DRUGSTORE COM INC (Form Type: 8-K, Filing Date: 12/28/2009)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):

On December 27, 2009, drugstore.com, inc., a Delaware corporation, and Silk Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of drugstore.com, entered into a definitive Agreement and Plan of Merger with Salu, Inc., a Delaware corporation, certain of the principal stockholders of Salu, and a representative of all stockholders of Salu.

Upon the terms and subject to the conditions of the merger agreement, Silk Acquisition Corp. will merge with and into Salu, with Salu surviving as a subsidiary of drugstore.com. At the effective time of the merger, drugstore.com will acquire all of the outstanding capital stock of Salu.

Pursuant to the merger agreement, the stockholders of Salu (other than holders of dissenting shares) will receive an initial payment of approximately $36 million, consisting of $18 million cash (less certain transaction expenses and the amount of financial debt (net of cash and cash equivalents), and subject to a net working capital adjustment) and drugstore.com common stock with an aggregate value of approximately $18 million. Of this initial consideration, approximately $2.7 million in cash and $2.7 million in drugstore.com common stock will be paid into escrow to secure post-closing indemnification obligations of the stockholders. Additionally, certain senior management of Salu will be eligible to receive a performance incentive payment payable in cash over a two-year period commencing in fiscal year 2010 with an aggregate value of up to $2.5 million based on the achievement of certain performance targets and integration milestones. The merger agreement provides that any options to acquire Salu common stock that are not exercised as of the effective time of the merger shall be cancelled.

The merger agreement contemplates that drugstore.com will submit to the California Commissioner of Corporations an application for a permit pursuant to Sections 25121 and 25142 of the California Corporate Securities Law of 1968 so that, if approved, the issuance of drugstore.com common stock as part of the merger consideration would be exempt from registration under federal securities laws by virtue of the exemption provided by Section 3(a)(10) of the Securities Act of 1933, as amended.

drugstore.com and Salu have agreed to customary representations, warranties and covenants in the merger agreement, including, among others, pre-closing covenants by Salu to carry on its business in the ordinary course consistent with past practices and not to engage in certain kinds of transactions without the consent of drugstore.com. The merger agreement contains provisions designed to cause the transactions contemplated thereby to qualify as a tax-free exchange to Salu stockholders with respect to the stock portion of the merger consideration.

The completion of the merger is subject to customary closing conditions, including, among others, that neither drugstore.com nor Salu shall have experienced a material adverse effect (as defined in the merger agreement). The merger agreement also contains certain termination rights for both drugstore.com and Salu.

The boards of directors of drugstore.com and Salu have unanimously approved the Merger Agreement.

James O. Steeb, CEO of Salu, is the beneficial owner of approximately 7.7% percent of Salu’s capital stock (on an as-converted basis).

The merger agreement also includes various other provisions customary for transactions of this nature. The foregoing is a summary of the material provisions of the merger agreement. This summary is not intended to be complete and is qualified in its entirety by reference to the merger agreement, which drugstore.com intends to file with the SEC. Stockholders of drugstore.com are not third-party beneficiaries under the merger agreement and should not rely on the representations, warranties and covenants or any descriptions thereof as characterizations of the actual state of facts or condition of drugstore.com, Salu or any of their respective subsidiaries. A copy of drugstore.com’s press release announcing the execution of the merger agreement is attached to this report as Exhibit 99.1.

drugstore.com will finance a portion of the cash payable at the closing of the merger described in Item 1.01 and thereafter by borrowing up to $10 million under its revolving two-year line of credit pursuant to its March 2009 loan and security agreement with its existing bank. This amount will accrue interest at the higher of prime rate plus 0.50% (3.75% at December 28, 2009), or 4.50%. The loan and security agreement contains certain covenants that are customary in transactions of this nature, including a prohibition on other debt and liens, requirements regarding the payment of taxes, and certain restrictions on mergers and acquisitions, investments, and transactions with our affiliates, as well as certain financial covenants related to our cash and cash equivalents and our free cash flow, with which it was in compliance as of November 29, 2009, the date of its last assessment under the terms of the loan and security agreement. The agreement identifies certain events of default that are customary for transactions of this nature and subject to materiality provisions and grace periods where appropriate, including failure to pay any principal or interest under this facility or other instruments when due, the occurrence of a material adverse change, violations of any covenants, a material cross-default to its other debt, or a change of control. As of December 28, 2009, none of these events had occurred.

The disclosure set forth in Item 1.01 above is incorporated by reference into this Item 3.02. The merger agreement provides that drugstore.com will file a permit application for a public fairness hearing before the Commissioner of Corporations of the State of California pursuant to Sections 25121 and 25142 of the California Corporate Securities Law of 1968. In the event that such permit is obtained, drugstore.com will rely on an exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933, as amended, for the issuance of the drugstore.com common stock in the transaction.

On December 28, 2009, drugstore.com, inc. issued a press release announcing the execution of the merger agreement. A copy of that press release is attached to this report as Exhibit 99.1.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


DRUGSTORE.COM, INC. (Registrant)

By:		/s/ ROBERT POTTER
		Robert Potter Vice President, Chief Accounting Officer

BELLEVUE, WA – December 28, 2009 – drugstore.com, inc., (NASDAQ: DSCM) a leading online retailer of health, beauty, vision, and pharmacy products that owns and operates the Beauty.com^TM webstore, today announced that it has entered into an agreement to acquire Salu, Inc. in a stock and cash transaction. Salu owns and operates the SkinStore.com^TM webstore, a leading online retailer of clinical skin care and beauty products. Additionally, Salu has distribution capabilities in Australia and operates the spalook.com^TM webstore for Sandow Media, parent company of NewBeauty Magazine. In 2009, Salu is expected to generate at least $40 million of revenue, $500,000 of net income and $1.4 million of adjusted EBITDA, excluding one-time transaction-related charges.

The acquisition will create one of the largest online beauty retailers offering consumers a wide-ranging product selection, with mass beauty products on drugstore.com, prestige beauty brands on Beauty.com and clinical skin care products on SkinStore.com. Together, the companies will have a broader array of products to offer across their online stores and will gain efficiencies in many operational areas. Under the agreement, Salu will continue to focus on its brands and exceptional customer experience and will operate in Sacramento, California.

“Beauty is a cornerstone of our growth strategy, and we are delighted to expand our footprint with the addition of SkinStore.com to our online portfolio,” said Dawn Lepore, CEO and chairman of the board, drugstore.com, inc. “This acquisition will further solidify our position as a first choice for beauty consumers and brings us one step closer toward achieving our goal of becoming the leading online retailer of beauty and spa products.”

Under the terms of the agreement, the transaction is valued at $36 million payable half in cash and half in drugstore.com common stock, plus an opportunity for senior management of Salu to receive an additional amount based on achievement of certain performance targets and integration milestones.

“This partnership is a tremendous opportunity to leverage each other’s strengths and together become a clear leader in online beauty,” said Jim Steeb, CEO, Salu, Inc. “We will continue to build the SkinStore brand and our partnership with spalook and to serve our customers well. We believe drugstore.com, along with Beauty.com, is the best partner to help us do this over the long term.”

The acquisition is expected to be accretive to drugstore.com, inc. earnings per share in 2010, excluding one-time transaction fees and integration costs. drugstore.com, inc. expects to record approximately $2.4 million to $2.9 million of transaction and integration related expenses in fiscal year 2010. The transaction is expected to close in the first quarter of fiscal 2010.

drugstore.com, inc. (NASDAQ:DSCM) is a leading online retailer of health, beauty, vision and pharmacy products. Our portfolio of brands include: drugstore.com™, Beauty.com™ and VisionDirect.com™. All are accessible from http://www.drugstore.com and provide a convenient, private, and informative shopping experience while offering a wide assortment of more than 45,000 products at competitive prices.

The drugstore.com pharmacy is certified by the National Association of Boards of Pharmacy (NABP) as a Verified Internet Pharmacy Practice Site (VIPPS) and operates in compliance with federal and state laws and regulations in the United States.

Salu, Inc. is the parent company of SkinStore.com, physician founded and directed since 1997. SkinStore.com carries over 200 premium brands of skin care and beauty products typically found only in luxury spas, fine stores and dermatologist offices. An aesthetician-staffed call center is available to answer customer questions. The privately-owned venture-funded company is headquartered in Gold River (Sacramento), California.

This announcement was issued on December 28, 2009. In connection with the proposed acquisition, drugstore.com has filed a current report on Form 8-K dated December 27, 2009 with the SEC. The Form 8-K is available at www.sec.gov or at www.investor.drugstore.com.

This release includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 based on our expectations, estimates and projections as of the date of this release. These forward-looking statements include statements regarding the expected 2009 financial results of Salu, the anticipated benefits of the acquisition and impact on drugstore.com’s business and 2010 financial results, and the expected timing of the closing of the transaction. Forward-looking statements are based on current expectations, and are not guarantees of future performance and involve assumptions, risks, and uncertainties. Actual performance may differ materially from that contained or implied in such forward-looking statements. Risks and uncertainties that could lead to such differences could include, among other things: the occurrence of any event, change or other circumstance that could give rise to the termination of the merger agreement; the inability to complete the transaction due to the failure to receive approvals or to satisfy other conditions to the transaction; the risk that the proposed transaction disrupts current plans and operations; the risk that anticipated synergies and opportunities as a result of the transaction will not be realized; difficulty or unanticipated expenses in connection with integrating Salu into drugstore.com; the risk that the acquired business does not perform as planned, including as a result of overall changes in the economy; changes in consumer spending and consumer trends; fluctuations in the stock market; changes affecting the Internet, online retailing, and advertising; the unpredictability of future revenues, expenses, and potential fluctuations in revenues and operating results; possible tax liabilities relating to the collection of sales tax; and the ability to manage multiple growing businesses. Certain of these and other risks and uncertainties are discussed in the section entitled “Risk Factors” in drugstore.com’s most recent quarterly filing with the SEC. You should not rely on a forward-looking statement as representing the views of drugstore.com or its management as of any date other than the date on which it made the statement. drugstore.com expressly disclaims any intent or obligation to update any forward-looking statement after the date on which it made such statement.

In this release, we present the non-GAAP financial measure of adjusted EBITDA for Salu, Inc., defined as earnings before interest, taxes and depreciation, adjusted to exclude the impact of stock based compensation expense. This non-GAAP measure is provided to enhance the user’s overall understanding of Salu’s current financial performance. We believe that adjusted EBITDA, as defined, provides useful information to management and to investors by excluding certain items that may not be indicative of Salu’s core operating results. In addition, because drugstore.com, inc. has historically provided adjusted EBITDA measures to investors, management believes that including Salu’s adjusted EBITDA measures provides consistency in drugstore.com’s financial reporting. However, adjusted EBITDA is not intended to be considered in isolation of, as a substitute for, or superior to GAAP financial information. We have included reconciliations in this release of this non-GAAP measure to the nearest GAAP measure.

SUPPLEMENTAL INFORMATION: Reconciliation of Net Income to Adjusted EBITDA (See Note 1 below):

NOTE 1: Supplemental information related to Salu’s adjusted EBITDA for the nine months ended September 30, 2009 is presented for informational purposes only and is not prepared in accordance with generally accepted accounting principles.

Adjusted EBITDA is defined as earnings before interest, taxes and depreciation, adjusted to exclude the impact of stock-based compensation expense.

SUPPLEMENTAL INFORMATION: Reconciliation of Forecasted Q4 2009 and FY 2009 Net Income Range to Forecasted Q4 2009 and FY 2009 Adjusted EBITDA Range:

As noted, net income and adjusted EBITDA for the three- and twelve-month periods ending December 31, 2009 exclude one-time transaction-related charges that cannot be estimated at this time. Such charges could be material to Salu’s net income and adjusted EBITDA for these periods.


Media Relations:		Investor Relations:
Anne Marshall		Brinlea Johnson
drugstore.com		The Blueshirt Group
425.372.3464		212-551-1453
amarshall@drugstore.com		brinlea@blueshirtgroup.com


*(In thousands, unless otherwise indicated)*	Nine Months Ended September 30, 2009
Net income	$	468
Stock-based compensation		48
Depreciation		272
Interest expense, net		333

Adjusted EBITDA	$	1,121


	Three Months Ended December 31, 2009				Twelve Months Ended December 31, 2009
*(In thousands, unless otherwise indicated)*	Range High		Range Low		Range High		Range Low
Net income	$	150	$	50	$	618	$	518
Stock-based compensation		20		20		68		68
Depreciation		100		100		372		372
Interest expense, net		109		109		442		442

Adjusted EBITDA	$	379	$	279	$	1,500	$	1,400