Drugstore.com (DSCM)

Cost of Sales and Gross Margin

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.

16

Table of Contents

Cost of Sales and Gross Margin

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 2008 and 2007, as a result of growth in order volume and net sales. Gross margin percentage increased year-over-year in 2008 and 2007, as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, and improved gross margin percentages in our OTC and mail-order pharmacy segments in 2008, and in all of our business segments in 2007.

Cost of Sales and Gross Margin

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 2008 and 2007, as a result of growth in order volume and net sales. Gross margin percentage increased year-over-year in 2008 and 2007, as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, and improved gross margin percentages in our OTC and mail-order pharmacy segments in 2008, and in all of our business segments in 2007.

Cost of Sales and Gross Margin

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 purchase or rebate allowances and payment discount terms are netted against cost of sales.

Total cost of sales increased in absolute dollars in the three- and nine-month periods ended September 28, 2008, compared to the three- and nine-month periods ended September 30, 2007, as a result of growth in order volume and net sales. Total gross margin percentage increased year-over-year for the three- and nine-month periods ended September 28, 2008, primarily as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, as well as improved gross margins in our OTC and mail-order segments.

Cost of Sales and Gross Margin

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 purchase or rebate allowances and payment discount terms are netted against cost of sales.

Total cost of sales increased in absolute dollars in the three- and six-month periods ended June 29, 2008, compared to the three- and six-month periods ended July 1, 2007, as a result of growth in order volume and net sales. Total gross margin percentage increased year-over-year for the three- and six-month periods ended June 29, 2008, primarily as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, and improved gross margins in our mail-order and local pick-up pharmacy segments.

16

Table of Contents

Cost of Sales and Gross Margin

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 purchase or rebate allowances and payment discount terms are netted against cost of sales.

The year-over-year increase in cost of sales in absolute dollars in the first quarter of 2008 compared to the first quarter of 2007 resulted from growth in order volume and net sales. Total gross margin percentage increased year-over-year, resulting from both a favorable shift in our product mix to higher margin OTC net sales, and to a lesser extent, vision net sales, and improved margins in our OTC, mail-order pharmacy and local pick-up pharmacy segments.

Cost of Sales and Gross Margin

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 purchase or rebate allowances and payment discount terms are netted against cost of sales.

Total cost of sales increased in absolute dollars in 2007 and 2006 compared to the prior year, as a result of growth in order volume and net sales. Gross margin percentage increased in 2007 compared to the prior year, as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, and improved gross margin percentages in all of our business segments in 2007. Gross margin percentage increased in 2006 compared to the prior year, as a result of lower net shipping loss, a larger proportion of net sales in our OTC segment, and improved margins resulting from our operational initiatives, including the review of pricing and profitability of our OTC products.

Cost of Sales and Gross Margin

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 purchase or rebate allowances and payment discount terms are netted against cost of sales.

Total cost of sales increased in absolute dollars in the three- and nine-month periods ended September 30, 2007, compared to the three- and nine-month periods ended October 1, 2006, as a result of growth in order volume and net sales. Total gross margin percentage increased year-over-year for the three- and nine-month periods ended September 30, 2007, primarily as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, as well as improved gross margins in all of our other segments.

Cost of Sales and Gross Margin

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 purchase or rebate allowances and payment discount terms are netted against cost of sales.

Total cost of sales increased in absolute dollars in the three- and six-month periods ended July 1, 2007, compared to the three- and six-month periods ended July 2, 2006, as a result of growth in order volume and net sales. Total gross margin percentage increased year-over-year for the three- and six-month periods ended July 1, 2007, primarily as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, and improved gross margins in our mail-order and local pick-up pharmacy segments and vision segment.

We include in net sales our revenues from shipping charges to customers, which were $4.0 million and $3.3 million in the three-month periods ended July 1, 2007, and July 2, 2006, respectively, and were $7.7 million and $6.7 million in the six-month periods ended July 1, 2007 and July 2, 2006, respectively. We include in cost of sales outbound shipping costs, which were $6.3 million and $5.0 million in the three-month periods ended July 1, 2007 and July 2, 2006, respectively, and were $12.1 million and $10.5 million in the six-month periods ended July 1, 2007 and July 2, 2006, respectively. 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.

Cost of Sales and Gross Margin

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 purchase or rebate allowances and payment discount terms are netted against cost of sales.

Total cost of sales increased in absolute dollars in the three-month period ended April 1, 2007, compared to the three-month period ended April 2, 2006, as a result of growth in order volume and net sales. Total gross margin percentage increased year-over-year, primarily as a result of a larger proportion of net sales in our OTC segment, which is our highest-margin segment, lower net shipping costs that we absorbed, and our operational initiatives.

We include in net sale our revenues from shipping charges to customers, which were $3.8 million and $3.4 million in the three-month periods ended April 1, 2007, and April 2, 2006. We include in cost of sales outbound shipping costs, which were $5.8 million and $5.5 million in the three-month periods ended April 1, 2007 and April 2, 2006. As part of our profitability initiatives, in 2006, we eliminated free 3-day shipping on orders of $99 or more, added shipping surcharges for shipments to Alaska, Hawaii, U.S. Territories, and APO/FPO military addresses, added a weight-based shipping surcharge for orders over 20 pounds, and secured a lower contractual rate from one of our shipping carriers. 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.

16