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 "anticipates," "believes," "continues," "could," "expects," "focus," "intends," "may," "outlook," "plan," "project," "remains," "should," "targets," "will," "would," 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 and consumer trends; 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, 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; the level of competition; seasonality; the timing and success of expansion efforts; changes in senior management; risks related to systems interruptions and disruptions in service by shipping carriers; possible changes in governmental regulation; changes in price of fuel used in the transportation of packaging or other energy products, primarily natural gas and electricity; 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.sexualwellbeing.com, www.riteaidonlinestore.com, www.medcohealthstore.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.sexualwellbeing.com, www.riteaidonlinestore.com, www.medcohealthstore.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 throughwww.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 the fourth quarter of 2009, to accelerate our OTC growth, we are focusing on the continued development of our partnerships with Medco Health Solutions, Inc. and Rite Aid Corporation, launching microsites, such as www.sexualwellbeing.com, that allow us to better target specific customers with tailored marketing programs, by offering a larger assortment of niche specific SKUs and product content, and international market expansion.

• Mail-Order Pharmacy. Our mail-order pharmacy segment includes prescription drugs and supplies, other than prescription contact lenses, sold online through the pharmacy section of the drugstore.com web store or over the telephone and delivered to customers through our mail-order facility. We procure our prescription inventory through Rite Aid Corporation as part of our ongoing relationship. We market to both cash-paying and insurance-covered individuals, and we also serve as a third-party provider of mail-order prescription fulfillment services for pharmacy benefit managers, or PBMs. We sell over 5,500 prescription drugs, including many specialty drugs for the treatment of chronic conditions such as cancer, HIV, and multiple sclerosis, which are not carried by brick-and-mortar pharmacies and require special handling or service. In this segment, we focus our marketing efforts directly on consumers online and through doctors to maximize growth in our cash prescription and specialty pharmacy business. In addition to the sale of prescription drugs, we sell advertising on our website to monetize the large volume of unique visitors per month researching drugs and other healthcare content provided on the site. In the fourth quarter of 2009, we anticipate that our mail-order pharmacy segment revenues will decline due to the loss of one of our PBM customers as a result of its acquisition in late 2008, but anticipate our year-over-year contribution margin as a percentage of revenue will continue to improve.

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 recognized over the ten-month contractual payment period ending in June 2009. Additionally, Rite Aid pays 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. We consider the marketing service fees to be indirect cash inflows of our discontinued LPU segment, as the fees earned are not a significant source of ongoing future revenue. We have classified the results of operations of our 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 third quarter of 2009, we reported consolidated total net sales of $96.8 million, which reflected a $9.0 million, or 10%, increase over the third quarter of 2008. For the nine-month period ended September 27, 2009, we reported consolidated net sales of $295.5 million, which reflected a $22.8 million, or 8%, increase over the nine-month period ended September 28, 2008. Our net sales growth was driven by a 15% year-over-year increase in our total order volume for the third quarter of 2009, to 1.5 million orders, and a 11% year-over-year increase in total order volume for the nine-month period ended September 27, 2009, to 4.4 million orders. Our average net sales per order decreased to $67 for the third quarter of 2009, compared to $69 in the third quarter of 2008, and decreased to $68 for the nine-month period ended September 27, 2009 compared to $69 for the nine-month period ended September 28, 2008, primarily due to a lower mix of mail-order pharmacy net sales and a slight decrease in our OTC segment average net sales per order. Our revenues benefited from strong growth in our OTC segment, which grew year-over-year net sales by 17% for the third quarter of 2009 and 12% for the nine-month period ended September 27, 2009, and benefited from year-over-year growth in our vision segment of 11% for the third quarter of 2009 and 12% for the nine-month period ended September 27, 2009. Our net sales in our mail-order pharmacy segment decreased year-over-year by 25% and 18%, respectively, in the third quarter and the nine-month period ended September 27, 2009, primarily resulting from the loss of one of our PBM partners in the fourth quarter of 2008.

Expenses. Our operating expenses, including cost of goods sold, decreased as a percentage of net sales to 102% in the third quarter and nine-month period ended September 27, 2009, from 106% in the third quarter of 2008 and 105% in the nine-month period ended September 28, 2008. During the third quarter and nine-month period ended September 27, 2009 our overall cost of goods sold as a percentage of net sales decreased year-over-year by 70 and 80 basis points, respectively, primarily due to a favorable shift to higher margin OTC sales, as well as improved margins in our OTC segment. For the third quarter and nine-month period ended September 27, 2009, our year-over-year fulfillment and order processing expenses as a percentage of net sales were lower by 110 and 90 basis points, respectively, resulting from a reduction in our per order labor fulfillment cost as a result of our increased efficiencies in our primary distribution facility, and to a lesser extent, reduced consulting expenses related to process improvement projects. General and administrative expenses as a percentage of net sales were also lower year-over-year by 160 basis points for the third quarter of 2009 and 170 basis points for the nine-month period ended September 27, 2009 primarily resulting from costs spread over a higher revenue base, a reduction in stock-based compensation, a net benefit of $725,000 realized in the first quarter of 2009 from legal settlements, and a reduction in professional fees related primarily to consulting projects focused on our profitability initiatives in the prior year, partially offset by increases in certain employee related expenses. Technology and content expenses were lower year-over- year by 40 basis points as a percentage of net sales in the third quarter of 2009, and were flat year-over-year as a percentage of

net sales in the nine-month period ended September 27, 2009 driven by costs spread over a higher revenue base, partially offset by an increase in depreciation expense resulting from the completion of internally developed software projects and the acquisition of software and computer equipment to enhance our websites and IT infrastructure. These decreases were offset by a year-over-year increase in marketing and sales expense as a percentage of net sales for the third quarter and nine-month period ended September 27, 2009 resulting primarily from increased order volume.

Net Income (Loss); Cash Position. Our net loss for the third quarter of 2009 decreased by 55% or $2.0 million to $1.6 million, compared to $3.6 million in the third quarter of 2008, and for the nine-month period ended September 27, 2009 decreased 103% to net income of $246,000 compared to a net loss of $8.6 million in the nine-month period ended September 28, 2008. We ended the third quarter of 2009 with $37.4 million in cash, cash equivalents, and marketable securities, compared to $38.2 million at December 28, 2008, and $33.4 million at September 28, 2008. This balance primarily reflects cash proceeds of $5.9 million from the sale of discontinued operations, cash provided by operating activities from continuing operations and discontinued operations of $1.6 million, proceeds from borrowings on our line of credit of $3.0 million, partially offset by cash used for capital expenditures of $5.8 million, and $5.3 million to repay debt obligations.

Results of Operations

Customer Data

We shipped approximately 412,000 and 1.2 million new customer orders, inclusive of our strategic partnerships, during the third quarter and the nine-months ended September 27, 2009, increasing our total customer base to approximately 11.1 million customers since inception. The number of active customers in the nine-month period ended September 27, 2009 increased to approximately 2.9 million, an increase of 14% from approximately 2.5 million active customers in the nine-month period ended September 28, 2008. Orders from repeat customers as a percentage of total orders decreased year-over-year in the third quarter and nine-month period ended September 27, 2009 to 71% from 73% in the third quarter of 2008 and nine-month period ended September 28, 2008, primarily as a result of a decrease in repeat orders in our mail-order pharmacy segment due to the loss of one of our PBM partners in the fourth quarter of 2008. 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 and Medco online stores, orders generated through the Beauty.com Amazon marketplace, and orders generated through our fulfillment agreement with Weil.

Net Sales



                                               Three Months Ended                                 Nine Months Ended
                                  September 27,                   September 28,     September 27,                   September 28,
                                      2009         % Change           2008              2009         % Change           2008
                                      (in thousands, except per order data)             (in thousands, except per order data)
Total net sales                  $        96,815       10.2 %    $        87,823   $       295,471        8.4 %    $       272,639
Total customer orders shipped              1,456       14.6 %              1,270             4,373       11.2 %              3,932
Average net sales per order      $            67       -2.9 %    $            69   $            68       -1.4 %    $            69

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 certain partners, under which we do not take title to the inventory and do not establish pricing. We record on a net basis consignment service fees, which constitute approximately 1% of total net sales in each period presented. 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 third quarter and the nine-month period ended September 27, 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 for the third quarter and nine-month period ended September 27, 2009 primarily from an 18% and 14% increase in orders in our OTC segment, respectively, and to a lesser extent, a 6% increase in orders in our vision segment. These order increases were partially offset by a 25% and 24% year-over-year decrease in orders in our mail-order pharmacy segment for the third quarter and nine-month period ended September 27, 2009, respectively. The average net sales per order decreased year-over-year in the third quarter and nine-month period ended September 27, 2009 resulting primarily from a lower mix of mail-order pharmacy orders and a decrease in the average net sales per order in our OTC segment, partially offset by an increase in the average net sales per order in our vision segment. Revenues from repeat customers decreased year-over-year to 77% of net sales for the third quarter and nine-month period ended September 27, 2009, compared to 79% in the third quarter and nine-month period ended September 28, 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.

OTC Net Sales



                                                      Three Months Ended                                            Nine Months Ended
                                     September 27,                          September 28,          September 27,                          September 28,
                                         2009              % Change             2008                   2009              % Change             2008
                                            (in thousands, except per order data)                         (in thousands, except per order data)
OTC net sales                       $        71,349            16.5 %      $        61,223        $       214,735            12.4 %      $       190,985
Percentage of total net sales
from OTC                                       73.7 %                                 69.7 %                 72.7 %                                 70.0 %
Average net sales per order         $            57            -1.7 %      $            58        $            57            -1.7 %      $            58

Net sales in our OTC segment increased year-over-year for the third quarter and nine-months ended September 27, 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 by 18% to 1.3 million in the third quarter of 2009, compared to 1.1 million in the third quarter of 2008, and grew by 14% to 3.8 million in the nine-months ended September 27, 2009, compared to 3.3 million in the nine-months ended September 28, 2008, resulting from increased orders from both new and repeat customers as a result of our increasing active customer base, orders generated through our partnerships with Medco and Rite Aid, and our continued efforts to improve customer retention and conversion. The year-over-year decrease in the average net sales per order in our OTC segment in the third quarter and nine-months ended September 27, 2009 resulted from a decrease in shipping revenue as customers are taking advantage of free shipping offers and not choosing expedited shipping methods, increased discounts driven by promotional activity, and a slight decrease in the number of units per order, partially offset by a shift in product mix to higher priced items.

Vision Net Sales



                                                       Three Months Ended                                            Nine Months Ended
                                      September 27,                          September 28,          September 27,                          September 28,
                                          2009              % Change             2008                   2009              % Change             2008
                                             (in thousands, except per order data)                         (in thousands, except per order data)
Vision net sales                     $        17,227            10.6 %      $        15,579        $        52,249            11.5 %      $        46,865
Percentage of total net sales
from vision                                     17.8 %                                 17.7 %                 17.7 %                                 17.2 %
Average net sales per order          $           118             3.5 %      $           114        $           117             5.4 %      $           111

Net sales in our vision segment increased year-over-year for the third quarter and nine-months ended September 27, 2009 as a result of increases in both order volume and average net sales per order. The number of orders in our vision segment grew by 7% to 146,000 in the third quarter of 2009, compared to 137,000 in the third quarter of 2008, and grew by 6% to 448,000 in the nine-months ended September 27, 2009, compared to 423,000 in the nine-months ended September 28, 2008, resulting from increased orders from both new and repeat customers driven primarily by increased promotional offers. The year-over-year increase in average net sales per order was driven primarily by customers making larger quantity purchases, price increases for certain SKUs (none of which were individually material), and selling higher-priced newer technology contact lenses, partially offset by increased use of discount and promotional offers by our customers.

Mail-Order Pharmacy Net Sales



                                                   Three Months Ended                                            Nine Months Ended
                                  September 27,                          September 28,          September 27,                          September 28,
                                      2009              % Change             2008                   2009              % Change             2008
                                         (in thousands, except per order data)                         (in thousands, except per order data)
Mail-order pharmacy net
sales                            $         8,239           -25.2 %      $        11,021        $        28,487           -18.1 %      $        34,789
Percentage of total net
sales from mail-order
pharmacy                                     8.5 %                                 12.6 %                  9.6 %                                 12.8 %
Average net sales per order      $           163             1.2 %      $           161        $           174             7.4 %      $           162

Net sales in our mail-order pharmacy segment decreased year-over-year in the third quarter and the nine-months ended September 27, 2009 as a result of a decrease in order volume, partially offset by an increase in average net sales per order. Included in net sales of our mail-order pharmacy segment for the third quarter of 2009 were wholesale orders to two different parties totaling $471,000, which increased our average net sales per order by $11, and for the third quarter of 2008 there were wholesale orders to two parties totaling $216,000, which increased our average net sales per order by $2. Included in net sales of our mail-order pharmacy segment for the nine-month period ended September 27, 2009 were wholesale orders to three different parties totaling $4.0 million, which increased our average net sales per order by $25, and for the nine-month period ended September 28, 2008 were wholesale orders to three different parties totaling $1.5 million, which increased our average net sales per order by $6. Excluding the wholesale orders, the year-over-year average net sales per order for the third quarter and nine-month period ended September 27, 2009 decreased

by $7, as a result of the loss of one of our PBM partners in the fourth quarter of 2008, which had a higher average net sales per order, a decrease in the number of prescriptions per order, and an increase in customers purchasing a 30-day supply compared to a 90-day supply. The number of orders in this segment decreased 25% year-over-year to 51,000 for the third quarter of 2009, compared to 68,000 for the third quarter of 2008, and also decreased 24% year-over-year to 164,000 for the nine-month period ended September 27, 2009, compared to 215,000 for the nine-month period ended September 28, 2008 as a result of a decrease in orders from new and repeat customers due to our declining active customer base and the loss of the PBM partner in the fourth quarter of 2008.

Cost of Sales and Gross Margin



                                                      Three Months Ended                                            Nine Months Ended
                                     September 27,                          September 28,          September 27,                          September 28,
                                         2009              % Change             2008                   2009              % Change             2008
                                                       ($ in thousands)                                              ($ in thousands)
Cost of sales                       $        68,408             9.1 %      $        62,708        $       210,722             7.2 %      $       196,570
Gross profit dollars                $        28,407            13.1 %      $        25,115        $        84,749            11.4 %      $        76,069
Gross margin percentage                        29.3 %                                 28.6 %                 28.7 %                                 27.9 %

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

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