms of our current general liability
insurance policy, and may subject us to a higher standard of care than would
be applicable to activities that do not require a professional license.
Regulation of Other Healthcare Professions. We provide general information
regarding pharmacology, nutrition and general mental and physical health
issues on our websites, including electronically accessible information
regarding prescription drugs and answers to frequently asked questions about
prescription drugs. The practice of pharmacology, nutrition, psychology and
certain personal counseling is defined and regulated by state law, which
varies from state to state. While we have taken the same precautions to avoid
the practice of other healthcare professions as we have with the practice of
medicine, a local professional licensing board, local
9
professionals, professional advocacy groups, or consumers may seek to impose
state law licensing requirements on some aspects of our business. Any
application of the regulation of the practice of another healthcare profession
to our business could harm our business or require us to change our business
model. Further, any liability based on a determination that we are engaged in
the practice of a healthcare profession without a license may cause us to be
excluded from coverage under the terms of our current general liability
insurance policy, and may subject us to a higher standard of care than would
be applicable to activities which do not require a professional license.
Regulation of Prescription Drug Activities and Pharmacies. Our business of
providing drugs and other medical products pursuant to a prescription is
subject to federal, state and local laws and regulations, many of which are
specific to pharmacies. For example, under the Omnibus Budget Reconciliation
Act of 1990 and related state and local regulations, pharmacists are required
to offer counseling, without additional charge, to prescription drug customers
about medication, dosage, delivery systems, common side effects, adverse
effects or interactions and therapeutic contraindications, proper storage,
prescription refill, and other information they deem significant. In addition,
state laws specify how prescription drugs and medical devices may be filled
and dispensed and which individuals and entities are allowed to fill and
dispense them. Moreover, while we believe our discussions of drugs and medical
devices on our websites are not regulated "advertising or promotion" of
prescription drugs, the FDA and many state agencies which regulate advertising
and product performance claims for prescription drugs may determine otherwise.
We are also subject to FDA regulation of product safety, including
adulteration, misbranding and mishandling of prescription drugs and medical
devices.
Pharmacy operations are also subject to federal, state and local licensing
and registration regulations with respect to the Controlled Substances Act and
federal Drug Enforcement Agency (DEA) regulations, as well as related state
and local laws and regulations relating to pharmacy operations, including
registration, security, recordkeeping, and reporting requirements related to
the purchase, storage and dispensing of controlled substances and prescription
drugs, and certain over-the-counter (OTC) drugs. We own, operate and are
linked to the WebRX website, which is licensed to fill prescriptions in all
states that require pharmacy licensing, with the exception of Michigan. We
plan to obtain a license that will enable WebRX to fill prescriptions in
Michigan in the near future.
Because we are considered a "pharmacy" under state regulations as well as
being the subject of Food and Drug Administration (FDA), Federal Trade
Commission (FTC), DEA and state agency enforcement actions, we could also be
liable to consumers in connection with adulterated drugs, false or misleading
advertising or claims or problems with the storage, transport and sale of
controlled substances. While we have rights against drug manufacturers as to
adulteration of prescription products and rights against drug and device
manufacturers as to false advertising for prescription products that are
provided to us, we may have liability if manufacturers cannot or will not
indemnify us in a specific situation.
The U.S. Congress and the General Accounting Office (GAO) are currently
investigating online pharmacies and online prescribing. They are especially
focused on those who prescribe drugs online and on pharmacies that fill
invalid prescriptions, including prescriptions that are written online. In
addition, several state Attorneys General have instituted enforcement actions
against Internet pharmacies which they believe have dispensed prescription
drugs without proper prescriptions or without first obtaining the proper state
licenses. The U.S. House of Representatives' Committee on Commerce has
requested that the GAO undertake a formal review of a number of issues
pertaining to online pharmacies, including an assessment of mechanisms to
ensure that online pharmacies are obeying the various state and federal
regulations for the industry. Moreover, there is currently before the U.S.
Congress a proposed law that would require the FDA to oversee the operations
of all Internet pharmacies. A change in the law with respect to the regulatory
requirements relating to Internet pharmacies would require our compliance with
any corresponding rules and regulations.
The National Association of Boards of Pharmacy, a coalition of state
pharmacy boards, has developed a program, the Verified Internet Pharmacy
Practice Sites (VIPPS) as a model for self-regulation for online pharmacies.
We have obtained VIPPS certification. In addition, various state legislatures
are considering new
10
legislation related to the regulation of Internet pharmacies. The inclusion of
prescription drugs as a Medicare benefit has been the subject of numerous
bills in the U.S. Congress. Should legislation on prescription drug coverage
for Medicare recipients be enacted into law, compliance with any corresponding
rules and regulations would be required, even though at this time we do not
accept Medicare prescriptions.
Regulation of the Sale of OTC Drugs, Nutritional Supplements, and
Cosmetics. The FDA and FTC and similar state agencies regulate OTC drug and
cosmetic advertising and promotion, including direct-to-consumer advertising,
done by or on behalf of drug and cosmetic manufacturers and marketers. In
addition, the FDA regulates product safety for nutritional supplements as well
as product safety of OTC drugs and medical devices. Many of our OTC products
and services are subject to FDA and FTC regulation and enforcement for false
advertising and misleading advertising. This includes overstatements regarding
product performance, especially regarding nutritional supplements. While we
have rights against manufacturers as to adulteration issues and product claims
(to the extent we have received the claims as a result of the manufacturers),
we may have liability if the manufacturers cannot or will not indemnify us in
a specific situation.
FDA and State Regulation of Computer Software as a Medical Device/Medical
Practice. Certain computer applications and software may be considered medical
devices and would, therefore, be subject to regulation by the FDA or by states
with respect to the practice of pharmacy or the practice of medicine. We do
not believe that our current applications or services will be regulated by any
of these entities; however, our applications and services may become subject
to regulation. Additionally, we may expand our applications and service
offerings into areas that subject us to regulation. We believe that complying
with such regulations would be time consuming, burdensome and expensive and
could delay or prevent our introduction of new applications or services.
Application of State and Foreign Laws. Although our business offices are
located in California, our websites are available to users all over the United
States and the world. Therefore, the governments of other states and foreign
countries also regulate our activity and our transmissions and may take action
against us for violations of their laws. For example, many states have enacted
laws related to telemedicine, where physicians are practicing medicine by
various means of communication over state lines. The states have varied
tremendously in their approaches to this issue, including, among others,
requiring full licensing of the out of state practitioner or by requiring the
involvement of a state licensed practitioner. The states have uniformly
asserted their right to regulate telemedicine activity, based upon the
location of patients in their state, and we would expect the states to take
the same approach as to other electronic activities directed to consumers in
their states. We have not undertaken a state by state or a country by country
review of the health-related laws that could apply to our business. Violations
of these laws may be alleged or charged by state or foreign governments or may
be modified, or new laws may be enacted, in the future. Any of such changes in
laws could harm our business.
Liability for Health Information and Health Products. Due to the nature of
our business, we may become involved in litigation regarding the information
transmitted from our websites, with the risk of adverse publicity, significant
defense costs and substantial damage awards. In addition, if we are deemed to
be engaged in the practice of medicine or another healthcare profession,
including pharmacy, we could be subject to claims and/or malpractice liability
exposure for which we may not be insured. We may also be liable for personal
and property damage from products provided by us, including from prescription
drugs. Finally, the FDA could look to us first in enforcing a product recall.
In recent years, participants in the healthcare industry have been subject to
an increasing number of lawsuits alleging malpractice, product liability and
related legal theories, many of which involve large claims and significant
defense costs. We have legal rights against the manufacturer and fulfillment
companies, with some limits, for their activities related to the products we
provide. To date, we have not been the subject of any claim involving the
operation of our site. However, claims may be brought against us. Even if
these claims ultimately prove to be without merit, defending against them can
be time-consuming and expensive, and any adverse publicity associated with
these claims could adversely affect our business. Our liability insurance does
not provide coverage for professional malpractice, so these claims would not
come within the scope of or be covered by our insurance. We may not be able to
maintain existing coverage or expand its scope to address evolving risks, or
obtain increased amounts of coverage on acceptable terms or at all.
11
Federal and State Anti-Kickback Laws. Provisions of the Social Security Act
known as the Federal Anti-Kickback Law prohibit knowingly or willfully,
directly or indirectly, paying or offering to pay, or soliciting or receiving,
any remuneration in exchange for the referral of patients to a person
participating in, or for the order, purchase or recommendation of items or
services that are subject to reimbursement by, Medicare, Medicaid, the
Civilian Health and Medical Program of the Uniformed Services (CHAMPUS) and
similar other federal or state healthcare programs. Violations may result in
civil and criminal sanctions and penalties. Civil penalties include exclusion
from government health programs. Criminal sanctions include imprisonment for
up to five years and fines of up to $25,000 or both, for each violation.
Recent federal legislation expanded the sanctions to include civil monetary
penalties up to $50,000 for each prohibited act and up to three times the
total amount of remuneration offered, paid, solicited or received, even in
circumstances where a portion of such remuneration is offered, paid, solicited
or received for a lawful purpose. Certain courts reviewing the statute have
taken a broad view of the Federal Anti-Kickback Law and have ruled that it can
be violated if only one purpose of a payment arrangement is to induce
referrals. Many states also have enacted similar local anti-kickback laws.
At present, Medicare does not reimburse outpatient prescription drugs, with
the exception of a few items. However, Medicaid and CHAMPUS do include a
significant outpatient prescription drug benefit. In addition, Medicare,
Medicaid, CHAMPUS and other healthcare programs subject to the Federal Anti-
Kickback Law cover various medical supplies sold through our websites, such as
slings and splints. While we believe that we have structured our fee
relationships so that the Federal Anti-Kickback Law is not implicated for any
items or services covered by it, enforcement agencies may take a contrary
position, especially if Medicare benefits are expanded to cover prescription
drugs. Our arrangements with our e-commerce pharmacy, medical supply and
medical service affiliates, as currently structured, may not qualify as among
the practices exempted from federal prosecution or other enforcement under the
Federal Anti-Kickback Law by the regulatory safe harbors promulgated by the
Department of Health and Human Services (DHHS). Failure to meet a safe harbor,
however, does not mean that an arrangement violates the statute. Many
activities engaged in by healthcare providers and related entities fall
outside the safe harbors yet are not deemed illegal. While we believe that our
fee arrangements are not illegal as to products and services reimbursable by
Medicare, Medicaid, CHAMPUS or other programs covered by the Federal Anti-
Kickback Law, given the breadth of the statute, the limited scope of the
existing safe harbors and the desire of the agencies to eliminate programs
that create financial incentives to provide excessive care, we may face
adverse regulatory positions. The Office of Inspector General is authorized to
issue advisory opinions regarding the interpretation and applicability of the
Federal Anti-Kickback Law, including whether an activity or proposed activity
constitutes grounds for the imposition of civil or criminal sanctions. We have
not sought this kind of opinion and are aware of no opinion that has been
issued regarding website sponsorships or planned sales activities.
In addition, most states have enacted anti-kickback, or illegal
remuneration, laws that are similar to the Federal Anti-Kickback Law. Some of
these state laws are very closely patterned on the Federal Anti-Kickback Law;
others, however, are broader and reach reimbursement by private payors, and
still others are more narrow, applying, for example, only to kickbacks paid or
received by providers. We have not conducted a survey of these laws in all
fifty states and therefore, our arrangements with our e-commerce affiliates
may result in investigation or prosecution by state regulators or attorneys
general.
If our activities were deemed to be inconsistent with the Federal Anti-
Kickback Law or with state anti-kickback or illegal remuneration laws, we
could face civil and criminal penalties or be barred from such activities, any
of which could harm our business. Further, we could be required to restructure
our existing or planned sponsorship compensation arrangements and e-commerce
activities in a manner that could harm our business.
12
Federal and State Self-Referral Prohibitions. The federal physician self-
referral statute, often identified as the Stark Law, generally forbids
payments under Medicare or Medicaid that are based on a physician referral for
"designated health services" to any entity with which the physician or an
immediate family member has a financial relationship. The financial
relationship can be direct or indirect. The financial relationship can take
the form of an ownership or investment interest or a compensation
relationship. A referral, under the Stark Law, can include prescribing or
requesting designated health services, and also establishing a plan of care
for the designated health services. The Stark Law applies to clinical
laboratory services and other designated health services, including outpatient
prescription drugs, prosthetics, orthotics, prosthetic devices and durable
medical equipment. Penalties for violating the Stark Law include denial of
payment from Medicare and Medicaid programs for any services referred to an
entity in violation of the Stark Law, civil monetary penalties of up to
$15,000 for each offense and exclusions from the Medicare and Medicaid
programs. Many states have adopted similar self-referral laws, which may
extend to governmental and third-party payors. We have not conducted a survey
of these laws in all fifty states.
Other Governmental Regulation
General. There is an increasing number of laws and regulations pertaining
to the Internet. In addition, a number of legislative and regulatory proposals
are under consideration by federal, state, local and foreign governments and
agencies. Laws or regulations may be adopted with respect to the Internet
relating to liability for information retrieved from or transmitted over the
Internet, online content regulation, user privacy, taxation and quality of
products and services. Moreover, it may take years to determine whether and
how existing laws such as those governing issues such as intellectual property
ownership and infringement, privacy, libel, copyright, trademark, trade
secret, obscenity, personal privacy, taxation, regulation of professional
services, regulation of medical devices and the regulation of the sale of
other specified goods and services apply to the Internet and Internet
advertising. The requirement that we comply with any new legislation or
regulation, or any unanticipated application or interpretation of existing
laws, may decrease the growth in the use of the Internet, which could in turn
decrease the demand for our service, increase our cost of doing business or
otherwise harm our business.
Online Content Regulations. Several federal and state statutes prohibit the
transmission of indecent, obscene or offensive content over the Internet to
certain persons. In addition, pending legislation seeks to ban Internet
gambling and federal and state officials have taken action against businesses
that operate Internet gambling activities. The enforcement of these statutes
and initiatives, and any future enforcement activities, statutes and
initiatives, may result in limitations on the type of content and
advertisements available on HealthCentral.com. Legislation regulating online
content could slow the growth in use of the Internet generally and decrease
the acceptance of the Internet as an advertising and e-commerce medium, which
could impair our ability to generate revenues.
Privacy of Individually Identifiable Health Information and Consumer
Information. There have recently been increased efforts in both the United
States and in other countries to safeguard the privacy and security of
individually identifiable health information and consumer information.
These efforts are reflected in changing federal and state laws governing
the storage, transmission and disclosure of medical information and healthcare
records. In addition to having recently enacted legislation, the U.S. Congress
is currently considering several bills dealing with privacy of personal health
information which may create a need for us to modify our practices concerning
the collection and use of such information. Our database contains personally
identifiable health information submitted by users in response to questions on
our personal health evaluation form and in connection with a customer's
request for a prescription drug and certain healthcare product orders. We
expect that our websites will also contain information compiled by users for
their personal healthcare histories. While this information is not intended to
constitute or be treated as formal medical records, users or regulatory
agencies may seek to characterize this information as medical records and
impose requirements and/or sanctions upon us related to the maintenance and
handling of medical records. We have a stringent privacy policy covering this
information, and we only grant access to this information as required by
13
law or to third party contractors who are also bound by a stringent privacy
policy or, as disclosed to our users, to third parties where it is necessary
for the delivery of goods or services ordered by the user.
The FTC has recently promulgated regulations implementing the financial
privacy provisions of the Gramm-Leach-Bliley Financial Services Reform Act
(GLB), and has been active in investigating alleged misrepresentations by
Internet sites regarding their privacy practices. Although the GLB rules do
not directly apply to us, we have established a set of privacy principles and
practices based upon those proposed by Health Internet Ethics, of which we are
a founding member. The FTC, as part of its inquiry into privacy practices by
e-health sites, looked into our privacy practices last year. The agency
subsequently closed its inquiry without taking any action after expressing
satisfaction with the steps we took to clarify our privacy practices and to
safeguard against any inadvertent disclosure of personal information.
The Health Insurance Portability and Accountability Act of 1996 (HIPAA)
requires personally identifiable health information be used and disclosed only
in compliance with specified rules and regulations, which have not yet been
finalized. Our pharmacy operations will more likely than not be directly or
indirectly subject to certain HIPAA requirements. We have not to date
undertaken an evaluation of the impact of HIPAA on our operations, but intend
to review such regulations once they are finalized.
In December, 2000 DHHS published privacy regulations under HIPAA, which may
be revised before they are implemented. They describe the permissible uses and
disclosures of individually identifiable health information by health care
providers, health plans and health care clearinghouses, known collectively as
"covered entities." It is possible that we could be considered a covered
entity if we are deemed to be a health care provider. Covered entities are
required to enter into agreements with their "business associates," extending
applicable provisions of the regulations to those business associates.
These regulations establish a complex regulatory framework for a variety of
subjects, including (1) disclosure and use of health information, (2)
individuals' rights to access and amend their health information, and (3)
individuals' rights to an accounting of disclosures. They generally prohibit
covered entities and their business associates from disclosing protected
health information unless they first obtain patient consent or authorization,
and then only allow the disclosure of the minimum necessary amount of
protected health information. We will need to comply with these requirements
if we are deemed to be a covered entity or a business associate of a covered
entity.
In August, 1998 DHHS issued proposed regulations addressing security
standards for the transmission of protected health information under HIPAA.
These standards require affected entities to establish and maintain reasonable
and appropriate administrative procedures, physical safeguards, technical
security services, and technical security mechanisms to ensure the integrity,
confidentiality and availability of such information. The proposed regulations
are designed to protect such information against reasonably anticipated
threats or hazards to its security or integrity. They require covered entities
to enter into "chain of trust partner agreements" with all entities with whom
they share protected health information. We will need to comply with these
standards if we are deemed to be a health care provider, or if we are required
to enter into chain of trust partner agreements with any of our customers,
such as health care providers.
If third persons were able to penetrate our network security and gain
access to, or otherwise misappropriate or misuse, our users' personal
information, we could be subject to liability. This liability could include
claims for misuses of personal information, such as for unauthorized marketing
purposes or unauthorized use of credit cards. These claims could result in
litigation, our involvement in which, regardless of the outcome, could require
us to expend significant financial resources. Moreover, to the extent any of
the data constitute or are deemed to constitute individually identifiable
health information, a breach of privacy could violate federal law. Because
there are both pharmacy components and consumer components to our websites, we
may be subject to different requirements and be required to comply with
different privacy policies for these separate components.
14
The confidentiality of medical information and the circumstances under
which such information may be provided to us are also subject to substantial
regulation by state governments. Many states have laws and regulations that
govern both the disclosure and use of confidential medical information.
Although compliance with these requirements is at present principally the
responsibility of health care providers, it is possible that we could be
deemed to be a health care provider, and even if we are not the requirements
are evolving rapidly. The HIPAA privacy regulations do not supercede
conflicting state laws that are more restrictive. Therefore, we may have to
comply with various different state requirements depending upon the location
of our customers.
The federal Children's Online Privacy Protection Act (COPPA) prohibits
Internet companies from seeking or obtaining certain information from children
under the age of thirteen. While we have safeguards in place to comply with
the provisions of COPPA, we may be unable to detect when an underage person is
utilizing our services such that we have obtained information prohibited under
COPPA.
It is possible that the use of "cookies" may become subject to laws
limiting or prohibiting their use. The term cookies refers to information
keyed to a specific server, file pathway or directory location that is stored
on a user's hard drive, possibly without the user's knowledge and which is
used to track demographic information and to target advertising. Cookies do
not personally identify the user, unless the owner of the cookie also has
personally identifiable information about the user which can be linked to the
cookie numerical identifier. Both we and DoubleClick use cookies to
personalize the websites and to target advertising. Most currently available
Internet browsers allow users to modify their browser settings to remove
cookies at any time or prevent cookies from being stored on their hard drives.
In addition, a number of Internet commentators, advocates and governmental
bodies in the United States and other countries have urged the passage of laws
limiting or abolishing the use of cookies. Limitations on or elimination of
the use of cookies could limit our ability to personalize the websites for the
user, and could limit the effectiveness of the targeting of advertisements,
both of which could impair our ability to generate advertising revenue.
Foreign countries and political entities, such as the European Union (EU)
have adopted legislation and regulatory requirements regarding notification of
Internet users about the use of information collected by them by website
usage, including notification that data may be used by both the websites and
third party marketing entities. The EU has adopted a directive that imposes
restrictions on the collection and use of personal data. Under this EU
directive, persons in the EU are guaranteed rights, including the right of
access to their data, the right to know where the data originated, the right
to have inaccurate data rectified, the right to recourse in the event of
unlawful processing and the right to withhold permission to use their data for
direct marketing. The EU directive could, among other things, affect U.S.
companies that collect information over the Internet from individuals in EU
member countries, and may impose restrictions that are more stringent than
current Internet privacy standards in the United States. In particular,
companies with offices located in EU countries may not be allowed to send
personal information to countries that do not maintain standards of privacy
that are determined not to be equivalent to those of the EU. The EU directive
does not, however, define what standards of privacy are adequate. As a result,
the EU directive may adversely affect the activities of companies like ours,
which plan to engage in data collection from users in EU member countries.
We will likely incur additional expenses regarding privacy and security
practices and policies. We continually review our policies to provide notice
of the use of information to users and to improve our practices and technology
to maintain confidentiality of user information. Any changes in policies and
practices, whether self-imposed or imposed by government regulation could
affect the way in which we conduct our business, especially those aspects that
involve the collection, use and access to personal identifying information,
could have a material adverse effect on our business, financial condition and
operating results.
Data Protection. Legislative proposals have been made by the federal
government that would afford broader protection to owners of databases of
information, such as stock quotes and sports scores. This kind of protection
already exists in the EU. If enacted, this legislation could result in an
increase in the price of services that provide data to websites. In addition,
this legislation could create potential liability for unauthorized use of this
data.
15
Internet Taxation. A number of legislative proposals have been made at the
federal, state and local level, and by foreign governments, that would impose
additional taxes on the sale of goods and services over the Internet, and some
states have taken measures to tax Internet-related activities. Although in
1998 the U.S. Congress placed a moratorium until October 21, 2001 on state and
local taxes on Internet access and on discriminatory taxes on electronic
commerce, existing state or local laws were expressly excepted from this
moratorium. Congress is currently considering extending this moratorium. If it
were to be lifted, some type of federal and/or state taxes may be imposed upon
Internet commerce. Attempts at regulating commerce over the Internet may
substantially impair the growth of commerce on the Internet and, as a result,
adversely affect our opportunity to derive financial benefit from these
activities.
Domain Names. Domain names are the user's Internet address. Domain names
have been the subject of significant trademark litigation in the United
States. Third parties may bring claims for infringement against us for the use
of the HealthCentral, and RxList trademarks, as well as for the use of the
trademarks we acquired. Moreover, because domain names derive value from the
individual's ability to remember these names, our domain names may lose their
value if, for example, users begin to rely on mechanisms other than domain
names to access online resources.
The current system for registering, allocating and managing domain names
has been the subject of litigation and of proposed regulatory reform. Our
domain names may lose their value, or we may have to obtain entirely new
domain names in addition to or in lieu of our current domain names if
litigation or reform efforts result in a restructuring in the current system.
State Insurance Regulation. In the future we may market insurance online.
The use of the Internet in the marketing of insurance products is a relatively
new practice. It is not clear whether or to what extent state insurance
licensing laws apply to these activities. If we were required to comply with
such licensing laws, compliance could be costly or impossible, which could
harm our business or require us to change our business plans.
Jurisdiction. Due to the global reach of the Internet, it is possible that,
although our transmissions over the Internet originate primarily in the State
of California, the governments of other states and foreign countries might
attempt to regulate Internet activity and our transmissions or take action
against us for violations of their laws. Violations of these laws may be
alleged or charged by state or foreign governments, or these laws may be
modified, or new laws enacted, in the future. Any of the foregoing could harm
our business.
Employees
As of February 28, 2001, we employed a total of 228 employees, of whom 20
were employed in engineering, 23 were employed in marketing and merchandising,
71 were employed in our warehouses, 24 were employed in general management and
administration, 25 were employed in customer service, 22 were employed in
activities related to the catalog business, 38 were employed in activities
related to the Vitamins.com retail stores and 5 were employed in pharmacy.
From time to time, independent contractors are employed to supplement our
staff. None of our employees is represented by a labor union, and we have
never experienced a work stoppage. We believe our relationship with our
employees is good.
Executive Officers
The following sets forth the name, age and biographical information for
each of our executive officers as of March 31, 2001:
C. Fred Toney, age 35, has served as Chief Executive Officer since February
2001, as President since November 2000 and as Chief Financial Officer since
July 1999 when he joined HealthCentral. From August 1992 to July 1999, Mr.
Toney served as Senior Managing Director, Senior Research Analyst, Medical,
Technology and Health Care Information Technology and Director of Research at
Pacific Growth Equities, Inc., an
16
investment banking firm. Previously he held investment or research analyst
positions at Volpe, Welty & Company; Donaldson, Lufkin & Jenrette Securities
Corporation and RCM Capital Management; and sales and merchandising positions
at Pharmavite Pharmaceutical Corporation, a pharmaceutical manufacturing and
distribution company. He also serves on the boards of directors of private
companies. Mr. Toney received a B.A. in both Economics and English from the
University of California, Davis.
Jay Hammer, age 45, has served as President of our ComfortLiving division
since December 2000, when we acquired the Comfort Living business. From
December 1999 to December 2000, Mr. Hammer served as Chief Executive Office
and President for ComfortLiving.com. From February 1999 to November 1999, Mr.
Hammer was a private investor and consultant to internet companies. From
January 1997 to February 1999, Mr. Hammer served as Director of Stores and
Corporate Secretary for Urban Outfitters, a retailer of home and fashion
apparel. From March 1990 to December 1996, Mr. Hammer served as Regional
Manager for The Gap, an apparel retailer. Mr. Hammer received a B.A. in
English Literature from the University of Chicago and an M.B.A. from Harvard
University.
Karin Hern, age 50, has served as Vice President and General Counsel since
January 2000. From May 1997 to January 2000, Ms. Hern was a legal and business
consultant to several non-profit organizations, including Alta Bates Medical
Center. From September 1984 to May 1997, Ms. Hern served as Western Division
Counsel for Sutter Health System, a California non-profit healthcare
organization, and its wholly controlled subsidiary, Alta Bates Health System.
Ms. Hern received a B.A. in Criminology from the University of California,
Berkeley and a J.D. from the University of California, Davis.
Miles Munger, age 42, has served as Vice President of Marketing and General
Merchandising Manger since January 2000, when he joined HealthCentral, and
previously served as a consultant to HealthCentral from November 1999 to
January 2000. From April 1997 to October 1999, Mr. Munger was Vice President
of Merchandising for West Marine, a marine retail company. From January 1995
to April 1997, Mr. Munger was Director of Product Procurement for The North
Face, an apparel and sports retail company. Mr. Munger received a B.S. in
Economics and Business Administration from Portland State University.
Neil Sandow, age 53, has served as Vice President of Pharmacy since
November 2000. He previously served as Vice President of Drug Information
Services and Producer and Editor-In-Chief of RxList.com from October 1999,
when HealthCentral.com acquired RxList.com, to November 2000. From November
1995 to October 1999, Dr. Sandow was founder, Chairman and Chief Executive
Officer of RxList.com. From June 1997 to April 1999, Dr. Sandow served as
Manager of Automated Technologies for Oncology Therapeutics Network, a
subsidiary of Bristol Myers-Squibb. From December 1991 to April 1997, Dr.
Sandow served as Director of Pharmacy Services for Brookside Hospital. Dr.
Sandow received a B.A. in Zoology from the University of California, Berkeley,
and a Pharm.D. from the University of the Pacific.
James Schanzenbach, age 37, has served as Vice President of Engineering and
Chief Information Officer since September 2000, when HealthCentral acquired
DrugEmporium.com. From January 1999 to September 2000, Mr. Schanzenbach served
as Chief Information Officer for DrugEmporium.com. From November 1998 to
December 1999, Mr. Schanzenbach served as Vice President of Information
Technology for Smartalk Teleservice, a telecommunications company. From May
1994 to November 1998, he served in several managerial and vice president
level technology positions at Banc One Financial, a financial services
company. Mr. Schanzenbach received a B.A. in Accounting and an M.B.A. from
Ohio University.
Deryk Van Brunt, age 41, has served as Executive Vice President of Business
Development and Chief Privacy Officer since November 2000. He previously
served as Executive Vice President of Operations from January 2000 to November
2000 and served as Senior Vice President of Operations from August 1999, when
HealthCentral acquired Enterprise Web Services (formerly Windom Health,) until
January 2000. From June 1994 to August 1999, Dr. Van Brunt was Chief Operating
Officer of Enterprise Web Services. Dr. Van Brunt received a B.S. in Natural
Resources, an M.P.H. in Epidemiology and a Dr.P.H. in Health Informatics from
the University of California, Berkeley, and is currently an Assistant Clinical
Professor, U.C. Berkeley School of Public Health.
17
Item 2. Properties
We maintain our corporate headquarters in Emeryville, California where we
lease three facilities that total approximately 24,000 square feet. The lease
for approximately 7,300 square feet expires in March 2004, the lease for
approximately 8,800 feet expires in December 2003, and the lease for
approximately 7,900 square feet expires in September 2005. We also lease
approximately 9,900 square feet of office space in Falls Church, Virginia
under a lease that expires in June 2002, but is subject to two three-year
renewal options. In addition, we lease approximately 1,360 square feet and
5,000 square feet of office space in Columbus, Ohio and Long Island City, New
York under leases that expire in March 2003 and April 2001, respectively. We
do not intend to renew the Long Island City, New York lease, which is expiring
in April 2001.
We maintain a pharmacy, warehouse and fulfillment center in Louisville
Kentucky where we lease approximately 64,800 square feet of office and
warehouse under a lease that expires in July 2004, and we lease a 24,500
square foot warehouse in Gaithersburg, Maryland under a lease that expires in
May 2004. We currently intend to terminate the Gaithersburg, Maryland
warehouse lease.
We lease all six of our Vitamins.com retail stores, which are in the
Maryland and Virginia suburbs of Washington, DC. We are currently in the
process of negotiating lease terminations for three additional stores that
have been closed. The following table sets forth information about our
Vitamins.com retail store facilities and the lease applicable to each.
[Download Table]
Lease Term
Approx. Size ----------------------------------
Location (Sq. Ft.) Expiration Renewal(s)
-------- ------------ ----------------- ----------------
Alexandria, VA............ 2,362 January 15, 2009 Two 5 Year Terms
Annapolis, MD............. 3,000 June 8, 2003 Two 5 Year Terms
Falls Church, VA.......... 2,250 August 20, 2002 Two 5 Year Terms
Gaithersburg, MD.......... 3,133 March 13, 2008 None
Rockville, MD............. 4,041 September 4, 2007 None
Vienna, VA. .............. 3,769 July 24, 2003 One 5 Year Term
We believe that the existing facilities are well suited to their current
use and will remain adequate for our needs for the foreseeable future. We may
seek to sublease or terminate certain leases if they are not needed for
current and proposed operations.
Item 3. Legal Proceedings
On December 28, 2000, Bergen Brunswig Drug Company and its wholly owned
subsidiary, Medi-Mail, filed an action in Orange County, California Superior
Court (Case No. 00CC15552) against HealthCentral.com and more.com. The
complaint alleges inducement of breach of contract and fraudulent conveyance
by HealthCentral.com and breach of contract by more.com arising out of
HealthCentral's acquisition of certain of the assets of more.com. The Company
believes this claim is without merit and has retained the law firm of Rutan &
Tucker, LLP, to vigorously defend against this claim. The complaint alleges
monetary damages of approximately $6 million. Bergen has requested a halt in
document production and the parties have commenced settlement negotiations.
The Company is involved in litigation from time to time that is routine in
nature and incidental to the conduct of its business.
18
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 2000.
PART II
Item 5. Market for Registrant's Common Equity And Related Stockholder Matters
Price Range of Common Stock
Our Common Stock has been listed for quotation on the Nasdaq National
Market under the symbol "HCEN" since the effective date of our initial public
offering on December 7, 1999. The following table shows the high and low sale
price per share of our Common Stock as reported by the Nasdaq National Market
for the period indicated.
[Download Table]
High Low
($) ($)
------- ------
Stock Price Fiscal Year 2000
First Quarter............................................ 13.6875 5.4375
Second Quarter........................................... 6.1870 3.0000
Third Quarter............................................ 4.5000 2.3750
Fourth Quarter........................................... 2.3750 0.1250
Stock Price Fiscal Year 1999
IPO date (December 7, 1999) to December 31, 1999......... 12.7500 6.8750
The closing sale price of our Common Stock as reported on the Nasdaq
National Market on February 28, 2001 was $0.4062 per share. As of that date,
there were approximately 245 holders of record of our Common Stock. This does
not include the number of persons whose stock is in nominee or in "street
name" accounts through brokers.
The market price of our Common Stock has been and may continue to be
subject to wide fluctuations in response to a number of events and factors,
such as quarterly variations in our operating results, announcements of
technological or competitive developments, changes in estimates of our
financial performance or changes in recommendations by securities analysts,
acquisitions or strategic alliances by us or our competitors, the operating
and stock performance of other companies that investors may deem comparable to
us, and news reports relating to trends in the markets. These fluctuations may
be exaggerated if the trading volume of our Common Stock is low. In addition,
the stock market in recent years has experienced extreme price and volume
fluctuations that have particularly affected the market prices of many high
technology and Internet-related companies that have often been unrelated or
disproportionate to the operating performance of companies. These
fluctuations, as well as general economic and market conditions, may adversely
affect the market price of our common stock. We have received a notice from
Nasdaq regarding the possible delisting of our stock.
Dividend Policy
We have never declared or paid any cash dividends on our capital stock. We
currently anticipate that we will retain all available funds to support
operations and to finance the growth and development of our business.
Therefore, we do not anticipate paying cash dividends for the foreseeable
future.
Unregistered Equity Securities Sold in 2000
Between August 1, 2000 and December 31, 2000, the Company sold and issued
the following unregistered securities:
On August 2, 2000, we issued 300,000 shares of Common Stock for
aggregate consideration of $938,000 to a strategic partner in full
consideration for the satisfaction of our obligations under a commercial
agreement.
19
On December 1, 2000, we issued 16,500 shares of Common Stock for
aggregate consideration of $16,500 to a creditor of Vitamins.com in
exchange for the cancellation of a debt.
On December 2, 2000, we issued 25,000 shares of Common Stock for
aggregate consideration of $75,000 to a creditor of Vitamins.com in
exchange for the cancellation of a debt.
On December 2, 2000, we issued 19,846 shares of Common Stock for
aggregate consideration of $80,003 to a creditor of Vitamins.com in
exchange for the cancellation of a debt.
On December 14, 2000, we issued 5,002,525 shares of common stock to
more.com, Inc. in exchange for certain assets and certain liabilities of
more.com's Comfort Living subsidiary and certain assets of more.com. The
aggregate consideration received for these shares was $6.3 million.
There were no underwritten offerings employed in connection with any of the
transactions set forth above. The sales and issuances of the unregistered
securities in the transactions described above were deemed to be exempt from
registration under the Securities act in reliance upon Section 4(2) of the
Securities act as transactions by an issuer not involving any public offering.
Changes in Securities and Use of Proceeds
On December 7, 1999, in connection with our initial public offering, a
Registration Statement on Form S-1 (File No. 333-88019) was declared effective
by the Securities and Exchange Commission, pursuant to which 7,500,000 shares
of our common stock were offered and sold on December 7, 1999 for our account,
generating net proceeds of approximately $74.6 million. We used $60.4 million
of the net offering proceeds through December 31, 2000, of which $45.7 million
was used for funding working capital and operating losses, $6.2 million was
used for capital expenditures and $5.8 million for acquisition costs. Other
than $1.4 million paid to Dr. Dean Edell, a director, for the purchase of the
Dr. Dean Edell Eyewear license, and $1.3 million paid to Neil Sandow, an
officer, in connection with the purchase of RxList, none of these payments
represented direct or indirect payments to our directors, officers or other
affiliates. The remaining initial public offering proceeds have been invested
in short-term, investment grade, interest bearing securities.
20
Item 6. Selected Financial Data
The following selected statement of operations data for the years ended
December 31, 2000, 1999 and 1998 and the balance sheet data as of December 31,
2000 and 1999 is derived from the consolidated financial statements included
elsewhere in the Form 10-K. The selected financial data should be read in
conjunction with the Company's consolidated financial statements and the notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in the Form 10-K.
[Enlarge/Download Table]
Period from
Years Ended December 31, Inception to
----------------------------------------------------- December 31,
2000 1999 1998 1997 1996
------------- ------------ ----------- ----------- ------------
Statement of Operations
Data:
Revenues:
eCommerce and other
product sales......... $ 43,051,726 $ 17,041,760 $ 4,340,297 $ 436,406 $ --
Advertising, content
and other............. 2,952,974 1,188,753 15,259 -- --
------------- ------------ ----------- ----------- ----------
Total revenues........ 46,004,700 18,230,513 4,355,556 436,406 --
------------- ------------ ----------- ----------- ----------
Operating and other
expenses:
Cost of eCommerce and
other product sales... 32,301,566 11,793,276 2,646,179 288,751 --
Content and product
development........... 10,346,029 4,398,580 136,788 -- --
Sales and marketing.... 56,435,754 28,671,971 2,318,122 818,218 --
General and
administrative........ 10,593,593 4,683,423 914,002 591,188 99,535
Amortization of
intangible assets..... 14,799,823 3,657,222 -- -- --
Stock compensation..... 1,765,279 6,245,822 104,641 -- --
Acquired in-process
research and
development........... -- 804,525 -- -- --
Acquisition and
contract termination
costs................. 9,258,375 -- -- -- --
Write-off of
intangibles........... 39,134,092 -- -- -- --
------------- ------------ ----------- ----------- ----------
Total operating and
other expenses....... 174,634,511 60,254,819 6,119,732 1,698,157 99,535
------------- ------------ ----------- ----------- ----------
Loss from operations.... (128,629,811) (42,024,306) (1,764,176) (1,261,751) (99,535)
Other expense, net...... (343,426) (32,568) -- -- --
Interest income
(expense), net......... 2,477,004 777,867 (20,519) (2,997) 367
------------- ------------ ----------- ----------- ----------
Net loss................ (126,496,233) (41,279,007) (1,784,695) (1,264,748) (99,168)
Preferred stock
dividends.............. -- (22,275,542) -- -- --
------------- ------------ ----------- ----------- ----------
Net loss attributable to
common stockholders.... $(126,496,233) $(63,554,549) $(1,784,695) $(1,264,748) $ (99,168)
============= ============ =========== =========== ==========
Basic and diluted net
loss per share
attributable to common
stockholders(1)........ $ (3.39) $ (5.67) $ (0.25) $ (0.19) $ (0.02)
============= ============ =========== =========== ==========
Shares used in computing
basic and diluted net
loss per share
attributable to common
stockholders(1)........ 37,359,590 11,204,708 7,016,416 6,724,874 4,162,602
============= ============ =========== =========== ==========
December 31,
-------------------------------------------------------------------
2000 1999 1998 1997 1996
------------- ------------ ----------- ----------- ------------
Balance Sheet Data:
Cash and cash
equivalents............ $ 14,208,364 $ 83,690,072 $ 4,102,047 $ 124,932 $ 12,439
Working capital......... 7,840,648 80,995,956 3,991,742 (314,377) (24,403)
Total assets............ 45,385,848 148,837,995 8,196,659 1,469,677 15,174
Long-term obligations... 1,483,966 792,824 343,352 157,404 --
Total stockholders'
equity................. 23,404,395 97,499,656 6,341,491 484,091 (21,668)
--------
(1) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the method employed to determine the number of shares used
to compute per share amounts.
Note: The selected financial data for all periods presented has been restated
to reflect the acquisition of Vitamins.com, which was accounted for as a
pooling of interest.
21
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with
our "Selected Financial Data" and the Company's consolidated financial
statements and notes thereto included elsewhere in this Form 10-K. Except for
historical information, this discussion and analysis and other parts of this
Form 10-K (including, without limitation, the discussion under the heading
"Results of Operations") contains forward-looking statements that involve
risks, uncertainties and assumptions. These forward-looking statements are
based on our current expectations and are not guarantees of future
performance. Actual results may differ materially from those anticipated in
these forward-looking statements, as a result of many factors, including but
not limited to those discussed in the section entitled "Risk Factors That May
Affect Future Results and Market Price of Stock." The cautionary statements
made in this Report should be read as being applicable to all related forward-
looking statements wherever they appear in this Report. Readers are cautioned
not to place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date hereof. We undertake no obligation
to revise or publicly release the results of any revision to these forward
looking statements.
Overview
HealthCentral.com is a leading provider of online healthcare related e-
commerce and content to consumers through our network of websites, which
includes WebRx.com, Vitamins.com, HealthCentral.com, RxList.com,
DrugEmporium.com and ComfortLiving.com, and through our Vitamins.com mail
order and retail operations. In addition, we design, host and maintain
healthcare institutions' websites for healthcare content and e-commerce.
HealthCentral.com offers more than 25,000 SKU's of health, beauty,
nutraceuticals, home and personal care products in addition to a full service
pharmacy and a vision center. We also offer user-friendly interactive tools,
customized health information pages, personalized health risk assessments and
topical newsletters.
On April 11, 2000, we acquired the exclusive licensing rights to market and
sell "Dr. Dean Edell Eyewear" through 2006. Payment for the product license
was $2.8 million in cash, of which $1.4 million was paid to a related party.
Simultaneously, we entered into a license and distribution agreement with
Cable Car Eyewear to sell the Dr. Dean Edell Eyewear to brick-and-mortar
pharmacies and grocery chains. This agreement requires minimum purchases of
products from us for the years 2000 through 2006; we are in negotiations with
the distributor regarding changes to the existing agreement that may result in
inventory values not being realized. In addition, we entered into a supply
agreement with Invision Optical Products through 2006 to supply us with the
Dr. Dean Edell Eyewear products, and we are in negotiations with the supplier
regarding changes to the existing agreement.
On June 16, 2000, we acquired Vitamins.com, a retailer that provides
dietary supplements, related health and wellness products and information to
consumers, for consideration consisting of 22,432,801 shares of our common
stock. Each share of Vitamins.com stock was exchanged for 0.387 shares of
HealthCentral.com common stock. We also incurred transaction costs of
approximately $2.5 million. Vitamins.com is our wholly owned subsidiary. The
transaction was recorded using the pooling of interests method of accounting
and was a tax-free reorganization under Section 369 of the Internal Revenue
Code of 1986, as amended.
In September 2000, we and Bergen Brunswig terminated our fulfillment
contracts and entered into a settlement agreement. An expense of $99,000 was
incurred in association with the termination of this contract. We also amended
our agreement with AltaVista, an internet portal, to issue 300,000 shares of
our common stock, valued at $938,000, to AltaVista in exchange for the
termination of all our payment obligations under the amended agreement dated
May 15, 2000. Our relationship with AltaVista was formally terminated on
September 15, 2000.
On September 14, 2000, we consummated an asset purchase agreement with Drug
Emporium and its online drugstore subsidiary, DrugEmporium.com. Under the
terms of the asset purchase agreement, we acquired substantially all of the
assets and assumed some liabilities, primarily trade payables and
hardware/software leases, of the DrugEmporium.com business in exchange for the
issuance of shares of our non-voting preferred stock, which does not carry a
liquidation preference and is convertible into 2,400,000 shares of common
stock. Drug Emporium also has an opportunity to receive additional shares of
our convertible preferred stock, which do not carry a liquidation preference,
if certain revenue targets are met. In connection with this acquisition,
22
we also entered into a 10-year services agreement with Drug Emporium under
which we receive in-store promotional and advertising support and access to
Drug Emporium electronic purchasing system and in-store order pickup
capabilities at certain Drug Emporium retail stores. The total purchase price
of $7.8 million consisted of 480,000 shares of preferred stock, convertible
into 2.4 million shares of common stock, valued at $7.3 million based upon the
fair market value of our common stock of $3.0312 per share on the date the
asset purchase agreement was signed as well as transaction costs of $522,000.
Drug Emporium recently filed for Chapter 11 bankruptcy protection in
connection with its buyout by Snyder's Drug Stores.
On December 14, 2000, we acquired certain assets and properties and assumed
certain liabilities associated with more.com's Comfort Living subsidiary,
including its website, inventory and a leased 18,000 square foot warehouse and
distribution center in Gaithersburg, Maryland, which we intend to close by
June 2001. We also acquired certain other assets of more.com. The
consideration for the asset purchase was the issuance of 5,002,525 shares of
our common stock, and the total purchase price approximated $6.3 million,
including transaction costs. We have accounted for this acquisition as a
purchase transaction.
During the fourth quarter ended December 31, 2000, we performed an
impairment analysis of the identifiable intangibles and enterprise level
goodwill recorded in connection with the acquisitions of Enterprise Web
Services, L&H Vitamins, HealthCentralRx.com, RxList.com, DrugEmporium.com and
the license agreement with regard to Dr. Dean Edell Eyewear. The analysis was
performed in response to the sustained decline in our stock price, the overall
decline in our industry growth rate, the excess of the carrying value of the
identifiable intangibles and goodwill over our market capitalization and lower
projected future operating results. As a result of this review, a $39.1
million impairment charge was recorded to eliminate all of our identifiable
intangibles and enterprise level goodwill, except for the amounts recorded in
December 2000 in connection with our acquisition of certain assets of
more.com, Inc. and its subsidiary, Comfort Living. The charge was determined
based upon our estimated future discounted cash flows using a discount rate of
30%. The assumptions supporting the cash flow analysis, including the discount
rate, were based on management's best estimates. The remaining goodwill and
identifiable intangibles at December 31, 2000 with a new book value of
approximately $4.9 million will be amortized over the assets' remaining useful
lives of three to four years, which we consider appropriate.
E-commerce and other product sales revenues are recognized for prescription
and non-prescription drugs, over-the-counter health and beauty aid products
and other health-related products, net of discounts, when products are shipped
to customers or sold through our retail stores. Net sales include outbound
shipping and handling fees charged to customers. Prior to September 2000, we
recognized commission revenue for the use of our website related to sales made
by Medi-Mail for prescription drugs. However, as a result of our acquisition
of DrugEmporium.com, beginning in September 2000 we began to recognize gross
sales from the sale of pharmaceuticals products, which we sell and ship
directly to our customers. We are in the process of reviewing pharmacy
operations, and, as a result, may make changes in the future. Revenue also
includes the wholesale revenue from the sales of the "Dr. Dean Edell Eyewear"
brand eyeglasses to our brick-and-mortar distribution partner. All revenues
are recognized, net of allowances for product returns, promotional discounts
and coupons, at the time the products are shipped to the customer for e-
commerce sales and at the point of sale for retail stores. We are responsible
for all refunds relating to all sales where a customer is not satisfied with
the products received. We record an estimated allowance for such returns in
the period of sale. We also retain the credit risk for all sales.
Advertising revenues are recognized in the period the advertising
impressions are delivered to customers. We use an outside vendor to solicit
customers to use our advertising services, to serve the ads to our website and
to bill and collect for these services. This outside vendor provides monthly
reports indicating the impressions delivered, the amounts billed for our
advertising services and the related administrative fee. We recognize
advertising revenues, as reported by the outside vendor, net of this
administrative fee, as we bear no collection risk for the gross amount of the
advertising fees. Our advertising contracts do not guarantee a minimum number
of impressions to be delivered. We also enter into sponsorship agreements with
vendors to provide them with an opportunity to market their products through
our websites.
23
Content and other revenues are derived from contracts with healthcare
providers, health product resellers, and third party organizations and
principally consist of license fees for website development applications,
consulting fees from custom website development, and hosting and maintenance
fees related to the websites' maintenance. We recognize software license
revenue under Statement of Position ("SOP") 97-2, Software Revenue
Recognition, and SOP 98-9, Modifications of SOP 97-2, Software Revenue
Recognition, with Respect to Certain Transactions. When contracts contain
multiple elements and vendor-specific objective evidence exists for all
undelivered elements, we account for the delivered elements in accordance with
the "residual method" prescribed by SOP 98-9. For consulting projects,
revenues are recognized at the time services are rendered based on charges for
time and materials. Deferred revenues represent the amount of cash received or
services performed and billed prior to revenue recognition.
We incurred net losses of approximately $126.5 million, $63.6 million, and
$1.8 million for the years ended December 31, 2000, 1999 and 1998,
respectively. We anticipate incurring additional operating losses through at
least 2001.
Results of Operations
Years ended December 31, 2000, 1999 and 1998
Revenues
E-commerce and Other Products Sales. E-commerce and other product sales
consist of prescription drug and other health-related product sales online and
through our mail order business, as well as wholesale sales of Dr. Dean Edell
brand eyewear. For 2000, e-commerce and other product sales increased from
$9.1 million to $35.7 million, or 292%, over 1999. The increase was primarily
attributable to growth in our mail order and e-commerce sales, an increased
customer base, repeat purchases from existing customers and new product
offerings. There were no e-commerce or other product sales in 1998. Revenues
are targeted to increase in 2001 as we target continued growth of our e-
commerce and mail order customer base and our affiliate relations and as we
focus our marketing efforts on our existing customer base. However, the future
level of our sales will continue to depend upon a number of factors, including
our ability to increase sales with a greatly reduced marketing budget, the
frequency of customer purchases, the quantity and mix of products sold and the
price we charge for our products.
Retail Store Sales. Retail store sales, consisting of brick-and-mortar
sales of healthcare and related over-the-counter products, were $7.3 million
in 2000, $7.9 million in 1999 and $4.3 million in 1998. Retail sales declined
7% during 2000 as a result of lower volume, primarily due to a substantial
decrease in the marketing and advertising budget for the stores as we shifted
our focus from brick-and-mortar stores to e-commerce and mail order sales. The
83% growth during 1999 was primarily due to the opening of four new stores in
1999 and to the inclusion of a full year of results in 1999 from the six
retail stores in operation as of December 1998. In February 2001, we closed
four of our unprofitable brick-and-mortar stores. We expect the retail store
sales for the remaining six stores to remain flat in the future as we continue
to focus on our other sales channels including Internet and mail order sales.
Advertising, Content and Other. Advertising, content and other revenues
consist of advertising and sponsorship revenues, content subscription and
license revenues. Advertising, content and other revenues were $3.0 million in
2000, $1.2 million in 1999 and $15,000 in 1998. The increase of 148% from 1999
to 2000 was primarily attributable to increased advertising and vendor
sponsorship revenue of $549,000 and an increase in institutional content,
subscription and license revenue of $1.2 million in 2000 due to additional
institutional clients. The increase from 1998 to 1999 was also attributable to
increased vendor sponsorship and advertisement revenues of $886,000 and
increased institutional content, subscription and license revenue of $287,000.
We are targeting our vendor sponsorship revenues to continue to increase
modestly in the future as we focus on providing vendors with opportunities in
which to communicate their marketing messages to customers on our content and
e-commerce websites; however institutional content revenues are not expected
to grow as we have de-emphasized this business and these revenues are targeted
to decline in the future.
24
Cost of Revenues
Cost of E-commerce and Other Product Sales. Cost of e-commerce and other
product sales consist primarily of the cost of products sold to customers,
certain promotion costs and inbound shipping charges. These costs were $32.3
million in 2000, $11.8 million in 1999 and $2.6 million in 1998. The 174%
increase from 1999 to 2000 was attributable to an increase in sales, an
increase in unit costs of certain products, and increases in inbound shipping
and promotion costs associated with new customer acquisitions. The 346%
increase from 1998 to 1999 was attributable to the acquisition of L&H Vitamins
in August 1999, the relaunch of the Vitamins.com website in October 1999, the
increase from six to ten Vitamins.com retail stores and promotion costs
associated with new customer acquisitions. We expect that our cost of e-
commerce and other product sales will continue to fluctuate ratably with
changes in e-commerce and other product sales and price discounting and other
promotion costs.
Operating Expenses
Content and Product Development. Content and product development expenses
consist primarily of payroll and related expenses for website development,
editorial, engineering and telecommunications operations personnel and
consultants, systems and telecommunications infrastructure and cost of
acquired content. Product development costs are generally expensed as
incurred, except for costs relating to the development of internal-use
software, which are capitalized and depreciated over their estimated useful
lives. Content and product development expenses were $10.3 million, $4.4
million and $137,000 in 2000, 1999 and 1998, respectively. The increase of
135% from 1999 to 2000 and the 3,116% increase from 1998 to 1999 were
primarily attributable to an increase of $5.0 million and $2.5 million,
respectively, in staffing and associated costs related to enhancing and
maintaining our websites. We expect content and product development expenses
to decrease in 2001 as we completed most of our significant development
projects in 2000, which we expect to result in lower consultant expenses. We
also reduced our editorial and content staff as we are refocusing on
e-commerce revenues and de-emphasizing advertising revenues, and we wrote-off
previously capitalized website development costs of $4.5 million.
Sales and Marketing. Sales and marketing expenses consist primarily of
advertising and certain promotional expenditures, payroll and related expenses
for personnel engaged in marketing and customer service activities, outbound
shipping charges and certain fulfillment costs. Fulfillment costs include the
external fulfillment fee charged by our third party fulfillment partners prior
to August 2000 and the internal cost of operating and staffing the
distribution center. Sales and marketing expenses were $56.4 million in 2000,
$28.7 million in 1999 and $2.3 million in 1998. The 97% increase in sales and
marketing expense from 1999 to 2000 was primarily attributable to increases of
$15.7 million in online and offline advertising expenses incurred to increase
awareness of our HealthCentral brands, $6.2 million in salary and staff
expenses and $3.6 million in shipping and fulfillment costs. From 1998 to
1999, the increase was attributable to increases of $14.9 million in both
online and offline advertising, $6.3 million in retail store overhead
expenses, $3.5 million in salary and staff expenses and $1.6 million in
shipping and fulfillment costs. Sales and marketing expenses are expected to
decrease as we expect lower headcount through consolidation of facilities, and
as we shift our marketing efforts toward vendor partnership agreements and
away from more traditional and expensive marketing, branding and promotional
efforts, such as print media campaigns, radio and billboards.
General and Administrative. General and administrative expenses consist
primarily of payroll and related expenses for finance, human resources,
business development, investor relations, executive and administrative
personnel, as well as professional services and other general corporate
expenses. General and administrative expenses were $10.6 million in 2000, $4.7
million in 1999 and $914,000 in 1998. The 126% increase from 1999 to 2000 was
primarily attributable to an increase of $3.3 million in personnel related
costs and $1.4 million in professional services related to our operations as a
public company. The increase from 1998 to 1999 was primarily attributable to
an increase of $2.1 million in personnel and professional services associated
with acquisitions and $1.7 million in overhead expense allocation. General and
administrative expenses are expected to decrease in the future as we expect
lower headcount, fewer acquisitions and improved operational efficiencies.
25
Amortization of Intangible Assets. Amortization of intangible assets
relates to the amortization of intellectual property related to domain names
and intangible assets resulting from acquisitions. For 2000, amortization of
intangible assets increased from $3.7 million to $14.8 million, or 305%, over
1999. There were no intangible assets in fiscal 1998. The increase from 1999
to 2000 was attributable to the acquisitions of the Dr. Dean Edell License
Agreement, DrugEmporium.com and Comfort Living, as well as recording a full
year of amortization expense for acquisitions completed throughout 1999. The
increase from 1998 to 1999 was attributable to the acquisitions of L&H
Vitamins, our enterprise web services division, RxList and HealthCentralRx.
Prior to December 31, 2000, goodwill and other intangibles were amortized on a
straight-line basis over two to ten years, except for the amortization of
goodwill from L&H Vitamins, which was being amortized over 20 years. After the
impairment analysis of intangibles and the write-offs discussed below, all
remaining intangible assets of $4.9 million are being amortized over their
estimated useful lives of two to four years.
Stock Compensation. Deferred stock compensation is amortized over the
respective vesting periods of the outstanding options, which is generally
three to four years. Options granted in the fourth quarter of 1998 and 1999
have been considered to be compensatory as their deemed value for accounting
purposes was greater than the exercise prices as determined by the Board of
Directors on the dates of grant. For 2000, $1.8 million in stock compensation
was amortized, a decrease of 72% from 1999, as a result of a decrease in the
number of employees and a decease in the market valuation of our stock. For
1999, we amortized $6.2 million in stock compensation expense. In 1998, we
recognized amortization of stock compensation of $105,000.
In November 2000, the Board of Directors approved an option exchange
program under which we offered to all employees and key consultants holding
outstanding options with per share exercise prices in excess of $0.4062 per
share, the opportunity to exchange such options for new options with exercise
prices equal to $0.4062 and with revised vesting schedules. As a result of
Financial Accounting Standards Board, Interpretation ("FIN") No. 44 , stock
options exchanged by us on December 11, 2000 are subject to variable plan
accounting from that date forward. Accordingly, we will continue to remeasure
compensation cost for the exchanged options until the options are exercised,
cancelled or forfeited without replacement. The remeasurement will be based on
any excess of the closing stock price at the end of the reporting period or
date of exercise, forfeiture or cancellation without replacement, if earlier,
over the fair value of the our common stock on December 11, 2000, which was
$0.4062. The resulting non-cash compensation charge will be recorded over the
three-year vesting schedule of the new options to be issued in the option
exchange program in accordance with FIN No. 28. There was no effect at
December 31, 2000 as the fair value of the common stock was less than $0.4062.
Acquired In-Process Research and Development. Acquired in-process research
and development expense was $805,000 in 1999. There was no in-process research
and development expense in 2000 or 1998. The valuation of the acquired in-
process research and development was based on the result of an independent
appraisal using the income approach. The acquired in-process technology was
not considered to have reached technological feasibility and had no
alternative future use.
Acquisition and contract Termination Costs. For 2000, acquisition and
contract termination costs were $9.3 million. We had no acquisition or
contract termination costs in 1999 or 1998. Of the total costs in 2000,
approximately $4.5 million was attributable to the write-off of website
development costs as a result of the DrugEmporium.com asset acquisition, and
$2.5 million consisted of integration costs, as well as legal, other
professional and financial advisory fees attributable to the Vitamins.com
acquisition, which was accounted for as a pooling of interests. contract
termination costs totaled $2.3 million, which included $625,000 amortization
of prepaid expense and $938,000 in common stock issued to AltaVista in
connection with the cancellation of our payment obligations, $603,000 related
to the termination of the America Online contract, and $99,000 associated with
the termination of the Bergen Brunswig contract.
Write-off of Intangibles. During the fourth quarter ended December 31,
2000, we performed an impairment analysis of the identifiable intangibles and
enterprise level good will recorded in connection with the acquisitions of
Enterprise Web Services, L&H Vitamins, Inc., HealthCentralRx.com, Inc.,
RxList.com, DrugEmporium.com
26
and the license agreement with regard to Dr. Dean Edell eyewear. The analysis
was performed in response to the sustained decline in our stock price, the
overall decline in Internet industry growth rates, the excess of the carrying
value of the identifiable intangibles and goodwill over our market
capitalization, and lower projected future operating results. As a result of
this review, a $39.1 impairment charge was recorded to eliminate all of our
identifiable intangibles and enterprise level good will, except for the
amounts recorded in December 2000 in connection with our acquisition of
certain assets of more.com, Inc. and its subsidiary, Comfort Living, Inc. The
charge was determined based upon our estimated future discounted cash flows
using a discount rate of 30%. The assumptions supporting the cash flows,
including the discount rate, were based on management's best estimates. The
remaining goodwill and identifiable intangibles balance of approximately $4.9
million will be amortized over their remaining useful lives of three to four
years, which we consider appropriate.
Other Expense, Net. Other expense, net was $343,000 in 2000 and $33,000 in
1999 and in each case was primarily attributable to the loss on disposal of
property. There were no other net expenses in 1998.
Interest Income (Expense), Net. Interest income (expense), net, consists of
earnings on our cash and cash equivalents partially offset by interest on
capital lease obligations. Interest income (expense), net was approximately
$2.5 million for 2000, $778,000 for 1999 and $(21,000) for 1998. The increases
for both 2000 and 1999 were due to higher interest-bearing asset balances as a
result of the cash raised in our private placement and our initial public
offering in 1999.
Preferred Stock Dividends. We recorded a $22.3 million preferred stock
dividend in 1999, which consisted of $11.4 million from a beneficial
conversion feature associated with our issuance of preferred stock and
$10.9 million as a result of the recapitalization of Vitamins.com from a
limited liability company to a C corporation. With regard to the $11.4 million
portion of the dividend, we issued 4,038,455 shares of Series B preferred
stock in August 1999 for $5.20 per share. The difference between the sales
price for those shares and the deemed value per share of the common stock on
the transaction date resulted in the $11.4 beneficial conversion feature.
There were no preferred stock dividends in 2000 or 1998.
Income Taxes. No provision for federal and state income taxes has been
recorded as we have incurred net operating losses through December 31, 2000.
As of December 31, 2000, we had approximately $77 million of federal and $49
million of state net operating loss carryforwards available to offset future
taxable income. Due to the change in ownership interests in connection with
our IPO and prior sales of equity securities, our use of these federal and
state net operating loss carryforwards will be subject to annual limitations.
27
Selected Quarterly Results of Operations
The following table presents HealthCentral.com's results of operations for
each of the last eight quarters. The quarterly information is unaudited, but
management believes that the information regarding these quarters has been
prepared on the same basis as the audited financial statements appearing
elsewhere in this Form 10-K. In the opinion of management, all necessary
adjustments have been included to present fairly the unaudited quarterly
results when read in conjunction with the financial statements and related
notes appearing elsewhere in this Form 10-K.
Selected Quarterly Results of Operations
[Enlarge/Download Table]
Fiscal 2000 Fiscal 1999
------------------------------------------------------- -----------------------------------------------------
December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2000 2000 2000 2000 1999 1999 1999 1999
------------ ------------- ------------ ------------ ------------ ------------- ----------- -----------
Statement of
Operations Data:
Revenues:
eCommerce and
other product
sales.......... $ 12,789,034 $ 10,270,240 $ 10,087,490 $ 9,904,962 $ 8,219,815 $ 4,926,930 $ 2,007,056 $ 1,887,959
Advertising,
content and
other.......... 763,801 799,687 757,577 631,909 700,107 362,100 98,637 27,909
------------ ------------ ------------ ------------ ------------ ------------ ----------- -----------
Total revenues.. 13,552,835 11,069,927 10,845,067 10,536,871 8,919,922 5,289,030 2,105,693 1,915,868
------------ ------------ ------------ ------------ ------------ ------------ ----------- -----------
Operating and
other expenses:
Cost of
eCommerce and
other product
sales.......... 9,687,908 7,464,770 7,410,560 7,738,328 6,541,402 2,842,350 1,246,671 1,162,853
Content and
product
development.... 1,818,778 2,450,399 3,269,415 2,807,437 2,648,334 1,254,048 329,361 166,837
Sales and
marketing...... 8,643,810 8,332,795 15,256,628 24,202,521 19,168,677 6,528,809 1,893,093 1,081,392
General and
administrative. 2,953,898 2,406,521 2,591,899 2,641,275 2,450,069 1,425,796 498,977 308,581
Amortization of
intangible
assets......... 3,917,877 3,782,699 3,555,445 3,543,802 3,138,205 519,017 -- --
Stock
compensation... 289,072 358,380 530,387 587,440 808,897 3,227,866 1,911,909 297,150
Acquired in-
process
research and
development.... -- -- -- -- 249,624 554,901 -- --
Acquisition and
contract
termination
costs.......... -- 6,796,029 2,427,677 34,669 -- -- -- --
Write-off of
intangibles.... 39,134,092 -- -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------ ----------- -----------
Total operating
and other
expenses....... 66,445,435 31,591,593 35,042,011 41,555,472 35,005,208 16,352,787 5,880,011 3,016,813
------------ ------------ ------------ ------------ ------------ ------------ ----------- -----------
Loss from
operations...... (52,892,600) (20,521,666) (24,196,944) (31,018,601) (26,085,286) (11,063,757) (3,774,318) (1,100,945)
Other expense,
net............. (323,503) -- (19,923) -- (9,356) (23,212) -- --
Interest income
(expense), net.. 147,764 538,325 793,813 997,102 555,184 175,414 25,921 21,348
------------ ------------ ------------ ------------ ------------ ------------ ----------- -----------
Net loss......... (53,068,339) (19,983,341) (23,423,054) (30,021,499) (25,539,458) (10,911,555) (3,748,397) (1,079,597)
Preferred stock
dividends....... -- -- -- -- -- (22,275,542) -- --
------------ ------------ ------------ ------------ ------------ ------------ ----------- -----------
Net loss
attributable to
common
stockholders.... $(53,068,339) $(19,983,341) $(23,423,054) $(30,021,499) $(25,539,458) $(33,187,097) $(3,748,397) $(1,079,597)
============ ============ ============ ============ ============ ============ =========== ===========
Basic and diluted
net loss per
share
attributable to
common
stockholders.... $ (1.15) $ (0.44) $ (0.77) $ (1.10) $ (1.08) $ (3.19) $ (0.44) $ (0.13)
============ ============ ============ ============ ============ ============ =========== ===========
The increase in each quarter of 2000 and 1999 in e-commerce and other
product sales was primarily attributable to growth in our e-commerce and mail
order sales, an increased customer base, repeat purchases from existing
customers, new product offerings and an increase in sales of the Dr. Dean
Edell eyewear. The increase in advertising, content and other revenues in each
quarter through September 30, 2000 was primarily attributable to increased
traffic on content websites, the increase in the number of vendor sponsorships
and institutional websites. The decline in advertising revenue in fourth
quarter 2000 is attributable to the de-emphasis on this business. The increase
in cost of e-commerce and other product sales was attributable to costs of
products, inbound shipping and promotion costs associated with new customer
acquisitions and is consistent with the increase in revenue.
An increase in operating and other expenses from the first quarter 1999
through the quarter ended March 31, 2000 was primarily due to advertising,
payroll and related expenses for content and product development, sales and
marketing, and general and administrative functions, consistent with growth in
operations and personnel, both internally and through multiple acquisitions.
These same expenses, excluding the write-off of intangible assets, decreased
beginning with the quarter ended June 30, 2000, and have continued to decrease
as we have gained efficiencies, consolidated functions, reduced head count and
terminated certain contracts.
28
The selected quarterly results of operations has been restated to reflect
the acquisition of Vitamins.com, which was accounted for as a pooling of
interest.
Liquidity and Capital Resources
Since inception, we have financed operations primarily through our initial
public offering, the sale of preferred stock and the issuance of notes
payable. Cash and cash equivalents were $14.2 million at December 31, 2000.
Net cash used in financing activities was $747,000 in 2000 and net cash
provided by financing activities was $121.8 million in 1999 and $7.4 million
in 1998. The increase in use of cash in financing activities in 2000 was
attributable to $1.2 million in cash payments on capital leases, partially
offset by $420,000 in proceeds from the issuance of common stock. Net cash
provided by financing activities in 1999 was primarily the result of
$75 million from the issuance of common stock in our initial public offering,
$41.6 million from the issuance of preferred stock, $3.4 million from the
collection of a related party note receivable and $1.5 million from the
issuance of notes payable. In 1998, the net cash provided by financing
activities was primarily from the issuance of preferred and common stock.
Net cash used in operating activities was $57.1 million in 2000, $29.7
million in 1999 and $1.9 million in 1998. In 2000, net cash used in operating
activities was comprised primarily of a $126.5 million net operating loss and
increases of $2.1 million in accounts receivable. This use of cash was
partially offset by $44.3 million in the write-off of intangible assets and
website development costs, $17.3 million in depreciation and amortization
expense, $1.9 million in stock compensation expense, $966,000 in amortization
of prepaid contracts, $938,000 in stock issued in connection with the
termination of the AltaVista contract, an increase of $3.7 million in accounts
payables and accrued expenses, $1.5 million in prepaid expenses and other
assets and $869,000 in deferred revenue and other liabilities. In 1999, net
cash used in operating activities was comprised primarily of a $41.3 million
net operating loss, and increases of $2.9 million in inventory, $2.6 million
in prepaid expenses and other assets and $417,000 in accounts and other
receivables. This use of cash was partially offset by $6.2 million in stock
compensation expense, $4.4 million in depreciation and amortization expense,
$805,000 in acquired in-process research and development and an increase of
$5.6 million in accounts payables and accrued expenses. In 1998, net cash used
in operating activities was comprised primarily of a $1.8 million net
operating loss and increases of $940,000 in inventory and $176,000 in prepaid
expenses and other assets, partially offset by $218,000 in depreciation and
amortization expense, $105,000 in stock compensation expense and increases of
$619,000 in accounts payable and accrued expenses and $110,000 in deferred
revenue and other liabilities.
Net cash used in investing activities was $11.6 million in 2000, $12.5
million in 1999 and $1.6 million in 1998. In 2000, net cash used in investing
activities was comprised primarily of $6.2 million for the purchase of
property and equipment, $3.3 million in cash paid in connection with
acquisitions and $2.2 million for payments to related parties. In 1999, net
cash used in investing activities was $6.2 million for various acquisitions,
$3.7 million for the purchase of property and equipment, $2.3 million for
payments to related parties and $291,000 in cash paid for domain names. In
1998, net cash used in investing activities was $990,000 for the purchase of
property and equipment and $564,000 for payments to related parties.
Our capital requirements depend on numerous factors, including our ability
to integrate our acquired technology from acquisitions and improve our
transaction processing fulfillment systems and our website infrastructure
without substantial capital expenditures. We have no material commitments for
capital expenditures at present and we do not anticipate entering into any new
capital commitments in the foreseeable future. In an effort to realize
efficiencies from acquisitions, reduce expenses, preserve our cash and improve
operational efficiencies, we have reduced our workforce, consolidated
facilities, eliminated duplicate positions, closed unprofitable retail stores
and reformatted our business model to focus on e-commerce and mail order
sales. We will continue to look at gaining efficiencies and intend to
eliminate additional positions.
We have experienced substantial increases in expenditures since inception,
consistent with growth in operations and personnel, both internally and
through multiple acquisitions. While we are targeting to reduce our cost
structure, we currently expect to continue to use cash to fund operating
losses, to integrate acquisitions, to
29
acquire and retain customers and to restructure agreements. We currently are
targeting that our available cash, cash equivalents and cash flows to be
generated from operations will be sufficient to meet our targeted cash needs
through approximately mid-year 2001, provided that we achieve our targeted
revenues, efficiencies and cost reductions and restructure certain
partnerships and other relationships. We are currently exploring various
possibilities with regard to equity and debt financing, as well as possible
asset sales. If we are unable to obtain this financing on a timely basis, or
at all, we may have to significantly reduce our operations and our business
may be jeopardized.
Any projections of future cash needs and cash flows are subject to
substantial uncertainty. We may need additional cash sooner than currently
anticipated. The sale of additional equity or debt securities that include
warrants could result in dilution to our stockholders. Any debt securities
issued could have rights senior to holders of common stock and could contain
convenants that would restrict our operations. Any additional financing may
not be available in amounts or on terms acceptable to us, or at all. We have
received a report from our independent accountants for the year ended December
31, 2000 containing an explanatory paragraph that describes the uncertainty as
to our ability to continue as a going concern due to our historical net
operating losses and negative cash flows, and because, as of the date they
rendered their opinion, we only had cash and cash equivalents on hand
sufficient to satisfy our liquidity requirements through approximately mid-
year 2001.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS NO. 133,
Accounting for Derivatives and Hedging Activities. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities. In July 1999, the FASB issued SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities-Deferral of the Effective Date
of FASB Statement No. 133. SFAS No. 137 deferred the effective date of SFAS
No. 1233 until fiscal years beginning after June 15, 2000. We will adopt SFAS
No. 133 during our fiscal year ending December 31, 2001, and do not expect
such adoption to have a material effect on its financial statements. To date,
we have not engaged in derivative or hedging activities.
Risk Factors That May Affect Future Results and Market Price of Stock.
You should carefully consider the following risk factors, in addition to
the other information in this Report on Form 10K. The risks and uncertainties
described below are intended to be the ones that are specific to our company
or industry and that we deem to be material, but are not the only ones that we
face.
We have a limited operating history.
We launched our HealthCentral.com website in November 1998, our
Vitamins.com website in March 1999, and our WebRx.com website in November
2000. We merged with Vitamins.com, Inc. in June 2000, and we acquired the
assets and certain liabilities of DrugEmporium.com, in September 2000 and
Comfort Living in December 2000. Accordingly, we have a limited operating
history and are subject to the risks, expenses and difficulties frequently
encountered by early stage companies in new and rapidly evolving markets such
as the Internet healthcare market. These challenges include our ability to:
. implement a successful e-Commerce strategy through our websites;
. attract and retain a large audience of users to our HealthCentral.com
network, including WebRx.com;
. compete effectively against other established Internet health companies,
such as drugstore.com and CVS.com;
. develop and upgrade our technology;
. retain and motivate qualified personnel;
30
. manage inventory levels and fulfillment operations effectively;
. gain advertising and sponsorship revenue from vendors of health-related
products and services; and
. create and maintain successful strategic alliances with provider groups,
content providers and other third parties.
We had an accumulated deficit of approximately $193 million at December 31,
2000, and we may not achieve our targeted expense reductions or achieve
profitability.
Since our inception, we have had limited revenues and have incurred
substantial net losses in each year. While we are unable to predict accurately
our future operating expenses, we may not be able to achieve our targeted
expense reductions, as we:
. restructure and/or terminate various contractual obligations;
. offer product promotions;
. integrate geographically dispersed operations as a result of
acquisitions;
. make payments to both our existing and future business partners to gain
advertising revenue; and
. develop and expand our systems infrastructure and support functions.
If we do not achieve our targeted expense reductions as planned, our
business may be jeopardized. Even if we were to achieve profitability, we
might not be able to sustain or increase profitability on a quarterly or
annual basis.
The Internet has not proven to be an effective or profitable marketing media
for advertisers and our institutional business has not developed as initially
anticipated, and thus our business depends on the success of our e-Commerce
and catalog business.
At the time of our public offering, we expected to build revenues from
three channels: Internet advertising, private label institutional website
services, and healthcare e-commerce. To date, the Internet has not proven to
be as effective an advertising medium as traditional media, and thus
advertising revenues contribute much less to our revenue mix than originally
expected. In addition, the institutional healthcare market has been slow to
adopt the Internet as a meaningful tool to improve patient service and
revenues. Thus, we have focused our business operations on the sale of
healthcare products online, the sale of vitamins through our mail order
business and our retail stores and the sale of Dr. Dean Edell Eyewear to our
distribution partner, and if we do not meet our target performance goals in
any of these business lines, our business may fail.
We need to generate substantial revenues and profit from our e-Commerce
business for healthcare products, but this market is unproven and we have
limited experience in it.
The healthcare e-Commerce market is unproven, and we have limited
experience in the sale of healthcare products and services online. Our rate of
revenue growth and profitability could be significantly less than that of
other online merchants, many of which have longer operating histories and
greater name recognition. The online market for pharmaceutical and other
health products is in its infancy and is highly fragmented and intensely
competitive, which has resulted in price discounting, the erosion of gross
margins and business failures by many of our better known competitors. This
market is significantly less developed than the online market for books,
music, software, toys and a number of other consumer products. Even if
Internet usage and electronic commerce continue to increase, the rate of
growth and profit margins, if any, of the online drugstore and health products
market could be significantly less than those in online markets for other
products.
31
We recently acquired our own fulfillment capabilities for e-Commerce product
orders (except for contact lenses), and we have limited experience in
providing these services.
As a result of our acquisition of assets of DrugEmporium.com and the
acquisition of assets of Comfort Living, we have begun managing fulfillment of
our e-Commerce product orders internally. Previously, we relied primarily upon
third parties to manage most of our product fulfillment responsibilities and
therefore have limited experience in providing these services. A failure in
the ability to purchase items on favorable terms, obtain sufficient types and
quantities of supplies, manage inventory levels effectively, or fill and ship
orders on a cost-effective and timely basis could result in customer
dissatisfaction and could significantly harm our e-Commerce business. We are
in the process of rationalizing various fulfillment functions, which may lead
to disruptions in inventory management and other fulfillment problems. We are
also in the process of reviewing our pharmacy operations and, as a result, may
make changes in the future.
We rely on third-party carriers for shipments to and from our distribution
facilities. We are therefore subject to the risks, including employee strikes
and inclement weather, associated with our distribution partners and our
carriers' ability to provide product fulfillment and delivery services to meet
our distribution and shipping needs. Failure to deliver products to our
customers in a timely manner could adversely affect our reputation, brand and
business.
Because we have very limited cash, we will need to raise additional capital
soon and may not be able to raise it on acceptable terms, or at all.
As of December 31, 2000, we had cash and cash equivalents of approximately
$14.2 million. While we are targeting to reduce our cost structure, we
currently expect to continue to use cash to fund operating losses, to
integrate acquisitions, to acquire and retain customers and to restructure
agreements. We currently are targeting that our available cash, cash
equivalents and cash flows to be generated from operations will be sufficient
to meet our targeted cash needs through approximately mid-year 2001, provided
that we achieve our targeted revenues, efficiencies and cost reductions and
restructure certain partnerships and other relationships. We are currently
exploring various possibilities with regard to equity and debt financing, as
well as possible asset sales. If we are unable to obtain financing on a timely
basis, or at all, we may have to significantly reduce our operations and our
business may be jeopardized.
Any projections of future cash needs and cash flows are subject to
substantial uncertainty. We may need additional cash sooner than currently
anticipated. The sale of additional equity or debt securities that include
warrants could result in dilution to our stockholders. Any debt securities
issued could have rights senior to holders of common stock and could contain
covenants that would restrict our operations. Any additional financing may not
be available in amounts or on terms acceptable to us, or at all. We have
received a report from our independent accountants for the year ended December
31, 2000 containing an explanatory paragraph that describes the uncertainty as
to our ability to continue as a going concern due to our historical net
operating losses and negative cash flows, and because, as of the date they
rendered their opinion, we only had cash and cash equivalents on hand
sufficient to satisfy our liquidity requirements through approximately mid-
year 2001.
Our stock price, like that of many companies in the Internet industry, has
been and may continue to be extremely volatile, and we may be delisted from
the Nasdaq National Market System.
The market price of our common stock has declined significantly in recent
months, and we expect that it will continue to be subject to significant
fluctuations as a result of variations in our quarterly operating results and
the overall decline in the Nasdaq stock market. These fluctuations have been,
and may continue to be, exaggerated because an active trading market has not
developed for our stock. Thus, investors may have difficulty selling shares of
our stock at a desirable price, or at all. Our stock is currently trading
below the $1 per share requirement for continued listing on the Nasdaq
National Market, and on January 4, 2001 we received notice from Nasdaq that
our stock may be delisted from the Nasdaq National Market if we are unable to
regain compliance with this requirement by April 4, 2001. We currently intend
to seek a Nasdaq hearing for appeal if and when we receive such notice. If our
efforts in this regard are unsuccessful, our stock will be delisted from the
Nasdaq National Market System.
32
In addition, due to the technology-intensive and emerging nature of our
business, the market price of our common stock may rise and fall in response
to:
. announcements of technological or competitive developments;
. acquisitions or strategic alliances by us or our competitors;
. the gain or loss of a significant strategic partner;
. changes in estimates of our financial performance or changes in
recommendations by securities analysts; and
. reductions in operating scope.
In the past, securities class action litigation has often been brought
against a company after a period of volatility in the market price of its
stock. Any securities litigation claims brought against us could result in
substantial expense and the diversion of management's attention from our core
business.
We are dependent on a single-source supplier and on a single distributor for
the "Dr. Dean Edell" brand of eyewear.
We currently sell our Dr. Dean Edell brand of eyewear to a single
distributor under an exclusive arrangement for resale to brick-and-mortar
retail stores. We are currently in negotiations with this distributor
regarding changes to the existing agreement that may result in inventory
values not being realized. Accounts receivable due from this distributor
represented almost 70% of our total receivables as of December 31, 2000. Any
failure of this distributor to effectively market and sell the product could
harm our business. We have entered into an exclusive supply agreement with a
single-source supplier for the "Dr. Dean Edell" brand of non-prescription
eyewear, and we are in negotiations with the supplier regarding changes to the
existing agreement. Any failure by this supplier to provide sufficient
quantities and types of products in a timely manner could result in our
inability to fulfill customer orders, which in turn could harm our business.
Any disruption in either our supply or distribution of these products could
harm our business.
We may not achieve the expected benefits of the acquisition of Vitamins.com,
or the acquisition of the assets of DrugEmporium.com and Comfort Living, and
their integration may result in disruption to our business or the distraction
of our management and employees.
We may not be able to successfully assimilate the Vitamins.com,
DrugEmporium.com or ComfortLiving.com assets and operations or accomplish the
execution of our e-Commerce business plan. The integration of these recent
acquisitions into our business has strained, and may continue to strain, our
existing technology and operations systems as we continue to assimilate
Vitamins.com and DrugEmporium.com into our existing operations and begin
integrating the assets of Comfort Living into our existing operations. In
addition, the personnel that we have hired pursuant to these acquisitions may
decide not to continue working for us or otherwise may not integrate
successfully with our current staff. These difficulties could disrupt our
ongoing business, distract our management and employees or increase our
expenses.
Our merger with Vitamins.com, and our acquisitions of the assets of
DrugEmporium.com and Comfort Living could adversely affect our combined
financial results or the market price of our common stock. If the benefits of
the merger or the acquisitions do not exceed the costs associated with them,
including any dilution to our stockholders resulting from the issuance of
shares in connection with the merger and acquisitions, our financial results,
including earnings per share, could be adversely affected. In addition, if we
do not achieve the perceived benefits of these acquisitions as rapidly as, or
to the extent, anticipated by financial or industry analysts, the market price
of our common stock may decline.
Future sales of shares by existing stockholders could affect our stock price.
We have filed an S-3 Registration Statement covering the resale of
approximately 29.4 million shares of our common stock by selling stockholders.
In addition to the shares being registered on the Form S-3, approximately 16.3
million shares are saleable in the public market without restriction under the
Securities Act or are saleable under Rule 144 of the Securities Act, subject
to volume, manner of sale, notice and current reporting information
33
requirements. In addition, approximately 4.5 million shares of our common
stock are subject to options outstanding, and approximately 2.9 million of
these options were repriced in December 2000 and carry an exercise price of
$0.4062 per share. Because our stock price is currently low and the trading
volume is thin, the sale of a substantial number of shares could depress the
price of our stock dramatically and could jeopardize our ability to maintain
our Nasdaq National Market listing. Any substantial sales could also make it
more difficult for us to sell equity-related securities in the future at an
appropriate price, or at all.
Consumer protection privacy concerns may result in a decrease in traffic or a
decrease in revenues.
Our network of websites captures information regarding our users in order
to personalize our websites for them and to assist sponsors and advertisers in
targeting their products and advertising campaigns to particular demographic
groups. Any changes in privacy policies and practices, whether self-imposed or
imposed by government regulation, could affect the way in which we conduct our
business, especially those aspects that involve the collection of, use of and
access to personal identifying information. For example, limitations on or
elimination of the use of cookies could limit our ability to personalize our
website for the user, and could limit the effectiveness of the targeting of
advertisements, both of which could impair our ability to generate sponsorship
and advertising revenue. Any perception of security and privacy concerns by
the public, whether or not valid, could inhibit market acceptance of our
network of websites. Privacy concerns may cause users not to visit our
websites or, if they visit, not to provide the personal data necessary to
target our content and advertising.
Because of the interest in the privacy of health-related information, we or
any other e-health company could become either a target of, or a witness in, a
federal or state agency or private party claim regarding privacy issues, any
of which could be expensive and time-consuming, could divert the attention of
senior management from our core business and could harm our business.
We face substantial competition from better-established companies, which could
result in our failure to gain needed market share.
Over 15,000 healthcare websites compete with us for customers, users,
advertisers, content and product providers, institutional clients and other
sources of online revenue. We compete with other dedicated healthcare
information websites, such as WebMD, drkoop.com, DiscoveryHealth.com,
InteliHealth, and Medscape.com. In addition, we compete with:
. traditional brick-and-mortar drug stores, including drug store chains,
supermarkets, mass market retailers, nutraceutical stores and independent
drug stores, many of whom have begun or have announced their intention to
offer online services;
. other online drug stores, such as drugstore.com and CVS.com
. other online dietary supplement stores, such as VitaminShoppe.com;
. pharmacy benefit managers, or PBMs, that direct sales of pharmaceuticals;
and
. hospitals, HMOs and mail order prescription drug providers, many of whom
are beginning to offer products and services over the Internet.
Most of our current and potential competitors enjoy substantial competitive
advantages, such as:
. greater name recognition and larger marketing budgets and resources;
. established marketing relationships with manufacturers and advertisers;
. larger customer and user bases;
. substantially greater financial, technical and other resources; and
. larger production and technical staffs.
34
The intense competition in the online drug store business has resulted in
price discounting and difficulty in building customer loyalty. We believe that
we may face a significant competitive challenge from our online competitors
forming alliances with brick and mortar drug stores, HMOs, PBMs or other
competitors, which could both strengthen our competitors and/or preclude us
from entering into similar relationships with their partners. For instance,
Merck/Medco has entered into an alliance with CVS.com and drugstore.com has
formed an alliance with RiteAid. Increased competition in the online drug
store business has resulted in, and could continue to result in, price
reductions, fewer customer orders, reduced margins and loss of, or failure to
build, market share.
In the market for enterprise web services, we compete mainly with payors'
and providers' internal systems development teams, with local web development
companies, and with other consumer-oriented websites that are selling
applications to institutions, such as drkoop.com and WebMD. We also compete
with drugstore.com and CVS.com in the sale of e-Commerce solutions to
healthcare institutions. Healthcare participants may determine that our tools
and website development and maintenance services are inferior to those of our
competitors, that our product mix is inappropriate for their needs, or that it
would be better for them to independently develop and manage their own
websites.
Consumers may reject the concept of an online health products store in favor
of a brick-and-mortar store.
Historically, many pharmaceutical and other healthcare products have been
sold through the personal referral of a physician or pharmacist, and thus
there is no established business model for the sale of healthcare products or
services over the Internet. Specific factors that could prevent widespread
customer acceptance of our online drug and health product stores include:
. lack of coverage of customer prescriptions by, or additional steps
required to obtain reimbursement from, insurance carriers or pharmacy
benefit managers;
. lack of consumer awareness of our online drug and health product stores;
. longer delivery times for Internet orders, delays in responses to
customer inquiries and/or difficulties in returning products as compared
to brick-and-mortar stores;
. shipping charges and problems related to shipping, such as product damage
or failure to ship the correct order;
. lack of face-to-face interaction with a pharmacist or other retail store
personnel;
. failure to meet shoppers' pricing expectations for prescription drugs,
over-the-counter medicines and health and beauty products;
. customer concerns about security and privacy with regard to transmitting
personal health information over the Internet; and
. inability to meet immediate delivery or pick-up requirements for
prescriptions for acute conditions.
Some of our major contractual relationships have been terminated or are in the
process of being terminated or renegotiated, which could result in disruption
of our business and/or payment obligations.
We are currently in dispute with Microsoft with regard to our claims of
breach of contract by Microsoft and their payment claims against us. We have
begun the process of settlement negotiations with Microsoft, however, if
Microsoft were to prevail on its claim, we could face potentially substantial
payment obligations.
We are in the process of renegotiating and/or terminating certain major
contractual relationships such as lease agreements, licensing agreements and
advertising agreements, and may renegotiate certain additional contractual
relationships, any of which could disrupt our business and/or cause us to
incur additional costs or make additional payments.
35
If consumers perceive our healthcare content to be influenced by our
relationships with advertisers or health-related product vendors, our
reputation could suffer.
We receive sponsorship revenues from advertisers of health-related products
on our websites and revenues from sales of health-related products. However,
our success in attracting and retaining users to our websites depends on our
being a trusted source of independent health-related information. Any consumer
perception that our editorial content is influenced by our commercial
relationships could harm our reputation and business.
We have experienced and may experience systems interruptions and capacity
constraints on our HealthCentral.com network, which could result in adverse
publicity, revenue losses and erosion of customer trust.
In the past, we have experienced system interruptions in the performance of
our websites. Any additional system problems in the HealthCentral.com network,
such as system disruptions, slower system response times and degradation in
customer service levels, could result in negative publicity, cause our users
to use our competitors' services and reduce our revenues. Additionally, if we
fail to meet the website performance standards in our contracts with our
institutional clients, they may terminate their agreements, require refunds or
fail to renew contracts with us, any of which could decrease our institutional
revenues.
We are also vulnerable to breaches in our security and to natural
disasters. We may not be able to correct any problem in a timely manner.
Because we outsource the server hosting function to third parties, some
systems interruptions may be outside of our control. We have no formal
disaster recovery plan, and our insurance may not adequately compensate us for
losses that may occur due to systems interruptions.
Breaches in our security and other unexpected problems could result in
lawsuits by customers and a violation of federal law.
We retain confidential customer and patient information on our servers. Any
breach of security from a physical break-in, computer virus, programming error
or attack by a third party or an unexpected natural disaster could subject us
to a lawsuit. We have expended, and may be required to expend, significant
sums to protect against security breaches or to alleviate problems caused by
breaches. In addition, a breach of privacy of patient health records could
constitute a violation of federal law.
We depend on our relationship with DoubleClick to generate advertising
revenues, and DoubleClick can terminate this relationship on short notice.
A portion of our revenues consists of the sale of advertising, all of which
is currently derived through our relationship with DoubleClick, an online
advertising sales agency. DoubleClick is our exclusive representative for
advertising sold on our HealthCentral.com website; however, DoubleClick can
enter into advertising sales contracts with our competitors, and either party
can terminate the contract on 90 days notice. We have no control over
DoubleClick's sales efforts, and if it fails to sell advertising in accordance
with our expectations, our revenues would likewise be lower.
Our quarterly operating results are subject to significant fluctuations, and
our stock price may continue to decline if we do not meet revenue goals or
quarterly expectations of investors and analysts.
In part because of our limited operating history, it is difficult to
forecast accurately our future revenues or results of operations. We have
recently made certain organizational changes to focus operations on e-commerce
and our catalog business and to conserve cash. We have reduced our marketing
budget substantially and thus it may be difficult for us to achieve our
revenue targets. A variety of factors may cause our annual and quarterly
operating results to fluctuate significantly including:
. reductions in spending on marketing and other promotional activities;
. customer visits and purchases on the WebRx.com, Vitamins.com,
DrugEmporium.com, ComfortLiving.com, HealthCentral.com and RxList.com
websites and associated costs;
36
. demand for our products and mix of products sold;
. shifts in the nature and amount of publicity about us or our competitors;
. changes in our pricing policies or the pricing policies of our
competitors;
. changes in the frequency and size of repeat purchases by customers of our
online stores and retail stores;
. management of our inventory levels and fulfillment operations;
. interruptions in product supply, supplier channels or relationships;
. fluctuations in the wholesale prices of the products we sell, as well as
shipping costs or delivery times;
. seasonal patterns of spending by customers, advertisers and sponsors and
trends in advertising rates;
. costs related to acquisitions of businesses or the timing of payments to
our strategic partners;
. fluctuations in expected revenues from our strategic relationships;
. changes in reimbursement policies and practices of pharmacy benefit
managers and other third party payors;
. systems problems, such as disruptions, slower system response times and
degradation in customer service; and
. changes in government regulation.
If we do not meet the expectations of investors and analysts in any given
quarter, our stock price could decline.
Our recent growth has strained our existing personnel and other resources, and
any failure to manage our operations could increase our operating costs.
We have experienced a period of significant growth in our business, which
has placed, and will continue to place, a significant strain on our resources.
As we continue to rationalize our cost structure, including the implementation
of additional planned layoffs, we will need to improve our efficiency, which
we may not be able to accomplish. Any failure to successfully manage our
operations and increase our efficiency could distract management attention and
result in our failure to execute on our business plan. As a result of our
acquisitions, we need to assimilate the operations of Vitamins.com,
DrugEmporium.com and Comfort Living into our operations. In order to manage
this growth effectively, we will need to implement and integrate transaction-
processing, operational, reporting, and financial systems, rationalize and
train our employee base, and maintain close coordination among our technical,
finance, marketing, sales and editorial staffs. Our integration and
operational efforts are complicated by the fact that Vitamins.com operates in
the Washington D.C. and New York areas, DrugEmporium.com operations are based
in Kentucky and the Comfort Living operations are based in Maryland. Thus, we
have to manage an enterprise operating over a wide geographical area. We will
need to expend significant amounts of our time and financial resources as we
consolidate these operations and otherwise restructure these operations to
achieve efficiencies from these acquisitions, which may distract management
and further strain our technology and staffing resources. We also need to
devote resources to website development, strategic relationships, technology
infrastructure and operational infrastructure.
In order to execute our business plan we must retain and motivate highly
skilled employees, and we face significant competition from other Internet,
healthcare and new media companies in doing so.
If we fail to retain and motivate our current personnel, our business and
future growth prospects could be severely harmed. Competition for personnel
throughout the Internet and healthcare industries is intense. We have from
time to time in the past experienced, and we expect to continue to experience
in the future, difficulty in retaining highly skilled employees with
appropriate qualifications. Recent and planned layoffs within our company may
make it harder to retain key employees. Additionally, the loss of any of our
key executive officers could have a significant negative impact on our
operations.
37
We may be exposed to liabilities that are not covered by the indemnification
available under the Vitamins.com merger agreement, the DrugEmporium.com asset
purchase agreement or the more.com and Comfort Living asset purchase
agreement, which may harm our results of operation and financial condition.
Upon consummation of our merger and asset purchase agreements, we assumed
all the liabilities of Vitamins.com, and certain liabilities of
DrugEmporium.com and Comfort Living. In addition, it is possible that
liabilities may arise in the future which we did not discover or anticipate.
To the extent these liabilities are inconsistent with representations and
warranties made in the respective agreements, we may have a claim for
indemnification against the former stockholders of Vitamins.com, DrugEmporium
or more.com. Pursuant to the Vitamins.com agreement, 10% of the
HealthCentral.com common stock issued in the merger was placed in an escrow
account and will be held to cover any indemnification claims for a period
equal to the lesser of twelve months after the effective time or the period
ending two business days after the escrow holder receives written notification
that we have issued our first independent audit report showing the combined
results of operations of HealthCentral.com and Vitamins.com. The
DrugEmporium.com and more.com agreements provide that 10% of the
HealthCentral.com stock issued in each purchase will be placed in an escrow
account for indemnification and held for a period of one year. The escrow
amount will be our sole recourse for indemnification claims other than in the
case of fraud. However, the assumed liabilities, both at the time of and
arising after the consummation of the agreements, may exceed our expectations
and the escrow amount may be insufficient to cover these liabilities. If
liabilities for which indemnification is available exceed the escrow amount,
we will suffer financial losses, which may harm our business, results of
operation and financial condition.
Any future acquisitions of companies or technologies may result in disruptions
to our business and/or the distraction of our management.
To date, we have completed mergers or asset acquisitions of six companies,
Enterprise Web Services, HealthCentralRx.com, RxList.com, Vitamins.com,
DrugEmporium.com and more.com/Comfort Living, and we have acquired the license
to use the Dr. Dean Edell Eyewear brand. We are not currently planning any
additional acquisitions; however we may acquire or make investments in other
complementary businesses and technologies in the future. We may not be able to
identify other future suitable acquisition or investment candidates, and even
if we do identify suitable candidates, we may not be able to make these
acquisitions or investments on commercially acceptable terms, or at all. If we
do acquire or invest in other companies, we may not be able to realize the
benefits we expected to achieve at the time of entering into the transaction
and will likely face integration risks, including but not limited to:
. expenses related to funding the operation, development and/or integration
of complementary businesses;
. expenses associated with the transactions;
. additional expenses associated with amortization of acquired intangible
assets;
. the difficulty of maintaining uniform standards, controls, procedures and
policies;
. the impairment of relationships with employees and customers as a result
of any integration of new personnel;
. the potential unknown liabilities associated with acquired businesses;
and
. the issuance of convertible debt or equity securities, which could be
dilutive to our existing stockholders.
Our failure to adequately address these issues could harm our business. See
also "We may not achieve the expected benefits of the acquisition of
Vitamins.com, or the acquisition of the assets of DrugEmporium.com and Comfort
Living, and their integration may result in a disruption to our business or
the distraction of our management and employees."
38
We could face significant non-cash stock-based charges.
In light of the recent decline in our stock price and in an effort to
retain our employee base, in December 2000 we exchanged stock options held by
employees and certain consultants. In exchange for accepting new vesting
schedules, the exercise price of all eligible employee and certain consultant
options with an exercise price in excess of $0.4062 was reduced to $0.4062,
the closing market price on the Nasdaq on December 11, 2000. As a result of
this repricing, options to purchase a total of 2,967,890 shares will be
subject to variable accounting treatment, which means that any increase in our
stock price will result in non-cash accounting charges, which would increase
our net loss.
Any failure to protect our intellectual property rights could impair our
ability to establish our brands.
If we fail to adequately protect our proprietary rights in our content,
technology, products and services, our competitors could use the intellectual
property that we have developed to enhance their products and services, which
could harm our business. We rely on a combination of copyright and trademark
laws, trade secrets, confidentiality provisions and other contractual
provisions to protect our proprietary rights, but these legal means afford
only limited protection. Unauthorized parties may attempt to copy aspects of
our websites or to obtain and use information that we regard as proprietary.
Our competitors or others may adopt service names similar to ours, thereby
impeding our ability to build our brand identity and potentially confusing
consumers. We also rely on a variety of technologies that are licensed from
third parties, including our database and Internet server software. These
third-party licenses may not be available to us on commercially reasonable
terms in the future.
Any errors in filling or packaging the prescription drugs for our customers or
dispensing products on our websites may expose us to liability and negative
publicity.
Pharmacy errors relating to prescriptions, dosage and other aspects of the
medication dispensing process could produce liability for us. Pharmacists are
required by law to offer counseling, without additional charge, to their
customers about medication, dosage, delivery systems, common side effects and
other information they deem important. This counseling is expected to be
accomplished by telephone access to pharmacists, but also in part through
inserts included with the prescription, which may increase the risk of
miscommunication because the customer is not personally present. We also post
product information on our WebRx.com, RxList.com, Vitamins.com,
DrugEmporium.com and ComfortLiving.com websites, which creates additional
potential for claims to be made against us. Our insurance may not cover
potential claims of this type or may not be adequate to protect us from all
liability that may be imposed.
Prescription orders are currently filled by our in-house pharmacists and we
may be exposed to liability for pharmacy errors. Pharmacy errors may produce
significant adverse publicity either for us or the entire online pharmacy
industry. The amount of negative publicity that we or the online pharmacy
industry may receive as a result of pharmacy or prescription processing errors
could be disproportionate in relation to the negative publicity received by
traditional pharmacies making similar mistakes. We believe that any negative
publicity could erode consumer trust and result in an immediate reduction in
product purchases.
We may be sued by consumers as a result of the health-related products we sell
through our online and offline channels.
Consumers may sue us if any of our products or services that are sold
through our online or offline channels are defective, fail to perform properly
or injure the user, even if such goods and services are manufactured and
provided by unrelated third parties. Liability claims could require us to
spend significant time and money in litigation or to pay significant damages
and could seriously damage our reputation.
We may be sued by third parties for infringement of their proprietary rights.
The healthcare and Internet industries are characterized by the existence
of a large number of patents and frequent litigation based on allegations of
patent infringement or other violations of intellectual property rights.
39
As the number of entrants into our market increases, the possibility of an
intellectual property claim against us grows. Our content, technology,
products and services may not be able to sustain any third party claims or
rights against their use. Some of the information in our website network
databases regarding dietary supplements, drug descriptions, clinical
pharmacology, indications and usage, warnings and the like is copied from
information contained in package inserts, which accompany the particular drug.
We have not obtained licenses to reproduce this information from the various
pharmaceutical companies. Although we have not received a copyright claim to
date, we could face potential copyright infringement claims in this regard.
Any intellectual property claims, with or without merit, could be time
consuming and expensive to litigate or settle and could divert management
attention from administering our core business.
As a publisher of online content, we may have liability for information we
provide on, or which is accessed from, the HealthCentral.com network.
Because users of our network and the websites of our institutional
licensees access health-related information, including information regarding
possible adverse reactions or side effects from medications or a particular
medical condition they may have, or may distribute our content to others,
third parties may sue us for various causes of action based on the nature and
content of materials that we publish. We could also become liable if
confidential information is disclosed inappropriately. These types of claims
have been brought successfully against online services in the past. Others
could also sue us for the content and services that are accessible from our
network through links to other websites or through content and materials that
may be posted by our users in chat rooms or bulletin boards, none of which we
edit.
Any indemnification provisions that we may have in agreements may not be
adequate to protect us. Our insurance may not adequately protect us against
these types of claims. Further, our business is based on establishing the
HealthCentral.com network as a trustworthy and dependable provider of
healthcare information and services. Allegations of impropriety, even if
unfounded, could therefore harm our reputation and business.
A failure to build our brand names quickly and significantly will result in
lower than expected revenues.
If we do not gain significant brand recognition quickly, we may lose the
opportunity to build a critical mass of customers, and our business may fail.
Some of our competitors, such as drugstore.com, CVS.com, drkoop.com, WebMD and
medscape.com, have stronger name recognition than do we. The increasing
competition in our markets makes building a brand more expensive and difficult
than it otherwise would be. To increase brand recognition, we may need to
offer product promotions and discounts, all of which are expensive.
Dr. Dean Edell provides us with unique content and credibility, and any
failure by Dr. Edell to participate in our business could result in reduced
site traffic and revenues.
Dr. Dean Edell provides us with unique content for, and drives traffic to,
our HealthCentral.com network. Dr. Edell is not contractually obligated to
provide content or drive traffic to our network, and he is not compensated for
such activity. If Dr. Edell ceased providing us with content or ceased
mentioning our HealthCentral.com network on his television and radio shows, we
would have to find a replacement for this unique content or an alternative
means of driving traffic to our site, both of which would be difficult and
expensive to do.
In addition, under his agreement with Premiere Radio Networks, the
syndicator of his radio show, Dr. Edell has agreed not to authorize the use of
his name or likeness to promote any product or service in any way that would
conflict with his programs' advertisers or potential advertisers, or would
impair his credibility as a program host.
Any diminishment in Dr. Edell's reputation as a medical expert and advisor,
his death or incapacity, the expiration of his 15 year agreement with us, or
any other development that would cause us to lose the benefits of our
affiliation with Dr. Edell, could diminish our standing with healthcare
consumers as a credible source of
40
healthcare information and could harm sales of the Dr. Dean Edell brand of
eyewear. Although we maintain key person life insurance for Dr. Edell, his
role in our company is sufficiently critical that the insurance would not
adequately protect us in the event of his death.
In order to attract and retain users to our HealthCentral.com network, we need
to continue to provide content, which is expensive and difficult to obtain
and/or develop.
To attract and retain users to our HealthCentral.com network, we need to
continue to provide informative content. We will need to purchase or license
much of this content from third persons. Competition for content from people
with the professional reputation, name recognition and expertise that we
require is intense and increasing. This competition may increase the fees
charged by high quality content providers, resulting in increased expenses for
us. We will not only have to expend significant funds to obtain and improve
our content, but we must also properly anticipate and respond to consumer
preferences for this content. If we are unable to enter into agreements for
the delivery of desirable content, or lose any existing agreements, it could
delay market acceptance of the HealthCentral.com network.
The success of our business model is dependent on continued growth and
acceptance of the Internet and growth of the online market for healthcare
information, products and services.
Our business model assumes that consumers will be attracted to and use
healthcare information and related content available on our Internet-based
consumer healthcare network which will, in turn, allow us the opportunity to
sell advertising and sponsorships designed to reach those consumers. Our
business model also assumes that those consumers will purchase health-related
products online using our website and that healthcare organizations and other
Internet healthcare companies will partner with us to reach these consumers.
This business model is not yet proven and may not be successful. Our future
revenues and profits, if any, substantially depend upon the widespread
acceptance and use of the Internet as an important channel for the delivery of
healthcare information, products and services. The Internet may not prove to
be a viable commercial medium due to inadequate development of a reliable
network, delays in development of high speed modems, or delays in the adoption
of new technologies or adapt our network, proprietary technology and
transaction-processing systems to customer requirements or emerging industry
standards.
If we do not respond to rapid technological changes affecting the Internet
healthcare industry, our products and services could become obsolete.
Any failure to respond to technological advances and emerging industry
standards could impair our ability to attract and retain customers. As the
Internet and online commerce industry evolve, we must 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 network, proprietary technology and transaction-
processing systems to customer requirements or emerging industry standards.
Extensive and changing government regulation of the healthcare, dietary
supplements and pharmacy industries is expensive to comply with and exposes us
to the risk of substantial government penalties.
Numerous state and federal laws regulate our health business covering areas
such as:
. storage, transmission and disclosure of medical information and
healthcare records;
. the practice of medicine and other healing arts professions;
. the sale of controlled products such as pharmaceuticals and other
healthcare products;
. prohibitions against the offer, payment or receipt of remuneration to
induce referrals to entities providing healthcare services or goods;
. dispensing and delivering prescription or over-the-counter drugs and
other medical products;
41
. advertising drugs, cosmetics and nutritional supplements; and
. state insurance regulations.
Further, because the Internet health business is novel, federal and state
agencies may apply laws and regulations to us in unanticipated ways, and may
produce new legislation regulating our business, which could increase our
costs or reduce or eliminate certain of our activities or our revenues. See
"Business--Government Healthcare Regulation" and "Business--Other Governmental
Regulation"
Governmental regulation of the Internet could increase our operating costs.
We receive confidential medical and credit card information from our
customers and website visitors. Laws and regulations directly applicable to
communications or commerce over the Internet are becoming more prevalent, and
compliance with any new laws could increase our operating expenses. In
particular, many government agencies and consumers are focused on the privacy
and security of medical and pharmaceutical records. The law of the Internet,
however, remains largely unsettled, even in areas where there has been some
legislative action. The rapid growth and development of the market for online
commerce may prompt calls for more stringent consumer protection laws, both in
the United States and abroad, that may impose additional burdens on companies
conducting business online and, in particular, on companies that maintain
medical or pharmaceutical records.
A number of proposals have been made to impose additional taxes on the sale
of goods through the Internet. Taxation of online commerce could impair the
growth of our e-commerce business and add to the complexity of our transaction
processing system. See "Business--Other Governmental Regulation."
The health industry is extremely dynamic and constantly changing, and thus our
business may be affected by pricing pressures and healthcare reform
initiatives.
The pressures of cost management, consumer demand for quality and safety
and professional concern about consumer reliance on non-professional advice
will dominate the healthcare marketplace for the foreseeable future. Any
efforts to contain costs by managed care entities will place downward
pressures on gross margins from sales of prescription drugs and other over-
the-counter healthcare products. Healthcare reform initiatives of federal and
state governments, including proposals designed to significantly reduce
spending on Medicare, Medicaid and other government programs, may further
impact our revenues from prescription drug sales. As a result, any company in
the health business is subject to the risk of an extremely changeable
marketplace, which could result in our need to continually modify our business
model, which could harm our business.
It may be difficult for a third party to acquire us even if doing so would be
beneficial to our stockholders.
Provisions of our certificate of incorporation and bylaws and Delaware law
may discourage, delay or prevent a merger or acquisition that a stockholder
may consider favorable. These provisions include the following:
. establishment of a classified board in which only a portion of the total
board members will be elected at each annual meeting;
. authorization for the board to issue preferred stock;
. prohibition of cumulative voting in the election of directors;
. advance notice requirements for nominations for election of the board of
directors or for proposing matters that can be acted on by stockholders
at stockholder meetings; and
. change of control clauses in the employment agreements with several
company officers.
42
Management has broad discretion over how our available cash is being used.
Our officers and directors have broad discretion with respect to the use of
our available cash. We currently expect to use our existing cash balances to
fund operating losses, costs associated with integrating acquisitions and
website development. In addition, we are continuing to evaluate possible
acquisitions or investments in complementary businesses.
If we are unable to acquire the necessary web domain names, our brands and
reputation could be damaged, and we could lose customers.
The regulation of domain names in the United States and in foreign
countries is subject to change. Regulatory bodies could establish additional
top-level domains, appoint additional domain name registrars or modify the
requirements for holding domain names. As a result, we may not acquire or
maintain our existing domain names in all of the countries in which we conduct
business.
The relationship between regulations governing domain names and always
protecting trademarks and similar proprietary rights is unclear. Therefore, we
could be unable to prevent third parties from acquiring domain names that
infringe or otherwise decrease the value of our brands, trademarks and other
proprietary rights. In addition, we may be unable to prevent third parties
from acquiring and using domain names relating to our brands. Any confusion
that may result from information on or related to any websites with domain
names relating to our brands could impair both our ability to capitalize upon
our brands and our marketing strategy.
Item 7a. Qualitative and Quantitative Disclosure About Market Risk.
Our exposure to market risk is limited to interest income sensitivity,
which is affected by changes in the general level of U.S. interest rates. Our
cash equivalents are invested with high quality issuers and limit the amount
of credit exposure to any one issuer. Due to the short-term nature of the cash
equivalents, we believe that we are not subject to any material interest rate
risk. We did not have any foreign currency hedges or other derivative
financial instruments as of December 31, 2000.
We do not enter into financial instruments for trading or speculative
purposes and do not currently utilize derivative financial instruments. Our
operations are conducted primarily in the United States and as such are not
subject to material foreign currency exchange rate risk. We have no long-term
debt.
Item 8. Financial Statements and Supplementary Data.
See Part IV, Item 14 of this Report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
The Company's Proxy Statement for its 2001 Annual Meeting of Stockholders
which, when filed pursuant to Regulation 14A under the Securities Exchange Act
of 1934, will be incorporated by reference in this Form 10-K pursuant to
General Instruction G(3) of Form 10-K and will provide the information
required under Part III (Items 10-13), except for the information with respect
to the Company's executive officers, which is included in "Item 1, Business-
Executive Officers."
43
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K.
(a) The following documents are filed as part of this Form 10-K:
(1) Consolidated Financial Statements and Report of
PricewaterhouseCoopers LLP, which are set forth in the Index to
Consolidated Financial Statements at page F-1
(2) Financial Statement Schedules--See Index to Consolidated Financial
Statements and Financial Statement Schedule on Page F-1 of this
Report on Form 10-K.
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is included in
the consolidated financial statements or notes thereto.
(3) Exhibits (number in accordance with Item 601 of Regulation S--K)
(b) Exhibits
[Download Table]
Number Description
------ -----------
2.1 Asset Purchase Agreement dated July 24, 2000 by and among
HealthCentral.com, HCC Subsidiary Corp., DrugEmporium.com, Inc. and
Drug Emporium, Inc. (as amended on September 11, 2000) (Filed as
Exhibits 2.1 and 2.2 to the Company's Current Report on Form 8-K filed
on September 28, 2000 and herein incorporated by reference.)
2.2 Asset Purchase Agreement dated October 23, 2000, by and among
HealthCentral.com, HCEN Acquisition Corporation, more.com, Inc. and
Comfort Living, Inc. (as amended on November 14, 2000 and November 27,
2000) (Filed as Exhibits 2.5, 2.6 and 2.7 to the Company's Current
Report on Form 8-K, filed on December 21, 2000 and herein incorporated
by reference.)
2.3 Agreement and Plan or Reorganization and Merger among
HealthCentral.com, HCC Acquisition Corp. and Vitamins.com, Inc., dated
as of March 15, 2000 (Filed as Exhibit 2.1 to the Company's Current
Report on Form 8-K, filed on June 19, 2000, and herein incorporated by
reference.)
3.3(1) Amended and Restated Certificate of Incorporation of the Company
3.5++ Amended and Restated Bylaws of the Company
3.8 Certificate of Designation of Series A Preferred Stock of
HealthCentral.com dated September 7, 2000
4.1(1) Form of Company's Common Stock Certificate
4.2(3) Registration Rights Agreement between the Company and Alta Vista
Company dated August 2, 2000
4.3 Registration Rights Agreement between the Company and Don Bayless
dated December 2, 2000
4.4 Registration Rights Agreement between the Company and Goldberg,
Marchesano Partners, Inc. dated December 22, 2000
10.1(1) First Amended and Restated Investors' Rights Agreement dated August
27, 1999 between the Company and certain investors
10.2(2) 1999 Stock Plan, as amended on January 2000, and form of stock option
agreements and restricted stock purchase agreements
10.3(2) Amended and Restated 1998 Stock Plan, as amended on January 2000, and
form of stock option agreements and restricted stock purchase
agreements
10.4(1) 1999 Employee Stock Purchase Plan, and form of subscription agreement
10.5(1) 1999 Directors' Stock Option Plan, and form of stock option agreement
44
[Download Table]
Number Description
------ -----------
10.6(1) Form of Common Stock Agreement between the Company and each of Dean
S. Edell M.D. and James J. Hornthal
10.9(1) Employment Agreement between the Company and Deryk Van Brunt
10.10(3) Employment Agreement between the Company and Albert Greene, dated
August 16, 1999, as amended June 27, 2000
10.11(1) Offer Letter from the Company to C. Fred Toney dated June 16, 1999
10.15(1) License and Confidential Information Agreement between the Company
and Dr. Dean S. Edell dated May 14, 1999
10.16(1) Office Lease between the Company and Christie Avenue Partners JS
dated March 26, 1999
10.17(1) Landlord's Consent and Agreement (Sublease) between the Company and
Burnham Pacific Operating Partnership, L.P. dated July 22, 1999
10.19(1)+ Co-Branded Site Agreement by and between the Company, Graedon
Enterprises, Inc., and Joe Graedon and Teresa Graedon dated
September 9, 1999
10.21(1) Agreement and Plan of Reorganization by and between the Company, HC
Acquisition Corporation and ePills, Inc. dated September 28, 1999
10.24(1) Form of Indemnification Agreement
10.25(1) Agreement and Plan of Reorganization by and between the Company and
RxList.com dated October 25, 1999
10.26(1) Industrial Lease between ePills.com and H.S.P. dated May 4, 1999
10.27(1)+ Co-Branding Content Agreement between the Company and MediaLinx
Interactive, L.P. dated June 30, 1999
10.29(1) Assumed HealthCentralRx.com 1999 Stock Option Plan and form of
incentive stock option agreement
10.30(2) Agreement with Covert Bailey dated December 1999
10.31(4) Employment Agreement between the Company and Robert M. Haft, dated
March 15, 2000 and effective as of June 16, 2000
10.32(4) Assignment and Amendment Agreement among the Company, Brand Optical
Corporation and Dr. Dean Edell, dated April 11, 2000
10.33 Industrial Lease Agreement between Telestar Court Limited
Partnership and Vitamins Superstore, L.L.C. dated June 19, 1997
10.34 Industrial Lease Agreement between Drug Emporium, Inc. and Crow
Family Holdings Industrial Limited Partnership dated July 15, 1999
10.35 Office Lease between the Company and Christie Avenue Partners JS
dated May 19, 2000 (as amended June 5, 2000)
10.36 Offer Letter from the Company to James Schanzenbach dated August 15,
2000
10.37 Assignment Agreement between Drug Emporium, Inc. and
DrugEmporium.com, Inc., dated February 29, 2000
10.38 Assignment Agreement between the Company and DrugEmporium.com, Inc.,
dated August 30, 2000
10.39 Common Stock Repurchase Agreement between the Company and C. Fred
Toney dated November 13, 2000
45
[Download Table]
Number Description
------ -----------
10.40 Amendment I to Industrial Lease Agreement between the Company and Crow
Family Holdings Industrial Limited Partnership, dated November 27, 2000
10.41 Severance and Change of Control Agreement between the Company and C.
Fred Toney dated December 2000
21.1++ List of subsidiaries
23.1 Consent of Independent Accountants, PricewaterhouseCoopers LLP
23.2 Consent of Independent Accountants, Arthur Andersen LLP
24.1 Power of Attorney (Page 47)
--------
+ Confidential treatment has been granted by the Securities and Exchange
Commission
++ Supersedes previously filed exhibit
(1) Filed with the Company's Registration Statement on Form S-1 (Commission
File No. 333-88019) and herein incorporated by reference
(2) Filed with the Annual Report on 10-K for the year ending December 31,
1999, filed on March 10, 2000 and herein incorporated by reference
(3) Filed with the Quarterly Report on 10-Q for the quarter ending June 30,
2000, filed on August 14, 2000 and herein incorporated by reference
(4) Filed with Quarterly Report on 10-Q for the quarter ending September 30,
2000, filed on November 14, 2000 and herein incorporated by reference.
(c) Reports on Form 8-K
A current report on Form 8-K was filed with the SEC on October 27, 2000 to
report the issuance of a press release on the more.com, Inc. and Comfort
Living, Inc. asset acquisition.
A current report on Form 8-K was filed with the SEC on November 16, 2000 to
report the receipt of notice of Robert M. Haft's resignation from the Board of
Directors.
A current report on Form 8-K/A was filed with the SEC on November 28, 2000
to include financial statements for the Drug Emporium, Inc. asset acquisition.
A current report on Form 8-K was filed with the SEC on December 11, 2000 to
announce the approval of an option repricing program.
A current report on Form 8-K was filed with the SEC on December 21, 2000 to
report the close of its acquisition of the assets of more.com, Inc. and
Comfort Living, Inc.
46
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.
HealthCentral.com
/s/ C. Frederick Toney
By: _________________________________
C. Frederick Toney,
Chief Executive Officer,
Chief Financial Officer and
Director
Date: April 2, 2001
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints C. Frederick Toney as his attorney-in-
fact, with the power of substitution, for him in any and all capacities, to
sign any amendments to this Report on Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith with the
Securities and Exchange Commission, hereby ratifying and confirming all that
said attorney-in-fact , or his substitute or substitutes may do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
[Download Table]
Signature Title Date
--------- ----- ----
/s/ C. Frederick Toney Chief Executive Officer, April 2, 2001
____________________________________ President, Chief Financial
C. Frederick Toney Officer and Director
(Principal Executive
Officer, Financial and
Accounting Officer)
/s/ Dean Edell Director April 2, 2001
____________________________________
Dean Edell
Chairman of the Board
____________________________________
Albert L. Greene
/s/ James Hornthal Director April 2, 2001
____________________________________
James Hornthal
/s/ Michael D. McDonald Director April 2, 2001
____________________________________
Michael D. McDonald
47
HEALTHCENTRAL.COM
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
[Download Table]
Page
----
Report of Independent Accountants--PricewaterhouseCoopers LLP.............. F-2
Report of Independent Accountants--PricewaterhouseCoopers LLP.............. F-3
Report of Independent Accountants--Arthur Andersen LLP..................... F-4
Consolidated Balance Sheets................................................ F-5
Consolidated Statements of Operations...................................... F-6
Consolidated Statements of Stockholders' Equity............................ F-7
Consolidated Statements of Cash Flows...................................... F-8
Notes to Consolidated Financial Statements................................. F-9
Report of Independent Accountants on Financial Statement Schedule.......... S-1
Schedule II--Valuation and Qualifying Accounts............................. S-2
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of HealthCentral.com:
In our opinion, based on our audit and the report of other auditors, the
accompanying consolidated balance sheet and the related consolidated
statements of operations, of stockholders' equity and of cash flows present
fairly, in all material respects, the financial position of HealthCentral.com
and its subsidiaries at December 31, 2000 and 1999, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements
based on our audits. We did not audit the financial statements of
Vitamins.com, Inc., a wholly owned subsidiary, which statements reflect total
assets of $30,694,894 as of December 31, 1999 and total revenues of
$16,940,977 for the year ended December 31, 1999. Those statements were
audited by other auditors whose report thereon has been furnished to us, and
our opinion expressed herein, insofar as it relates to the amounts included
for Vitamins.com, Inc., is based solely on the report of the other auditors.
We conducted our audit of these statements in accordance with auditing
standards generally accepted in the United States of America, which 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits and the report of
other auditors provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has sustained losses and negative cash flows
from operations since its inception. These matters raise substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 2. The accompanying financial
statements do not include any adjustments that might result from the outcome
of this uncertainty.
/s/ PricewaterhouseCoopers LLP
San Jose, California
February 9, 2001
F-2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of HealthCentral.com:
In our opinion, the accompanying consolidated statements of operations, of
stockholders' equity and of cash flows present fairly, in all material
respects, the results of operations and cash flows of HealthCentral.com and
its subsidiaries for the year ended December 31, 1998 in conformity with
accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements
based on our audit. We conducted our audit of these statements in accordance
with auditing standards generally accepted in the United States of America,
which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for the opinion expressed above.
We previously audited and reported on the consolidated statements of
operations and cash flows of HealthCentral.com for the year ended December 31,
1998, prior to its restatement for the June 16, 2000 pooling of interests. The
contribution of HealthCentral.com to revenues and net loss represented 3
percent and 25 percent for the year ended December 31, 1998 of the respective
totals. Separate financial statements of the other company included in the
1998 restated consolidated statements of operations and cash flows were
audited and reported on separately by other auditors. We also audited the
combination of the accompanying consolidated statements of operations and cash
flows for the year ended December 31, 1998, after restatement for the June 16,
2000 pooling of interests; in our opinion, such consolidated statements have
been properly combined on the basis described in Note 1 of notes to
consolidated financial statements.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has sustained losses and negative cash flows
from operations since its inception. These matters raise substantial doubt
about its ability to continue as a going concern. Management's plan in regard
to these matters are also described in Note 2. The accompanying financial
statements do not include any adjustments that might result from the outcome
of this uncertainty.
/s/ PricewaterhouseCoopers LLP
San Jose, California
February 9, 2001
F-3
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Vitamins.com, Inc.:
We have audited the consolidated balance sheets of Vitamins.com, Inc.
(formerly Vitamin Superstore, LLC; the "Company," a Delaware corporation), as
of December 31, 1998 and 1999, and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for each of the
three years in the period ended December 31, 1999. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Vitamins.com, Inc., as of December 31, 1998 and 1999, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999 in conformity with accounting principles generally accepted
in the United States.
The consolidated financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations and has a net capital deficiency that raises substantial doubt
about its ability to continue as a going concern. Management plans to raise
sufficient financing to meet its needs for the coming year (see Note 1). The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Arthur Andersen LLP
Vienna, Virginia
February 17, 2000
(except with respect to
the matter discussed
in Note 9 of the
financial statements
incorporated by
reference herein, as to
which the date is June
16, 2000)
F-4
HEALTHCENTRAL.COM
CONSOLIDATED BALANCE SHEETS
[Download Table]
December 31,
---------------------------
ASSETS 2000 1999
------ ------------- ------------
Current assets:
Cash and cash equivalents....................... $ 14,208,364 $ 83,690,072
Accounts receivable, net of allowance for
doubtful accounts of $83,941 and $64,609,
respectively................................... 3,058,940 1,149,020
Inventory....................................... 9,006,016 5,464,633
Prepaid expenses and other current assets....... 2,064,815 4,672,349
------------- ------------
Total current assets.......................... 28,338,135 94,976,074
Property and equipment, net....................... 11,685,865 6,253,153
Other assets...................................... 439,495 1,535,799
Intangible assets................................. 4,922,353 46,072,969
------------- ------------
Total assets.................................. $ 45,385,848 $148,837,995
============= ============
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE
PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
-----------------------------------------------
Current liabilities:
Accounts payable................................ $ 12,258,364 $ 8,360,133
Accrued expenses................................ 3,701,438 2,321,608
Deferred revenue and other current liabilities.. 1,279,645 431,535
Current portion of obligations under capital
leases......................................... 3,258,040 326,058
Note payable.................................... -- 2,540,784
------------- ------------
Total current liabilities..................... 20,497,487 13,980,118
Deferred rent..................................... 194,708 171,727
Obligations under capital leases.................. 1,289,258 621,097
------------- ------------
Total liabilities............................. 21,981,453 14,772,942
------------- ------------
Mandatorily redeemable convertible preferred
stock, $0.001 par value, 0 and 19,220,935 shares
authorized at December 31, 2000 and 1999,
respectively, 0 and 17,411,710 shares issued and
outstanding at December 31, 2000 and 1999,
respectively..................................... -- 36,565,397
------------- ------------
Commitments and contingencies (Notes 11 and 13)
Stockholders' equity:
Convertible preferred stock, $0.001 par value,
5,000,000 shares authorized at December 31,
2000 and 1999, respectively, 480,000 and 0
issued and outstanding at December 31, 2000 and
1999, respectively............................. 7,274,880 --
Common stock, $0.001 par value, 100,000,000
shares authorized at December 31, 2000 and
1999, respectively, and 50,282,394 and
27,602,336 issued and outstanding at December
31, 2000 and 1999, respectively................ 50,097 27,417
Additional paid-in capital...................... 210,831,291 169,646,821
Note receivable from stockholder................ (65,457) (465,457)
Deferred stock compensation..................... (1,487,023) (5,005,965)
Accumulated deficit............................. (193,199,393) (66,703,160)
------------- ------------
Total stockholders' equity.................... 23,404,395 97,499,656
------------- ------------
Total liabilities, mandatorily redeemable
convertible preferred stock and stockholders'
equity....................................... $ 45,385,848 $148,837,995
============= ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
HEALTHCENTRAL.COM
CONSOLIDATED STATEMENTS OF OPERATIONS
[Download Table]
Years Ended December 31,
----------------------------------------
2000 1999 1998
------------- ------------ -----------
Revenues:
eCommerce and other product sales.. $ 43,051,726 $ 17,041,760 $ 4,340,297
Advertising, content and other..... 2,952,974 1,188,753 15,259
------------- ------------ -----------
Total revenues................... 46,004,700 18,230,513 4,355,556
------------- ------------ -----------
Operating and other expenses:
Cost of eCommerce and other product
sales............................. 32,301,566 11,793,276 2,646,179
Content and product development.... 10,346,029 4,398,580 136,788
Sales and marketing................ 56,435,754 28,671,971 2,318,122
General and administrative......... 10,593,593 4,683,423 914,002
Amortization of intangible assets.. 14,799,823 3,657,222 --
Stock compensation................. 1,765,279 6,245,822 104,641
Acquired in-process research and
development....................... -- 804,525 --
Acquisition and contract
termination costs................. 9,258,375 -- --
Write-off of intangibles........... 39,134,092 -- --
------------- ------------ -----------
Total operating and other
expenses........................ 174,634,511 60,254,819 6,119,732
------------- ------------ -----------
Loss from operations................. (128,629,811) (42,024,306) (1,764,176)
Other expense, net................... (343,426) (32,568) --
Interest income (expense), net....... 2,477,004 777,867 (20,519)
------------- ------------ -----------
Net loss............................. (126,496,233) (41,279,007) (1,784,695)
Preferred stock dividends............ -- (22,275,542) --
------------- ------------ -----------
Net loss attributable to common
stockholders........................ $(126,496,233) $(63,554,549) $(1,784,695)
============= ============ ===========
Basic and diluted net loss per share
attributable to common stockholders. $ (3.39) $ (5.67) $ (0.25)
============= ============ ===========
Shares used in computing basic and
diluted net loss per share
attributable to common stockholders. 37,359,590 11,204,708 7,016,416
============= ============ ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
HEALTHCENTRAL.COM
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
[Enlarge/Download Table]
Convertible Note
Preferred Stock Common Stock Additional Receivable Deferred
---------------------- ------------------- Paid-In from Stock Accumulated
Shares Amount Shares Amount Capital Stockholder Compensation Deficit
---------- ---------- ---------- ------- ------------ ----------- ------------ -------------
Balance at
December 31,
1997........... -- $ -- 6,811,178 $ 6,580 $ 3,017,207 $(1,175,780) $ -- $ (1,363,916)
Issuance of
Series A
preferred stock
and warrants,
net............ 1,012,500 1,134 -- -- 1,933,891 -- -- --
Issuance of
common stock... -- -- 1,427,165 1,436 8,966,924 (3,365,931) -- --
Deferred
compensation
expense in
connection with
issuance of
stock options.. -- -- -- -- 389,122 -- (389,122) --
Amortization of
deferred stock
compensation... -- -- -- -- -- -- 104,641 --
Net loss........ -- -- -- -- -- -- -- (1,784,695)
---------- ---------- ---------- ------- ------------ ----------- ----------- -------------
Balance at
December 31,
1998........... 1,012,500 1,134 8,238,343 8,016 14,307,144 (4,541,711) (284,481) (3,148,611)
Deferred
compensation
expense in
connection with
issuances of
stock options.. -- -- -- -- 9,521,321 -- (9,661,178) --
Amortization of
deferred
compensation... -- -- -- -- -- -- 4,939,694 --
Issuance of
Series B
convertible
preferred stock
and warrants,
net............ 4,038,455 4,523 -- -- 19,810,542 -- -- --
Common stock
issued for
acquisitions... -- -- 5,324,871 5,576 35,572,592 -- -- --
Issuance of
Series A
convertible
preferred stock
warrants....... -- -- -- -- 49,372 -- -- --
Issuance of
common stock
warrants and
options........ -- -- -- -- 1,747,848 -- -- --
Preferred stock
dividend....... -- -- -- -- 11,388,000 -- -- (11,388,000)
Issuance of
common stock in
IPO, net....... -- -- 7,500,000 7,500 74,651,321 -- -- --
Conversion of
preferred
stock.......... (5,050,955) (5,657) 5,050,955 5,051 606 -- -- --
Exercise of
warrants and
options........ -- -- 936,796 722 1,285,895 (459,526) -- --
Common stock
issued......... -- -- 96,142 96 62,636 -- -- (58,648)
Issuance of
common stock
for domain name
purchase....... -- -- 193,774 194 1,249,806 -- -- --
Exercise of
dilution
rights......... -- -- 261,455 262 (262) -- -- --
Forgiveness of
note receivable
from
stockholder.... -- -- -- -- -- 1,175,780 -- --
Collection of
note receivable
from
stockholder.... -- -- -- -- -- 3,360,000 -- --
Recapitalization
(Note 8)....... -- -- -- -- -- -- -- (10,828,894)
Net loss........ -- -- -- -- -- -- -- (41,279,007)
---------- ---------- ---------- ------- ------------ ----------- ----------- -------------
Balance at
December 31,
1999........... -- -- 27,602,336 27,417 169,646,821 (465,457) (5,005,965) (66,703,160)
Stock issued for
acquisitions... 480,000 7,274,880 4,993,471 4,994 6,002,978 -- -- --
Conversion of
preferred stock
to common
stock.......... 17,411,710 17,412 36,547,985
Exercise of
options........ -- -- 268,098 268 437,199 -- -- --
Issuance of
common stock
warrants and
options........ -- -- -- -- 12,878 -- -- --
Amortization of
deferred
compensation... -- -- -- -- -- -- 1,693,913 --
Cancellation and
revaluation of
common stock
warrants....... -- -- -- -- (829,843) -- 159,026 --
Common stock
issued for
services....... -- -- 300,000 300 937,200 -- -- --
Common stock
issued under
employee stock
purchase plan.. -- -- 19,279 19 54,263 -- -- --
Deferred
compensation
adjustment for
terminated
employees...... -- -- -- -- (1,666,003) -- 1,666,003 --
Forgiveness of
note receivable
from
stockholder.... -- -- (312,500) (313) (312,187) 400,000 -- --
Net loss........ -- -- -- -- -- -- -- (126,496,233)
---------- ---------- ---------- ------- ------------ ----------- ----------- -------------
Balance at
December 31,
2000........... 480,000 $7,274,880 50,282,394 $50,097 $210,831,291 $ (65,457) $(1,487,023) $(193,199,393)
========== ========== ========== ======= ============ =========== =========== =============
Total
Stockholders'
Equity
--------------
Balance at
December 31,
1997........... $ 484,091
Issuance of
Series A
preferred stock
and warrants,
net............ 1,935,025
Issuance of
common stock... 5,602,429
Deferred
compensation
expense in
connection with
issuance of
stock options.. --
Amortization of
deferred stock
compensation... 104,641
Net loss........ (1,784,695)
--------------
Balance at
December 31,
1998........... 6,341,491
Deferred
compensation
expense in
connection with
issuances of
stock options.. (139,857)
Amortization of
deferred
compensation... 4,939,694
Issuance of
Series B
convertible
preferred stock
and warrants,
net............ 19,815,065
Common stock
issued for
acquisitions... 35,578,168
Issuance of
Series A
convertible
preferred stock
warrants....... 49,372
Issuance of
common stock
warrants and
options........ 1,747,848
Preferred stock
dividend....... --
Issuance of
common stock in
IPO, net....... 74,658,821
Conversion of
preferred
stock.......... --
Exercise of
warrants and
options........ 827,091
Common stock
issued......... 4,084
Issuance of
common stock
for domain name
purchase....... 1,250,000
Exercise of
dilution
rights......... --
Forgiveness of
note receivable
from
stockholder.... 1,175,780
Collection of
note receivable
from
stockholder.... 3,360,000
Recapitalization
(Note 8)....... (10,828,894)
Net loss........ (41,279,007)
--------------
Balance at
December 31,
1999........... 97,499,656
Stock issued for
acquisitions... 13,282,852
Conversion of
preferred stock
to common
stock.......... 36,565,397
Exercise of
options........ 437,467
Issuance of
common stock
warrants and
options........ 12,878
Amortization of
deferred
compensation... 1,693,913
Cancellation and
revaluation of
common stock
warrants....... (670,817)
Common stock
issued for
services....... 937,500
Common stock
issued under
employee stock
purchase plan.. 54,282
Deferred
compensation
adjustment for
terminated
employees...... --
Forgiveness of
note receivable
from
stockholder.... 87,500
Net loss........ (126,496,233)
--------------
Balance at
December 31,
2000........... $ 23,404,395
==============
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
HEALTHCENTRAL.COM
CONSOLIDATED STATEMENTS OF CASH FLOWS
[Download Table]
Years Ended December 31,
----------------------------------------
2000 1999 1998
------------- ------------ -----------
Cash flows from operating activities:
Net loss............................ $(126,496,233) $(41,279,007) $(1,784,695)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Common stock issued for services.... -- 62,500 2,429
Stock compensation expense.......... 1,884,273 6,245,822 104,641
Depreciation and amortization....... 17,253,459 4,384,989 218,403
Acquired in-process research and
development........................ -- 804,525 --
Loss on disposal of property........ 343,426 32,568 --
Amortization of prepaid contracts... 965,725 373,884 --
Stock issued for termination of
contracts.......................... 937,500 -- --
Write-off of intangible assets and
website development costs.......... 44,253,982 -- --
Changes in assets and liabilities:
Accounts and other receivables..... (2,070,060) (417,366) (32,749)
Prepaid expenses and other assets.. 1,514,928 (2,643,953) (176,376)
Inventory.......................... (248,585) (2,858,812) (940,242)
Accounts payable................... 2,361,814 5,373,302 520,554
Accrued expenses................... 1,332,468 272,189 98,374
Deferred revenue and other current
liabilities....................... 868,693 (30,897) 109,597
------------- ------------ -----------
Net cash used in operating
activities....................... (57,098,610) (29,680,256) (1,880,064)
------------- ------------ -----------
Cash flows from investing activities:
Purchase of property and equipment.. (6,159,784) (3,723,868) (990,300)
Proceeds from sale of property and
equipment.......................... 21,121 1,625 --
Cash paid in connection with
acquisitions, net of cash received. (3,340,339) (6,169,405) --
Cash paid for domain name........... -- (290,583) --
Payments to related party........... (2,157,398) (2,302,901) (563,541)
------------- ------------ -----------
Net cash used in investing
activities....................... (11,636,400) (12,485,132) (1,553,841)
------------- ------------ -----------
Cash flows from financing activities:
Proceeds from issuance of
mandatorily redeemable convertible
preferred stock.................... -- 23,266,584 --
Proceeds from issuance of
convertible preferred stock........ -- 18,315,065 1,935,025
Payments on capital leases.......... (1,167,080) (174,148) (124,005)
Proceeds from issuance of notes
payable............................ -- 1,500,000 --
Proceeds from warrant exercises..... -- 809,991 --
Collection of notes receivable from
stockholders....................... -- 3,360,000 --
Proceeds from issuance of common
stock.............................. 420,382 74,675,921 5,600,000
------------- ------------ -----------
Net cash (used in) provided by
financing activities............. (746,698) 121,753,413 7,411,020
------------- ------------ -----------
Net (decrease) increase in cash and
cash equivalents.................... (69,481,708) 79,588,025 3,977,115
Cash and cash equivalents at
beginning of year................... 83,690,072 4,102,047 124,932
------------- ------------ -----------
Cash and cash equivalents at end of
year................................ $ 14,208,364 $ 83,690,072 $ 4,102,047
============= ============ ===========
Supplemental disclosures of cash flow
information:
Cash paid for interest.............. $ 291,186 $ 173,043 $ 37,065
Supplemental disclosures of non-cash
investing and financing activities:
Deferred stock compensation adjusted
for terminations................... $ (1,666,003) $ 9,661,178 $ 389,122
Warrants and options issued in
connection with agreements......... 12,878 1,496,153 --
Cancellation of warrants issued in
connection with agreements......... (57,177) -- --
Conversion of preferred stock to
common stock....................... 36,565,397 -- --
Common stock purchased with notes
receivables........................ -- 459,526 3,365,931
Stock warrants issued in connection
with sale of preferred stock....... -- 301,317 408,629
Issuance of stock in connection with
acquisitions and purchase of
assets............................. 13,282,854 39,239,671 --
Payment of note payable with
preferred stock.................... -- 1,500,000 --
Forgiveness of note from
stockholder........................ (431,495) (1,175,780) --
Preferred stock dividends........... -- 22,275,542 --
Assets acquired under capital
leases............................. 35,612 375,225 138,314
Remeasurement of stock options and
warrants........................... (772,666) -- --
The accompanying notes are an integral part of these consolidated financial
statements
F-8
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. The Company and Summary of Significant Accounting Policies
The Company
HealthCentral.com (the "Company") was incorporated in California on August
12, 1996, and reincorporated in Delaware in 1999. The Company commenced
operations in 1998 and is a leading provider of online healthcare related e-
commerce and content to consumers through the Company's network of websites
which include WebRx.com, Vitamins.com, HealthCentral.com, RxList.com,
DrugEmporium.com and ComfortLiving.com, and through the Company's Vitamins.com
mail order and retail operations. In addition, the Company designs, hosts and
maintains healthcare institutions' websites for healthcare content and e-
commerce. The Company emerged from the development stage in 1999 and operates
in three business segments.
The Company has a limited operating history and its prospects are subject
to the risks, expenses and uncertainties frequently encountered by companies
in the new and rapidly evolving markets for Internet products and services.
These risks include the failure to develop and extend the Company's on-line
brands, the rejection of the Company's services by Internet consumers, vendors
and/or advertisers, the inability of the Company to maintain and increase the
levels of traffic on its on-line services, as well as other risks and
uncertainties. In the event that the Company does not successfully implement
its business plan, certain assets may not be recoverable. (See Note 2.)
On June 16, 2000, the Company completed the acquisition of Vitamins.com,
Inc. ("Vitamins.com") (formerly Vitamin Superstore, LLC, which converted to a
C corporation in August 1999), in a business combination that was accounted
for as a pooling of interests. The Company's consolidated financial statements
and the accompanying notes reflect the Company's financial position and the
results of operations as if Vitamins.com was a wholly owned subsidiary of the
Company for all periods presented.
Vitamins.com is a retailer that provides dietary supplements, related
health and wellness products and information to consumers. The Company
acquired Vitamins.com for consideration consisting of 22,432,801 shares of the
Company's common stock. Acquisition and related costs approximated $2.5
million. Each share of Vitamins.com stock was exchanged for 0.387 shares of
HealthCentral.com common stock. Vitamins.com will remain a wholly owned
subsidiary of HealthCentral.com. The transaction was recorded using the
pooling of interest method of accounting and was a tax-free reorganization
under Section 369 of the Internal Revenue Code of 1986, as amended.
Revenues and net losses included in the consolidated statement of
operations of HealthCentral.com and Vitamins.com (as adjusted to conform
Vitamins.com's accounting policies to those of the Company) prior to the
pooling of interest transaction are as follows:
[Download Table]
Three Months Years Ended December 31,
Ended -------------------------
March 31, 2000 1999 1998
-------------- ------------ -----------
Revenues:
HealthCentral.com.............. $ 1,301,655 $ 1,188,753 $ 15,259
Vitamins.com................... 9,235,216 17,041,760 4,340,297
------------ ------------ -----------
$ 10,536,871 $ 18,230,513 $ 4,355,556
============ ============ ===========
Net loss:
HealthCentral.com.............. $(23,247,640) $(22,999,386) $ (446,235)
Vitamins.com................... (6,773,859) (18,279,621) (1,338,460)
------------ ------------ -----------
$(30,021,499) $(41,279,007) $(1,784,695)
============ ============ ===========
F-9
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Principles of consolidation and basis of presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Cash and cash equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. At December 31, 2000
and 1999, the Company maintained its cash and cash equivalents in bank
accounts in amounts which, at times, exceed federally insured limits. Cash
equivalents consist primarily of corporate bonds and money market auction
instruments with maturities of three months or less for which the carrying
value approximated fair value. The cost of these investments at December 31,
2000 and 1999 was $5,979,000 and $69,942,000, respectively.
Inventory
The Company's inventory, which consists primarily of finished goods, is
priced at the lower of cost or market. The Company uses the weighted-average
method of inventory costing.
Property and equipment
Property and equipment are recorded at cost. Depreciation and amortization
are computed on a straight-line basis over the estimated useful lives of the
assets, as follows:
[Download Table]
Computer equipment and software.................................. 3-5 years
Equipment........................................................ 3-5 years
Furniture and fixtures........................................... 5-7 years
The Company accounts for website development costs in accordance with the
AICPA Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use and Emerging Issues Task
Force, and ("EITF") Issue No. 00-02, Accounting For Website Development Costs.
Website development costs consist of external and internal costs incurred to
purchase and implement the website software, and significant enhancements
thereto, used in the Company's business. These costs are capitalized and
amortized using the straight-line method over the estimated life of the asset.
Internal and external costs of developing website content are expensed as
incurred and included in content and product development expense.
Leasehold improvements are amortized on a straight-line basis over the life
of the lease, or the useful life of the assets, whichever is shorter.
Maintenance and repairs are charged directly to expense as incurred.
Impairment of long-lived assets
The Company assesses the impairment of identifiable intangibles and related
goodwill periodically in accordance with the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 121, Accounting
F-10
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of. The Company also assesses the impairment of enterprise level
goodwill periodically in accordance with the provision of Accounting
Principles Board (APB) Opinion No. 17, Intangible Assets. An impairment review
is performed whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors the Company considers important
which could trigger an impairment review include, but are not limited to,
significant underperformance relative to expected historical or projected
future operating results, significant changes in the manner of use of the
acquired assets or the strategy for the Company's overall business,
significant negative industry or economic trends, a significant decline in the
Company's stock price for a sustained period, and market capitalization
relative to net book value. When the Company determines that the carrying
value of goodwill may not be recoverable based upon the existence of one or
more of the above indicators of impairment, the Company measures any
impairment based on a projected discounted cash flow method using a discount
rate commensurate with the risk inherent in its current business model.
Goodwill and intangible assets
Goodwill and intangibles assets are carried at cost, less accumulated
amortization and any impairment write-offs, and are amortized on a straight-
line basis over their estimated useful lives as follows:
[Download Table]
Goodwill................... 2 to 20 years
Core technology............ 2 years
Acquired workforce......... 2 to 4 years
Contracts.................. 2 years
Tradenames................. 2 to 7 years
Customer lists............. 3 to 6 years
Domain name................ 4 to 10 years
Comprehensive income
The Company adopted the provisions of SFAS No. 130, Reporting Comprehensive
Income. The Company classifies items of other comprehensive income by their
nature in the financial statements and displays the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of the consolidated balance sheets. To
date, the Company has not had any transactions that are required to be
reported in comprehensive income.
Revenue recognition
e-Commerce and other product sales are recognized for over-the-counter
health and beauty aid products and dietary supplements, net of discounts, when
products are shipped to customers or sold through our retail stores. Net sales
include outbound shipping and handling fees charged to customers. Prior to
September 2000, the Company recognized commission revenue for the use of the
website related to sales made by Medi-Mail for prescription drugs. However,
the acquisition of DrugEmporium.com enabled the Company to sell and ship
prescription drugs directly to consumers. Accordingly, beginning in September
2000, the Company began to recognize gross revenues from the sale of
pharmaceutical products. Revenue also includes the wholesale revenue from the
sale of "Dr. Dean Edell Eyewear" brand eyeglasses to the Company's brick-and-
mortar distribution partner. All revenues are recognized, net of allowances
for product returns, promotional discounts and coupons, at the time the
products are shipped to the customer for e-commerce sales and at the point of
sale for retail stores. The Company is responsible for all refunds relating to
all sales where a customer is not satisfied with the products received. The
Company records an estimated allowance for such returns in the period of sale
and also retains the credit risk for all sales.
F-11
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Advertising revenues are recognized in the period the advertising
impressions are delivered to customers. The Company uses an outside vendor to
solicit customers to use the Company's advertising services, to serve the ads
to the Company's website and to bill and collect for these services. This
outside vendor provides monthly reports indicating the impressions delivered,
the amounts billed for advertising services and the related administrative
fee. The Company recognizes advertising revenues, as reported by the outside
vendor, net of this administrative fee, as the Company bears no collection
risk for the gross amount of the advertising fees. The advertising contracts
do not guarantee a minimum number of impressions to be delivered. The Company
also enters into sponsorship agreements and provides customers with enhanced
promotional opportunities and co-branded web pages.
Content and other revenues are derived from contracts with healthcare
providers, health product resellers, and third party organizations and
principally consist of license fees for website development applications,
consulting fees from custom website development and hosting, and maintenance
fees related to the websites' maintenance. The Company recognizes software
license revenue under SOP 97-2, Software Revenue Recognition, and SOP 98-9,
Modifications of SOP 97-2, Software Revenue Recognition, with Respect to
Certain Transactions. When contracts contain multiple elements and vendor-
specific objective evidence exists for all undelivered elements, the Company
accounts for the delivered elements in accordance with the "Residual Method"
prescribed by SOP 98-9. For consulting projects, revenues are recognized at
the time services are rendered based on charges for time and materials.
Deferred revenues represent the amount of cash received or services performed
and billed prior to revenue recognition.
During the year ended December 31, 2000, the Company adopted Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. The adoption of SAB 101 did not impact the Company's financial
position or results of operations.
Content and product development expense
Content and product development expenses consist primarily of salaries and
benefits, consulting fees and other costs related to content acquisition and
licensing, software development, application development and website
operations.
SFAS No. 86, Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed, requires capitalization of certain software
development costs subsequent to the establishment of technological
feasibility. To date, costs incurred following the establishment of
technological feasibility, but prior to general product release, have been
insignificant.
Advertising expenses
Internet advertising expenses are recognized based on the terms of the
individual agreements, but generally over the greater of the ratio of the
number of impressions received over the total number of contracted
impressions, or on a straight-line basis over the term of the contract.
Advertising expenses for the years ended December 31, 2000, 1999 and 1998 were
$30,965,566, $15,232,965 and $324,051, respectively, and have been included in
sales and marketing expense in the consolidated statements of operations.
Shipping and fulfillment
Fulfillment costs include the external fulfillment fee charged by our third
party fulfillment partner and the internal cost of operating and staffing the
distribution center. Shipping and fulfillment expenses for the years ended
December 31, 2000 and 1999 were $5,231,197 and $1,584,076, respectively, and
have been included in sales and marketing expense in the consolidated
statements of operations. There were no shipping and fulfillment expenses in
1998.
F-12
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Store openings
All costs of a noncapital nature incurred in opening a new store are
charged to expense as incurred.
Net loss per share
The Company computes net loss per share in accordance with SFAS No. 128,
Earnings per Share. Basic and diluted net loss per share are computed by
dividing the net loss available to holders of common stock for the period by
the weighted average number of shares of common stock outstanding during the
period. The calculation of diluted net loss per share excludes potential
common stock if their effect is antidilutive. Potential common stock consists
of restricted common stock, convertible preferred stock and incremental common
shares issuable upon the exercise of stock options and warrants. The net loss
per share for the year ended December 31, 1999 includes the weighted average
effect of 5,050,955 shares of convertible preferred stock that converted into
common shares on a one-to-one basis upon completion of the Company's initial
public offering in December 1999. The net loss per share for the year ended
December 31, 2000 includes the weighted average effect of 17,411,710 shares of
mandatorily redeemable convertible preferred stock that converted into common
stock at a ratio of .387 at the time of the merger with Vitamins.com.
The following table sets forth potential shares of common stock that are
not included in the computation of diluted net loss per share attributable to
common stockholders because to do so would be antidilutive for the periods
indicated:
[Download Table]
December 31,
------------------------------
2000 1999 1998
--------- ---------- ---------
Convertible preferred stock................. 480,000 17,411,710 1,012,500
Convertible preferred stock warrants........ 12,249 12,249 486,000
Convertible common stock warrants........... -- 73,896 --
Common stock options........................ 5,010,432 3,219,883 274,718
Common stock subject to repurchase.......... -- 312,500 17,937
--------- ---------- ---------
5,502,681 21,030,238 1,791,155
========= ========== =========
The restricted shares subject to repurchase are excluded from the
calculation of basic and diluted earnings per share attributable to common
stockholders until the restrictions lapse.
Income taxes
Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax basis of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to affect taxable income. Valuation allowances are established when necessary
to reduce deferred tax assets to the amounts expected to be realized.
Concentration of credit risk
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash equivalents and accounts
receivable. The Company's accounts receivable are derived from revenues earned
from customers located in the United States. The Company performs ongoing
credit evaluations of its customers' financial condition and, generally,
requires no collateral from its customers. The Company generally does not
extend credit to customers of e-commerce, except through the use of third-
party credit cards. Credit under these accounts is extended by third parties,
and accordingly, the Company bears no financial risk under these agreements
except in the case of fraud. Approximately 69% of the Company's accounts
receivables balance
F-13
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
reflect amounts due from the sale of the Dr. Dean Edell brand eyewear to Cable
Car Eyewear, which accounted for 11% of the Company's total revenue for the
year ended December 31, 2000. The Company maintains an allowance for doubtful
accounts receivable based upon the expected collectibility of these balances.
Financial instruments
Carrying amounts of certain of the Company's financial instruments,
including cash and cash equivalents, accounts receivable, prepaid expenses,
accounts payable, accrued liabilities, note payable and capital leases
approximate fair value due to their short maturities.
Stock options
The Company accounts for employee stock compensation arrangements in
accordance with provisions of APB No. 25, Accounting for Stock Issued to
Employees, and complies with the disclosure provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. Under APB No. 25, stock compensation
is based on the difference, if any, on the date of grant, between the
estimated fair value of the Company's common stock and the exercise price. In
July 2000, the Company adopted Financial Accounting Standards Board ("FASB")
Interpretation ("FIN") No. 44, Accounting for Certain Transactions Involving
Stock Compensation, an Interpretation of APB Opinion No. 25. FIN No. 44
clarifies the application of Opinion 25 for (a) the definition of an employee
for purposes of applying Opinion 25, (b) the criteria for determining whether
a plan qualifies as a non-compensatory plan, (c) the accounting consequence of
various modifications to the terms of a previously fixed stock option or
award, and (d) the accounting for an exchange of stock compensation awards in
a business combination. Deferred stock compensation is amortized in accordance
with FIN No. 28. The Company accounts for stock issued to non-employees in
accordance with the provisions of SFAS No. 123 and EITF Issue No. 96-18,
Accounting for Equity Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling Goods or Services.
Recent accounting pronouncements
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivatives and
Hedging Activities. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. In July 1999, the
FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133. SFAS No.
137 deferred the effective date of SFAS No. 133 until fiscal years beginning
after June 15, 2000. The Company will adopt SFAS No. 133 during fiscal 2001.
To date, the Company has not engaged in derivative or hedging activities.
Note 2. Need For Additional Financing and Nasdaq Listing
The Company has sustained net operating losses and negative cash flows from
operations since its inception. Further, the Company has experienced
substantial increases in expenditures consistent with its growth in operations
and personnel, both internally and through multiple acquisitions. These
matters raise substantial doubt about the Company's ability to continue as a
going concern. The accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty. The
Company has previously financed operations through the issuance of preferred
stock, the issuance of notes payable, an initial public offering completed in
December 1999 for $74.7 million in cash and through capital leases. Since the
Company's current cash and cash equivalents are insufficient to satisfy its
liquidity requirements beyond approximately mid 2001, the Company is seeking
to issue additional equity or debt securities, obtain credit facilities from
lenders and/or sell certain assets.
F-14
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On January 4, 2001, the Company received a notification from the Nasdaq
that it has 90 days to comply with the minimum closing bid price per share
rule. Management is exploring alternative strategies to bring the Company back
into compliance with the listing requirements. Should these efforts be
unsuccessful, the Company's common stock could be delisted from the Nasdaq
National Market System.
Note 3. Balance Sheet Components
[Download Table]
December 31,
-----------------------
2000 1999
----------- ----------
Property and equipment:
Computer equipment and software................ $10,020,495 $2,565,898
Equipment...................................... 620,361 498,063
Furniture and fixtures......................... 2,136,119 1,568,415
Leasehold improvements......................... 1,878,816 1,478,570
Website development............................ 513,672 1,099,485
----------- ----------
15,169,463 7,210,431
Less: Accumulated depreciation and
amortization.................................. (3,483,598) (957,278)
----------- ----------
$11,685,865 $6,253,153
=========== ==========
Property and equipment includes approximately $6,904,000 and $1,097,000 of
computer equipment under capital leases at December 31, 2000 and 1999,
respectively. Accumulated depreciation of assets under capital leases totaled
approximately $967,000 and $245,000 at December 31, 2000 and 1999,
respectively.
[Download Table]
December 31,
-----------------------
2000 1999
---------- -----------
Intangible assets:
Goodwill........................................ $ 875,911 $42,895,500
Core technology................................. -- 1,615,573
Acquired workforce.............................. 700,000 357,829
Contracts....................................... -- 1,189,103
Tradenames...................................... 600,000 443,062
Customer lists.................................. 3,000,000 1,566,279
Domain name..................................... -- 1,540,583
Other........................................... -- 122,260
---------- -----------
5,175,911 49,730,189
Less: Accumulated amortization.................. (253,558) (3,657,220)
---------- -----------
$4,922,353 $46,072,969
========== ===========
During the fourth quarter ended December 31, 2000, the Company performed an
impairment analysis of the identifiable intangibles and enterprise level
goodwill recorded in connection with the acquisitions of Enterprise Web
Services, L&H Vitamins, Inc., HealthCentralRx.com, Inc., RxList.com,
DrugEmporium.com and the license agreement with Dr. Dean Edell. The analysis
was performed in response to the sustained decline in the Company's stock
price, the overall decline in the Internet industry growth rates, the excess
of the carrying value of the identifiable intangibles and goodwill over the
Company's market capitalization, and lower projected future operating results.
As a result of this review, a $39.1 million impairment charge was recorded to
eliminate all of the Company's identifiable intangibles and enterprise level
goodwill, except for the amounts recorded in December 2000 in connection with
our acquisition of certain assets of more.com, Inc. and its subsidiary,
Comfort
F-15
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Living, Inc. The charge was determined based upon the Company's estimated
future discounted cash flows using a discount rate of 30%. The assumptions
supporting the cash flows analysis, including the discount rate, were
determined using management's best estimates. The remaining goodwill and
identifiable intangibles at December 31, 2000 with a net book value of
approximately $4.9 million will be amortized over the remaining useful lives
of three to four years.
[Download Table]
December 31,
---------------------
2000 1999
---------- ----------
Accrued expenses:
Accrued compensation.............................. $ 229,006 $ 395,994
Accrued advertising............................... 1,769,910 455,314
Accrued vacation.................................. 258,704 97,470
Accrued taxes..................................... 294,868 104,287
Accrued professional fees......................... 824,809 775,126
Frequent buyer program liability.................. 86,412 320,994
Other accrued liabilities......................... 237,729 172,423
---------- ----------
$3,701,438 $2,321,608
========== ==========
Note 4. Acquisitions
Domain Name www.vitamins.com
In March 1999, Vitamin Superstore, LLC (the predecessor to Vitamins.com)
purchased the domain name www.vitamins.com (the "Domain Name"), the
Vitamins.com website, and copyrighted content available on that website.
Vitamins.com paid $290,583 in cash, which included direct costs of the
purchase of $40,583, and issued 193,774 shares of its common stock that were
valued at approximately $6.46 per share.
Enterprise Web Services
On May 6, 1999, the Company entered into a definitive merger agreement with
Enterprise Web Services (formerly Windom Health Enterprises, Inc.)
("Enterprise") and completed the merger on August 12, 1999. Enterprise is
engaged in offering institutions the ability to license specialized tools and
services to provide their members with personalized online health information
and health risk assessments.
This transaction was recorded using the purchase method of accounting. The
allocation of the aggregate purchase price to the tangible and identifiable
intangible assets acquired and liabilities assumed in connection with this
acquisition was based on estimated fair values as determined by management.
The allocation is summarized below:
[Download Table]
Goodwill...................................................... $10,751,000
Identifiable assets........................................... 842,000
Core technology............................................... 375,000
Acquired workforce............................................ 180,000
In-process research and development........................... 555,000
-----------
Total purchase price........................................ $12,703,000
===========
The total purchase price of $12.7 million consisted of cash of $51,000, a
note payable of $458,000, 2,104,770 shares of the Company's common stock
valued at $9,311,514, assumed liabilities of $2,868,457 and estimated
transaction costs of $65,000. The deemed value of the Company's common stock
on the date the definitive merger agreement was signed was $4.42 per share.
F-16
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The valuation of the purchased in-process research and development of
$555,000 was based on the result of an independent appraisal using the income
approach. The income approach estimates the value of the asset based on its
expected economic benefit. The valuation analysis considered the contribution
of the core technology as well as the percentage of completion of the in-
process research and development. The expected cash flows associated with the
in-process research and development were discounted to the present value using
a rate of return that is commensurate with the risk of the asset. The
purchased in-process technology was not considered to have reached
technological feasibility and had no alternative future use.
L&H Vitamins, Inc.
On August 16, 1999, Vitamins.com acquired L&H Vitamins, Inc., and its
affiliate for $5.6 million in cash, which included acquisition costs of
$230,000, and 891,583 and 1,527,167 shares of its common stock and mandatorily
redeemable convertible preferred stock, respectively, valued at $2.58 per
share. The purchase price was subsequently reduced based on L&H's adjusted net
worth, and Vitamins.com recorded the reduction of $554,000 as a purchase price
receivable. In addition, the former owners of L&H had been granted employment
agreements with Vitamins.com for a period of four years.
This transaction was recorded using the purchase method of accounting. The
allocation of the aggregate purchase price to the tangible and identifiable
intangible assets acquired and liabilities assumed in connection with this
acquisition was based on estimated fair values as determined by Vitamins.com.
The allocation is summarized below:
[Download Table]
Goodwill...................................................... $ 9,526,000
Identifiable net assets....................................... 168,000
Customer lists................................................ 1,566,000
Stock consideration........................................... (6,250,000)
Purchase price receivable..................................... 554,000
-----------
Total purchase price........................................ $ 5,564,000
===========
HealthCentralRx.com
On October 5, 1999, the Company acquired HealthCentralRx.com, Inc.
(formerly ePills.com). HealthCentralRx.com operates an online drug store that
provides retail sales of prescription pharmaceuticals, over-the-counter
products and health and beauty aids on the Internet.
This transaction was recorded using the purchase method of accounting. The
allocation of the aggregate purchase price to the tangible and identifiable
intangible assets acquired and liabilities assumed in connection with this
acquisition was based on the estimated fair values as determined by
management. The purchase price allocation is summarized below:
[Download Table]
Goodwill....................................................... $11,441,000
Identifiable assets............................................ 1,147,000
Contracts...................................................... 1,189,000
Core technology................................................ 1,241,000
Tradename...................................................... 443,000
Acquired workforce............................................. 177,000
In-process research and development............................ 250,000
-----------
Total purchase price......................................... $15,888,000
===========
F-17
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The total purchase price of $15.9 million consisted of 1,492,096 shares of
common stock valued at $13,533,000 based upon the deemed value of the
Company's common stock of $9.07 per share on the date the definitive merger
agreement was signed. The purchase price also included the assumption of
86,969 employee stock options valued at $6.11 per share, assumed liabilities
of $1,653,000 and transaction costs of $171,000.
The valuation of the purchased in-process research and development of
$250,000 was based on the result of an independent appraisal using the income
approach. The income approach estimates the value of the asset based on its
expected economic benefit. The valuation analysis considered the contribution
of the core technology as well as the percentage completion of the in-process
research and development. The expected cash flow associated with the in-
process research and development was discounted to the present value using a
rate of return that is commensurate with the risk of the asset. The purchased
in-process technology was not considered to have reached technological
feasibility and had no alternative future use.
RxList.com
On October 28, 1999, the Company acquired RxList.com. RxList.com maintains
a website that allows visitors to search for information regarding
prescription and other medications.
This transaction was recorded using the purchase method of accounting. The
allocation of the purchase price to the tangible and identifiable intangible
assets acquired and liabilities assumed in connection with this acquisition
was based on estimated fair values as determined by management. The purchase
price allocation is summarized below:
[Download Table]
Goodwill...................................................... $11,212,000
Net liabilities assumed....................................... (287,000)
Pharmaceutical database....................................... 123,000
-----------
Total purchase price........................................ $11,048,000
===========
The total purchase price of $11.0 million consisted of 836,422 shares of
the Company's common stock valued at $8,364,216, an aggregate of $2.6 million
in notes payable issued to RxList.com shareholders discounted at a deemed
interest rate of 10% over 6 months and transaction costs of $143,000. The
deemed value of the Company's common stock on the date the acquisition
agreement was signed was $10.00.
Dr. Dean Edell Licensing Agreement
On April 11, 2000, the Company acquired the exclusive licensing rights to
market and sell "Dr. Dean Edell Eyewear" through 2006. Payment for the product
license was $2.8 million in cash of which $1.4 million was paid to a related
party. Simultaneously, the Company entered into a license and distribution
agreement with Cable Car Eyewear for it to sell the Dr. Dean Edell Eyewear to
brick-and-mortar pharmacies and grocery chains. This agreement requires Cable
Car Eyewear to make minimum purchases of products during 2000 through 2006
starting at $5.0 million in 2000 and increasing each subsequent year to $7.2
million in 2006. The Company is in negotiations with the distributor regarding
changes to the existing agreement that may result in inventory values not
being realized. In addition, the Company entered into a supply agreement with
a vendor through 2006 to supply the Company with the Dr. Dean Edell Eyewear
products, and we are in negotiations with the supplier regarding changes to
the existing agreement.
DrugEmporium.com
On September 14, 2000, the Company consummated an asset purchase agreement
with DrugEmporium, Inc. and its online drugstore subsidiary, DrugEmporium.com.
Under the terms of the asset purchase agreement, the
F-18
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company acquired substantially all of the assets and assumed some liabilities,
primarily trade payables and hardware/software leases, of DrugEmporium.com in
exchange for the issuance of shares of the Company's non-voting preferred
stock, which does not carry a liquidation preference and which is convertible
into 2,400,000 shares of common stock. Drug Emporium, Inc. also has an
opportunity to receive additional shares of the Company's convertible
preferred stock, which do not carry a liquidation preference, if certain
revenue targets are met. In connection with this acquisition, the Company also
entered into a ten year services agreement with Drug Emporium, Inc., under
which the Company receives in-store promotional and advertising support and
access to Drug Emporium, Inc.'s electronic purchasing system and in-store
order pickup capabilities at certain Drug Emporium, Inc. retail stores. In
consideration of Drug Emporium, Inc.'s services, the Company will pay Drug
Emporium, Inc. a fee equal to 2% of sales, net of any fees for shipping and
handling.
This transaction was recorded using the purchase method of accounting. The
allocation of the aggregate purchase price to the tangible and identifiable
intangible assets acquired and liabilities assumed in connection with this
acquisition was based on the estimated fair values as determined by
management. The purchase price allocation is summarized below:
[Download Table]
Goodwill........................................................ $ 888,000
Identifiable assets............................................. 1,939,000
Contracts....................................................... 1,700,000
Customer list................................................... 1,100,000
Tradename....................................................... 870,000
Acquired workforce.............................................. 1,300,000
----------
Total purchase price.......................................... $7,797,000
==========
The total purchase price of $7.8 million consisted of 480,000 shares of
preferred stock, which are convertible into 2.4 million shares of common
stock, valued at $7,274,880 based upon the fair market value of the Company's
common stock of $3.0312 per share on the date the asset purchase agreement was
signed. The purchase price also included transaction costs of $522,316.
Comfort Living, Inc. and certain assets of more.com, Inc.
On October 23, 2000, the Company entered into an asset purchase agreement
with more.com, Inc. and Comfort Living, Inc. Under the terms of the asset
purchase agreement, the Company acquired all of the assets and properties and
assumed certain liabilities associated with more.com's Comfort Living
subsidiary, including its website, inventory and a leased 18,000 square foot
warehouse and distribution center in Gaithersburg, Maryland. The Company also
acquired all of more.com's trademarks, tradenames, websites and customer lists
in exchange for the issuance of 5,002,525 shares of the Company's common
stock, valued at $1.233 per share. The total purchase price approximates $6.3
million, including transaction costs. The transaction was completed on
December 14, 2000. The Company accounted for the acquisition using the
purchase method of accounting.
The allocation of the aggregate purchase price to the tangible and
identifiable intangible assets acquired and liabilities assumed in connection
with this acquisition was based on the estimated fair values as determined by
management. The purchase price allocation is summarized below:
[Download Table]
Identifiable assets ............................................ $1,099,000
Goodwill ....................................................... 876,000
Customer list .................................................. 3,000,000
Tradename ...................................................... 600,000
Acquired workforce ............................................. 700,000
----------
Total purchase price.......................................... $6,275,000
==========
F-19
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following unaudited pro forma financial information presents the
consolidated results of operations as if the acquisitions had occurred at the
beginning of each period, and includes adjustments for amortization of
intangibles. This pro forma financial information is not intended to be
indicative of future results. Unaudited pro forma consolidated results of
operations are as follows (in thousands, except per share data):
[Download Table]
Years Ended December 31,
--------------------------
2000 1999
------------ ------------
Revenues...................................... $ 69,023 $ 40,750
Net loss attributable to common stockholders.. (195,600) (145,640)
Basic and diluted net loss per share
attributable to common stockholders.......... (5.24) (13.00)
Note 5. Related Party Transactions
In April 1999, the Company borrowed $500,000 in the form of convertible
notes from a related party. The notes bore interest at 4.99% per annum. In
August 1999, the notes were canceled upon the issuance of 96,153 shares of the
Company's Series B convertible preferred stock at $5.20 per share. In August
1999, the Company borrowed an additional $300,000 under the same agreement.
The new notes bore interest at the rate of ten percent per annum. In
connection with this additional borrowing the Company issued warrants to
purchase 8,333 shares of the Company's Series B convertible preferred stock at
an exercise price of $3.60 per share. The warrants expire at the earlier of
(a) August 2002, (b) the closing of an acquisition or (c) the effective date
of the Company's initial public offering. The Company valued the warrants
using the Black-Scholes option pricing model using an expected life of two
years, a weighted average risk-free rate of 5.76%, an expected divided yield
of zero percent, a volatility of 70% and a deemed value of the common stock of
$7.39 per share. The estimated fair value of the warrants of $39,008 was
amortized over the period of the borrowing agreement and included within
interest expense in the statement of operations until the notes were canceled
in August 1999 upon the issuance of 57,691 shares of the Company's Series B
convertible stock at $5.20 per share. In December 1999 the warrants were
exercised and 8,333 shares of the Company's common stock were issued.
In July 1999, the Company borrowed $100,000 from an officer in the Company
pursuant to a convertible promissory note. The note bears interest at the rate
of ten percent per annum. In August 1999, the note was canceled upon the
issuance of 19,230 shares of the Company's Series B convertible preferred
stock at $5.20 per share.
In July 1999, the Company borrowed an aggregate of $600,000 from four
stockholders in the form of promissory notes. The notes bear interest at the
rate of ten percent per annum. In connection with these notes, the Company
issued warrants to purchase an aggregate of 16,664 shares of the Company's
common stock at $3.60 per share. The warrants expire upon the earliest of (a)
July 1, 2003, (b) the closing of an acquisition, or (c) immediately prior to
the effective date of the Company's registration statement under the
Securities Act of 1933 with respect to an initial public offering. The Company
valued the warrants using the Black-Scholes option pricing model, applying an
expected life of four years, a weighted average risk-free rate of 5.7%, an
expected dividend yield of zero percent, a volatility of 70% and deemed values
of common stock of $6.07 and $6.92 per share. The estimated fair value of the
warrants of $64,017 was amortized over the period the notes became exercisable
and included within interest expense in the statement of operations. In August
1999, the notes were canceled upon the issuance of 115,383 shares of the
Company's Series B convertible preferred stock at $5.20 per share. In December
1999, the warrants were exercised and 16,664 shares of the Company's common
stock were issued.
In August 1999, the Company and Enterprise Web Services entered into a
joint development agreement with Global Health Initiatives, Inc. ("GHI"). A
member of the Board of Directors of the Company is also an officer of GHI. As
of December 31, 1999, GHI completed one project for the Company at a cost of
$37,338. Also, in September 1999, the Company subleased a portion of its
offices to GHI. Rent under the lease was $1,250 per
F-20
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
month. The original lease term expired on October 31, 1999 at which time the
lease was converted to a month-to-month basis. The joint development agreement
was terminated on February 29, 2000.
Note 6. Convertible Preferred Stock
Preferred stock dividend
In August 1999, the Company sold 4,038,455 shares of Series B convertible
preferred stock at $5.20 per share, for total cash proceeds to the Company of
approximately $21 million. The difference between the sales price and the
deemed value per share of the common stock on the transaction date resulted in
a beneficial conversion feature in the amount of $11.4 million. The beneficial
conversion feature has been reflected as a preferred stock dividend in the
statement of operations in the year ended December 31, 1999.
Warrants for convertible preferred stock
In connection with the sale of Series A convertible preferred stock in
December 1998, the Company issued warrants for 486,000 shares of Series A
convertible preferred stock at an exercise price of $2.00 per share. The
Company valued the warrants using the Black-Scholes option pricing model,
applying an expected life of five years, a weighted average risk-free rate of
4.36%, an expected dividend yield of zero percent, a volatility of 70% and a
deemed value of common stock of $1.52 per share. The estimated fair value of
the warrants of $408,629 has been netted against the proceeds of the offering.
In December 1999 the warrants were exercised and 463,089 shares of the
Company's common stock were issued.
In May 1999, in connection with entering into facility leases, the Company
issued an aggregate of 12,249 Series A convertible preferred stock warrants at
an exercise price of $2.00 per share. The warrants expire at the earlier of
(a) two years following the closing of an initial public offering, or (b) May
2009. The Company valued the warrants using the Black-Scholes option pricing
model, applying an expected life of ten years, a weighted average risk free
rate of 5.39%, an expected dividend yield of zero percent, a volatility of 70%
and a deemed value of common stock of $4.59 per share. The fair value of the
warrants of $49,372 is being amortized over the period of the leases.
In August, 1999, in connection with investment banking services provided
during the Series B preferred stock offering, the Company issued warrants to
purchase an aggregate of 69,231 shares of Series B preferred stock at an
exercise price of $5.20 per share. The warrants were exercised in December
1999. The Company valued the warrants using the Black-Scholes option pricing
model, applying an expected life of two years, a weighted average risk-free
rate of 5.74%, an expected dividend yield of zero percent, a volatility of 70%
and a deemed value of common stock of $7.95. The estimated fair value of the
warrants of $301,317 was netted against the proceeds from the offering. In
December 1999 the warrants were exercised and 36,503 shares of the Company's
common stock were issued.
Vitamins.com mandatorily redeemable convertible preferred stock
Vitamins.com, the Company's wholly owned subsidiary, had authorized the
issuance of Series A preferred, Series B preferred and Series C preferred
stock (together, the "Vitamins.com preferred stock"). Each share of the
Vitamins.com preferred stock is convertible, at any time, at the option of the
holder into one share of Vitamins.com common stock. On June 16, 2000, pursuant
to the acquisition of Vitamins.com by HealthCentral.com, all outstanding
shares of convertible preferred stock of Vitamins.com were converted to shares
of HealthCentral.com common stock.
F-21
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Drug Emporium, Inc. preferred stock
Under the terms of the asset purchase agreement with DrugEmporium, Inc. and
its online drugstore subsidiary, DrugEmporium.com, the Company issued 480,000
shares of its non-voting Series A preferred stock to Drug Emporium, Inc. The
preferred stock does not carry a liquidation preference and is convertible
into 2,400,000 shares of common stock . The Series A Preferred Stock has the
following conversion rights:
--Each share of the preferred stock is convertible, at any time, at the
option of the holder into five shares of fully paid and non-assessable
HealthCentral.com common stock, or
--Each share of the preferred stock may be automatically converted into
five shares of fully paid and non-assessable HealthCentral.com common
stock upon either (a) the occurrence of an average closing price of the
Company's common stock on the Nasdaq Stock Market equal to at least $9.00
for ten consecutive trading days or (b) the written consent of the
holders of a majority of the outstanding shares of Series A preferred
stock.
Drug Emporium Inc. also has an opportunity to receive additional shares of
the Company's convertible preferred stock, which does not carry a liquidation
preference, if certain revenue targets are met.
In addition, the holders of the Series A preferred stock are entitled to
receive noncummulative dividends, when and if declared by the Board of
Directors of the Company. The holders of Series A preferred stock are entitled
to participate in dividends on common stock, when and if declared by the Board
of Directors, based on the number of shares of common stock held on an as-if
converted basis. No dividends on convertible preferred stock or common stock
have been declared by the Board from inception through December 31, 2000.
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, the assets of the Company shall be
distributed to the holders of the common stock and to the holders of the
Series A preferred stock pro rata based upon the number of shares of common
stock held by each holder (assuming conversion into common stock of all
outstanding shares of Series A preferred stock.)
Note 7. Common Stock
HealthCentral.com
In April 1999, in connection with a content license agreement, the Company
issued a warrant to purchase 73,896 shares of the Company's common stock at an
exercise price of $6.50 per share. The warrant is exercisable at the earlier
of a) May 2002, b) the one year anniversary of an initial public offering, c)
the sale of 50% of the Company's equity, or d) the date of termination of the
content license agreement or the date in which all of the Company's material
is removed from the website according to the agreement. The Company valued the
warrant using the Black-Scholes option pricing model, applying an expected
life of three years, a weighted average risk-free rate of 5.40%, an expected
dividend yield of zero percent, an expected volatility of 80% and a deemed
value of common stock of $4.97 per share. The fair value of the warrant of
$155,301 was amortized over the period of the content license agreement and is
included in content and product development expense in the statement of
operations. In June 2000, a new contract was signed that cancelled the
outstanding warrants.
In June 1999, the Company granted an officer immediately exercisable
options to purchase an aggregate of 312,500 shares of common stock at an
exercise price of $1.28 per share. In July 1999, in connection with the
exercise of these options, the officer issued a promissory note in the amount
of $400,000 bearing interest at the rate of 5.74% per annum, due upon the
earlier of July 12, 2003 or the termination of employment. On November 13,
2000, the Company and the officer entered into an agreement to provide for the
repurchase by the Company of 312,500 shares of the Company's common stock (the
"Shares") for a purchase price of $1.381 per share, or an aggregate amount of
$431,500. The purchase price was paid by cancellation of two promissory notes
F-22
HEALTHCENTRAL.COM
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
executed for the aggregate principal amount of $400,000 and accrued interest
of $31,500. In connection with the repurchase, the Company recognized a
compensation expense of $118,995 for the difference between the fair value of
the common stock on November 13, 2000 and the amount paid for the common
stock. The officer was granted 447,000 additional options in November 2000, of
which 312,500 will be subject to variable accounting in accordance with FIN
No. 44.
The Company has reserved 7,378,751 shares of common stock at December 31,
2000 for future issuance in connection with stock options and warrants.
Vitamins.com
Vitamin Superstore, LLC (the "LLC") was initially formed as a limited
liability company in 1995. In August 1999, the LLC became a wholly owned
subsidiary of Vitamins.com, which was formed at that time as a C corporation
(the "Recapitalization"). To effect the Recapitalization, all member interests
and rights to acquire member interests in the LLC were exchanged for common
stock, options to acquire common stock and convertible preferred stock of
Vitamins.com. Each stockholder received approximately 0.66 shares of preferred
stock together with every share of common stock issued by Vitamins.com. Though
the preferred stock was issued as an integral part of the transfer of the
interests in the LLC to Vitamins.com, for financial reporting purposes the
issuance of the preferred stock was accounted for as a noncash dividend in the
amount of $10,828,894. All share and per share amounts in these consolidated
financial statement have been retroactively restated to reflect the
recapitalization.
In 1997, the LLC's wholly owned subsidiary, Vitamins.com, entered into a
subscription agreement (the "First Subscription Agreement") to issue 71,538
units of LLC member interests in return for the assignment to Vitamins.com of
a note valued at $1,175,780 including interest. The assignor of the note was
an existing member of the LLC. The First Subscription Agreement contained a
redemption right whereby, at any time from March 7, 1999, to March 7, 2005,
Vitamins.com could repurchase the shares issued under the Subscription
Agreement for $1,153,800 plus 8 percent per annum. In 1999, Vitamins.com
distributed the note to its maker as a distribution with respect to the
member's capital account in Vitamins.com. For financial reporting purposes,
the transfer of the note was reflected as a period expense in the amount of
$1,175,780, included in stock compensation expense for the year ended December
31, 1999. The First Subscription Agreement was effectively terminated in
August 1999 as a result of the acquisition by Vitamins.com of all the
interests in the LLC.
Note 8. Stock Option Plan
1998 Stock Plan
In August 1998, the Company adopted the 1998 Stock Option Plan (the "1998
Plan"). The 1998 Plan provides for the granting of stock options to employees
and consultants of the Company. Options granted under the 1998 Plan may be
either incentive stock options or nonqualified stock options. Incentive stock
options ("ISO") may be granted only to employees (including officers and |