You should read the following discussion and analysis in conjunction with the financial statements and accompanying notes included elsewhere in this quarterly report and in our annual report on Form 10-K for the fiscal year ended December 28, 2008.

Special Note Regarding Forward-Looking Statements

This quarterly report on Form 10-Q 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 filing. Actual results may differ materially from those expressed in forward-looking statements. All statements made in this quarterly report other than statements of historical fact, including statements regarding our future financial and operational performance, sources of liquidity and future liquidity needs, are forward-looking. Words such as "expects," "believes," "targets," "may," "will," "outlook," "continue," "could," "would," "should," and similar expressions or any variation of such expressions, are intended to identify forward-looking statements. Forward-looking statements are based on current expectations, and are not guarantees of future performance and involve assumptions, risks, and uncertainties. Actual performance may differ materially from those contained or implied in such forward-looking statements. Risks and uncertainties that could lead to such differences could include, among other things: effects of changes in the economy, changes in consumer spending, fluctuations in the stock market, changes affecting the Internet, online retailing and advertising, difficulties establishing our brand and building a critical mass of customers, the unpredictability of future revenues and expenses and potential fluctuations in revenues and operating results, risks related to business combinations and strategic alliances, possible tax liabilities relating to the collection of sales tax, consumer trends, the level of competition, seasonality, the timing and success of expansion efforts, changes in senior management, risks related to systems interruptions, possible governmental regulation, and the ability to manage a growing business. These factors described in this paragraph and other risks and uncertainties that could cause our actual results to differ significantly from management's expectations are discussed in the sections entitled "Risk Factors" in Part II, Item 1A of this quarterly report and Part I, Item 1A of our annual report on Form 10-K for the fiscal year ended December 28, 2008. You should not rely on a forward-looking statement as representing our views as of any date other than the date on which we made the statement. We expressly disclaim any intent or obligation to update any forward-looking statement after the date on which we make it.

Overview

drugstore.com, inc. is a leading online provider of health, beauty, vision, and pharmacy products. We believe that we offer a better way for consumers to shop for these products through our web stores, including those located on the Internet at www.drugstore.com, www.beauty.com, www.riteaidonlinestore.com, www.visiondirect.com, www.lensmart.com, www.lensworld.com, and www.lensquest.com.

Business Segments; Growth Strategies. We operate our business in three business segments: over-the-counter (OTC); vision; and mail-order pharmacy.

• OTC. Our OTC segment includes all non-prescription products sold online through our web stores at www.drugstore.com, www.beauty.com, www.riteaidonlinestore.com, www.visiondirect.com, www.lensmart.com, www.lensworld.com, and www.lensquest.com, or over the telephone at 1-800-DRUGSTORE or 1-800-VISIONDIRECT, including nutritional supplements sold through our subsidiary Custom Nutrition Services, Inc., or CNS. In addition, through our subsidiary CNS, we are the exclusive online distributor of nutritional supplement programs for Dr. Barry Sears at www.ZoneDiet.com and The Pritikin Longevity Center & Spa at www.Pritikin.com. In addition, we act as the exclusive fulfillment provider for customized nutritional supplements sold through www.DrWeilVitaminAdvisor.com, www.DrWeil.com, and other Dr. Weil-related websites. We source our OTC products from various manufacturers and distributors. We also sell advertising on our primary OTC site www.drugstore.com. Our business strategy is to offer our customers a wide selection of health, beauty, personal care, household, and other products at competitive prices and a superior online shopping experience. We are able to offer a significantly broader assortment of products, with greater depth in each product category, than brick-and-mortar drugstores, and provide a broad array of interactive tools and information on our websites to help consumers make informed purchasing decisions. We believe leveraging our strong capabilities in Internet marketing, merchandising, fulfillment, and customer care in the health, beauty, and wellness arena will be a key growth driver for our OTC segment. In 2009, we are focusing on key initiatives such as international market expansion and further development of our partnerships with Medco Health Solutions, Inc., Rite Aid Corporation, and new beauty brands to accelerate OTC growth.

• Vision. The vision segment includes contact lenses sold through our wholly owned subsidiary Vision Direct Inc. (Vision Direct), through web stores located at www.visiondirect.com, www.lensmart.com, www.lensworld.com, and www.lensquest.com, or over the telephone at 1-800-VISIONDIRECT. We purchase our contact lens inventory directly from various manufacturers and other distributors. In 2009, we will continue to focus on balancing customer acquisition with net margin in order to maximize our profits.

Discontinued Operations. On September 3, 2008, we entered into an amended and restated main agreement with Rite Aid whereby we transferred to Rite Aid the rights to our local pick-up pharmacy business (LPU), which includes prescription refills sold online through the drugstore.com web store or the Rite Aid online store and picked up by customers at Rite Aid stores, in exchange for $9.9 million, paid in ten monthly installments beginning in September 2008. We recorded the purchase price as a deferred gain that we are recognizing over the ten-month contractual payment period ending in June 2009. Additionally, Rite Aid will pay drugstore.com ongoing marketing service fees for the continued marketing of Rite Aid's LPU offering on the drugstore.com site during the term of the agreement, which continues for two years unless extended for another year by either party. The marketing service fees are considered indirect cash inflows of our discontinued LPU segment, as we anticipate the fees earned will not be a significant source of ongoing revenue in the future. We have classified the results of operations of our LPU segment as discontinued operations in the consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations for all periods presented.

Revenues. We generate revenue primarily from product sales and shipping fees. For the three-month period ended March 29, 2009, we reported consolidated total net sales of $98.3 million, which reflected a $5.7 million, or 6.2%, increase over the three-month period ended March 30, 2008. Our net sales growth was driven by a 10.6% year-over-year increase in our total order volume for the three-month period ended March 29, 2009, to 1.5 million orders. Our average net sales per order decreased to $67 in the first quarter of 2009, from $70 in the first quarter of 2008 primarily due to a decrease in our average net sales per order in our OTC and mail-order pharmacy segments driven primarily by changes in consumer behavior, as discussed in greater detail below. In the first quarter of 2009, our revenues benefited from strong year-over-year growth in our OTC segment of 11.2% and our vision segment of 13.0%, partially offset by a decline in our mail-order pharmacy net sales of 28.5%.

Expenses. Our operating expenses, including cost of goods sold, decreased as a percentage of net sales to 102% for the three-month period ended March 29, 2009 compared to 105% for the three-month period ended March 30, 2008. During the first quarter of 2009, our overall cost of goods sold as a percentage of net sales decreased year-over-year by 80 basis points, due primarily to a favorable shift in our product mix to higher margin OTC sales. As a percentage of net sales, in the first quarter of 2009, our general and administrative expense decreased year-over-year primarily as a result of a benefit of $1.2 million realized from the resolution of our New Jersey sales tax case, a reduction in stock compensation expense of $919,000, and a reduction in professional fees as compared to those we incurred in 2008, which were primarily related to consulting projects focused on our profitability initiatives, partially offset by a one-time charge of $475,000 related to a legal settlement. As a percentage of net sales, in the first quarter of 2009, our fulfillment and order processing expense decreased year-over-year primarily due to reduced labor costs resulting from increased efficiencies in our primary distribution facility and a reduction from 2008 in professional fees related to consulting projects focused on our profitability initiatives, partially offset by increased depreciation expense related to equipment and software improvements. As a percentage of net sales, in the first quarter of 2009, marketing and sales expense increased year-over-year primarily as a result of an increase in paid search, affiliate, and portal costs, resulting from growth in new customers and an increase in the percentage of paid orders to total orders in both our OTC and vision segments compared to the first quarter of 2008.

Net Income (Loss); Cash Position. Our net income for the three-month period ended March 29, 2009 increased by $3.5 million to $854,000, compared to a net loss of $2.7 million for the three-month period ended March 30, 2008. We ended the first quarter of 2009 with $36.7 million in cash, cash equivalents, and marketable securities, compared to $38.2 million at December 28, 2008, and $34.7 million at March 30, 2008. This balance primarily reflects cash used in operating activities from continuing operations and discontinued operations of $1.8 million in the first quarter of 2009, cash used for capital expenditures of $1.7 million, and $755,000 to repay debt obligations, partially offset by proceeds of $3.0 million from the sale of discontinued operations.

Results of Operations

Customer Data

We shipped approximately 400,000 new customer orders, inclusive of our strategic partnerships, during the first quarter of 2009, increasing our total customer base to 10.2 million customers since inception. The number of active customers in the first quarter of 2009 increased to approximately 2.7 million, an increase of 10.5% from approximately 2.4 million active customers in the first quarter of 2008. Orders from repeat customers as a percentage of total orders decreased in the first quarter of 2009 to 72% from 73% in the first quarter of 2008, primarily as a result of a decrease in repeat orders in our mail-order pharmacy segment. Active customer base includes those customers who have purchased at least once within the last 12 months and the number of customer orders includes new and repeat orders made through the drugstore.com web store and the web stores of our subsidiaries, orders generated through the Rite Aid online store, orders generated through the beauty.com Amazon marketplace, and orders generated through our fulfillment agreement with Weil.

Net Sales



                                                   Three Months Ended
                                        March 29,                       March 30,
                                           2009          % Change         2008
                                         (in thousands, except per order data)
      Total net sales                 $       98,315           6.2 %   $    92,568
      Total customer orders shipped            1,467          10.6 %         1,327
      Average net sales per order     $           67          -4.3 %   $        70

Net sales include gross revenues from sales of product, shipping fees, service fees, and advertising revenues, net of discounts and provision for sales returns, and other allowances. Net sales also include consignment service fees earned from our arrangements with GNC and Rite Aid, under which we do not take title to the inventory and do not establish pricing. We record on a net basis consignment service fees, which constitute approximately 1% of total net sales in each period presented. We bill orders to the customer's credit card or, in the case of prescriptions covered by insurance, we bill the co-payment to the customer's credit card and the remainder of the prescription price to insurance. We record sales of pharmaceutical products covered by insurance as the sum of the amounts received from the customer and the third party insurer.

Total net sales increased year-over-year for the first quarter of 2009 as a result of an increase in order volume, partially offset by a decrease in the average net sales per order. Order volume increased year-over-year in the first quarter of 2009 resulting from a 14% and 6% increase in orders in our OTC and vision segments, respectively, partially offset by a 22% decrease in orders in our mail-order pharmacy segment. The average net sales per order decreased year-over-year in the first quarter of 2009 resulting from a decrease in the average net sales per order in our OTC and mail-order pharmacy segments, partially offset by an increase in the average net sales per order in our vision segment. Revenues from repeat customers decreased to 77% of net sales in the first quarter of 2009, compared to 79% in the first quarter of 2008, as a result of a year-over-year decrease in the average net sales per order from repeat customers and a decrease in the percentage of repeat orders to new orders in the first quarter of 2009.

OTC Net Sales



                                                       Three Months Ended
                                            March 29,                        March 30,
                                               2009            % Change        2008
                                              (in thousands, except per order data)
 OTC net sales                            $       72,087           11.2 %   $    64,851
 Percentage of total net sales from OTC             73.3 %                         70.1 %
 Average net sales per order              $           57           -1.7 %   $        58

Net sales in our OTC segment increased year-over-year in the first quarter of 2009 as a result of an increase in order volume, partially offset by a decrease in average net sales per order. The number of orders in our OTC segment grew year-over-year by 14% to 1.3 million for the first quarter of 2009, compared to 1.1 million for the first quarter of 2008, resulting from increased orders from both new and repeat customers as a result of our increasing active customer base, our continued efforts to improve customer retention and conversion by adding website enhancements and offering a broad selection of basic necessity items and hard-to-find specialty items through the addition of new SKUs that encourages customers to return to our websites and make repeat, replenishment, and impulse purchases, and by adding value through our loyalty programs and discount offers. The year-over-year decrease in the average net sales per order in our OTC segment in the first quarter of 2009 resulted from a decrease in shipping revenue due to customers' not choosing expedited shipping methods, increased discounts, and a slight decrease in the number of units per order, partially offset by a shift in product mix to higher priced items.

Vision Net Sales



                                                                 Three Months Ended
                                                     March 29,                         March 30,
                                                        2009            % Change         2008
                                                       (in thousands, except per order data)
Vision net sales                                   $       17,441           13.0 %    $    15,436
Percentage of total net sales from vision                    17.8 %                          16.7 %
Average net sales per order                        $          115            6.5 %    $       108

Net sales in our vision segment increased year-over-year in the first quarter of 2009 as a result of an increase in order volume and average net sales per order. The number of orders in our vision segment grew year-over-year by 6% to 152,000 for the first quarter of 2009, compared to 143,000 for the first quarter of 2008, resulting from increased orders from both new and repeat customers driven primarily by increased promotional offers. The increase in average net sales per order was driven primarily by selling higher priced, newer technology contact lenses, and price increases for certain SKUs, partially offset by increased use of discount and promotional offers by our customers (none of which were individually material).

Mail-Order Pharmacy Net Sales



                                                                 Three Months Ended
                                                     March 29,                         March 30,
                                                        2009            % Change         2008
                                                       (in thousands, except per order data)
Mail-order pharmacy net sales                      $        8,787          -28.5 %    $    12,281
Percentage of total net sales from mail-order
pharmacy                                                      8.9 %                          13.2 %
Average net sales per order                        $          151            7.9 %    $       164

Net sales in our mail-order pharmacy segment decreased year-over-year in the first quarter of 2009 as a result of a decrease in order volume and average net sales per order. Included in net sales of our mail-order pharmacy segment for the first quarters of 2009 and 2008 were wholesale orders to two different parties totaling $203,000 and $963,000, respectively, which increased our average net sales per order by $3 and $13, respectively. Excluding the wholesale orders, the average net sales per order in the first quarter of 2009 decreased by $3 compared to the same period in 2008 as a result of a shift in mix to selling a higher percentage of generic drugs compared to brand-name drugs, a decrease in the number of prescriptions per order, and more customers' purchasing a 30-day supply compared to a 90-day supply. The number of orders in this segment decreased 22% year-over-year to 58,000 for the first quarter of 2009, compared to 75,000 for the first quarter of 2008 as a result of a decrease in orders from new and repeat customers due to a declining active customer base and the loss of one of our PBM partners in the fourth quarter of 2008.

Cost of Sales and Gross Margin



                                                Three Months Ended
                                      March 29,                    March 30,
                                        2009         % Change        2008
                                                 ($ in thousands)
           Cost of sales             $    70,552          5.0 %   $    67,183
           Gross margin dollars      $    27,763          9.4 %   $    25,385
           Gross margin percentage          28.2 %                       27.4 %

Cost of sales consists primarily of the cost of products sold to our customers, including allowances for shrinkage and damaged, slow-moving, and expired inventory, outbound and inbound shipping costs, and expenses related to promotional inventory included in shipments to customers. Payments that we receive from vendors in connection with volume purchases or rebate allowances and payment discount terms are netted against cost of sales.

Total cost of sales increased year-over-year in absolute dollars in the first quarter of 2009 as a result of growth in order volume and net sales. Total gross margin percentage increased year-over-year for the first quarter of 2009 primarily as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment.

Shipping



                                                 Three Months Ended
                                       March 29,                    March 30,
                                         2009         % Change        2008
                                                  ($ in thousands)
           Shipping activity:
           Shipping revenue           $     3,583         -9.1 %   $     3,940
           Shipping costs             $    (6,928 )        3.7 %   $    (6,678 )

           Net shipping loss          $    (3,345 )       22.2 %   $    (2,738 )

           Percentage of net sales:
           Shipping revenue                   3.6 %                        4.3 %
           Shipping costs                    -7.0 %                       -7.2 %
           Net shipping loss                 -3.4 %                       -3.0 %

We include in net sales our revenues from shipping charges to customers, and we include in cost of sales outbound shipping costs. Our net shipping loss increased in absolute dollars and as a percentage of net sales in the first quarter of 2009 compared to the first quarter of 2008, as a result of a decrease in shipping revenue resulting from a decrease in the number of customers choosing expedited shipping methods for their orders and the elimination of surcharges for APO/FPO and Alaska and Hawaii orders, combined with an increase in shipping costs resulting from a higher mix of OTC orders, which have a higher shipping cost than orders in our other business segments, partially offset by lower rates from our largest shipping carrier. We expect to continue to subsidize a portion of customers' shipping costs for the foreseeable future, through certain free shipping options, as a strategy to attract and retain customers.

OTC Cost of Sales and Gross Margin



                                                  Three Months Ended
                                        March 29,                    March 30,
                                          2009         % Change        2008
                                                   ($ in thousands)
         OTC cost of sales             $    49,927         10.9 %   $    45,013
         OTC gross margin dollars      $    22,160                  $    19,838
         OTC gross margin percentage          30.7 %                       30.6 %

The year-over-year increase in cost of sales in our OTC segment in absolute dollars for the first quarter of 2009 resulted from increased order volume and net sales. The year-over-year increase in gross margin percentage in this segment for the first quarter of 2009 resulted primarily from improvements in product margins in a majority of our product categories as a result of our ongoing pricing and sourcing profitability initiatives, and lower shipping costs due to fewer customers' choosing expedited shipping methods and lower rates from our largest shipping carrier, partially offset by higher customer use of discount offers.

Vision Cost of Sales and Gross Margin



                                                      Three Months Ended
                                            March 29,                    March 30,
                                              2009         % Change        2008
                                                       ($ in thousands)
     Vision cost of sales                  $    13,599         13.1 %   $    12,028
     Vision cost gross margin dollars      $     3,842                  $     3,408
     Vision cost gross margin percentage          22.0 %                       22.1 %

The year-over-year increase in cost of sales in our vision segment in absolute dollars for the first quarter of 2009 resulted from increased order volume and net sales. The year-over-year decrease in gross margin percentage in this segment for the first quarter of 2009 resulted primarily from increased promotional offers, partially offset by improved product margins due to pricing and sourcing changes.

Mail-Order Pharmacy Cost of Sales and Gross Margin



                                                          Three Months Ended
                                                March 29,                    March 30,
                                                  2009         % Change        2008
                                                           ($ in thousands)
 Mail-order pharmacy cost of sales             $     7,026        -30.7 %   $    10,142
 Mail-order pharmacy gross margin dollars      $     1,761                  $     2,139
 Mail-order pharmacy gross margin percentage          20.0 %                       17.4 %

The year-over-year decrease in cost of sales in our mail-order pharmacy segment in absolute dollars for the first quarter of 2009 resulted from a decrease in order volume and net sales. The year-over-year increase in gross margin percentage in this segment in the first quarter of 2009 resulted primarily from our ongoing review of pricing and profitability of pharmaceutical products and . . .