drugstore.com, inc. Reports Break-Out Second Quarter; Company Reports Smaller-than-Expected Net Loss and Positive Adjusted EBITDA of $1.6M, Raises 2006 Bottom Line Guidance

drugstore.com, inc. (NASDAQ:DSCM), a leading onlineprovider of health, beauty, vision, and pharmacy products, todayannounced its financial results for the second quarter ended July 2,2006. The company reported quarterly net sales of $102.4 million,driven by 18% year-over-year growth in core over-the-counter (OTC) netsales (1), and a net loss of $2.2 million or $0.02 per share,reflecting a $3.1 million sequential improvement from the firstquarter. Notably, the company achieved record adjusted EBITDA (profit)of $1.6 million in the second quarter, significantly ahead ofguidance. Previously, the company had targeted a net loss of $4.3million to $5.5 million for the second quarter, and an adjusted EBITDArange of break-even to a loss of $1.0 million. Adjusted EBITDA is anon-GAAP financial measure defined as earnings before interest, taxes,depreciation, and amortization of intangible assets and non-cashmarketing expense, adjusted to exclude the impact of stock-basedcompensation expense.

"The second quarter represents a critical inflection point in thehistory of drugstore.com, as we achieved a dramatic improvement to ourbottom line and now expect to report positive adjusted EBITDA for thefull year 2006," said Dawn Lepore, chief executive officer andchairman of the board of drugstore.com, inc. "Importantly, secondquarter gross margins also improved to 22.0%, up 150 basis points yearover year, and contribution margin dollars increased 22% to a record$14.8 million or $11.22 per order. Having achieved adjusted EBITDAprofitability, we plan to build on our strong and growing base ofbusiness and expect to continue to increase our adjusted EBITDAmargins over the long term, consistent with normal seasonal patterns."

"This is an exciting time for drugstore.com," added Ms. Lepore."In the second quarter, we completed our strategic business review tomake sure that each order and partnership we have is profitable.Moving forward, we are turning our strategic attention to a number ofnew growth initiatives that will be focused on increasing the numberof new customers we acquire, gaining more wallet share from our loyal,existing customer base and continuing to expand margins. We believethese efforts will drive top-line growth of our core OTC business andcontinued improvement in adjusted EBITDA."

GAAP net loss for the second quarter of 2006 was $2.2 million, or$0.02 per share, compared to a net loss of $4.3 million, or $0.05 pershare, for the second quarter of 2005. The company's GAAP resultsreflect $1.6 million in non-cash share-based compensation associatedwith FAS 123R. In accordance with FAS 123R, the expense for currentand comparative periods is reflected within the applicable functionaloperating expense lines within the statement of operations.

(1) Core OTC net sales is a non-GAAP financial measure thatexcludes from OTC net sales the company's wholesale OTC net sales andCustom Nutrition Services ("CNS") net sales. Wholesale OTC sales weregenerated by the company's December 2003 agreement to providefulfillment services to Amazon.com, Inc., which was terminatedeffective as of November 9, 2005. CNS sales are generated by sales ofcustomized vitamins through the company's CNS subsidiary. Prior toDecember 31, 2005, all CNS sales were recognized on a gross basis, netof promotional discounts, cancellations, rebates and returnsallowances. Under the terms of the company's December 31, 2005,fulfillment agreement with Weil Lifestyle, LLC (Weil), the companyrecognizes on a net basis the revenue associated with the fulfillmentof customized vitamins sold through its fulfillment agreement withWeil (which made up the majority of CNS net sales during the quarter).A reconciliation of OTC net sales to OTC net sales excluding wholesaleOTC and CNS is included in the financial data accompanying this pressrelease.

Outlook for Second Half of 2006

For the third quarter of 2006, the company is targeting net salesin the range of $100.0 million to $102.0 million, net loss in therange of $3.5 million to $4.2 million, and positive adjusted EBITDA inthe range of breakeven to $500,000. For the full year, the company isnow targeting a net sales range of $415 million to $420 million, a netloss range of $13.0 million to $14.7 million, and adjusted EBITDA of$1.5 million to $2.5 million.

Financial and Operational Highlights for the Second Quarter of2006

(All comparisons are made with the second quarter of 2005.)

Key Financial Highlights:

-- Bottom line improvements were driven by record contribution margins of 14.5%, up 190 basis points, and strong order volumes.

-- Contribution margin dollars increased 22%, while fixed costs increased by only 4%.

-- Orders reached 1.3 million, reflecting the highest second-quarter volume in the company's history and its third highest quarterly volume ever.

-- In the OTC segment, contribution margins grew to a record high of 21.7%, and contribution margin dollars grew 31%, on OTC net sales of $47.3 million.

-- Growth in OTC contribution margin dollars resulted from strong core OTC order volumes which increased by 23%, OTC gross margins, which rose 270 basis points to 30.9%, and core OTC gross margins, which rose 240 basis points to a record 30.1%. (1)

Net Sales Summary:

-- Core OTC net sales (1) grew by 18% to $46.6 million.

-- Mail-order pharmacy net sales were down 5% to $17.4 million and were negatively impacted by the Medicare Part D prescription drug program.

-- Local pick-up pharmacy net sales were up 6% to $25.3 million.

-- Vision net sales grew to $12.4 million, a 9% increase.

-- Average net sales per order were $77. Average net sales per order were down slightly at $56 for OTC, up by 11% to an all-time high of $161 for mail-order pharmacy, down 4% to $103 for local pick-up pharmacy, and up by 10% to $90 for vision.

-- Net sales from repeat customers represented a record 82% of net sales. (2)

Key Customer Milestones:

-- 7.8 million customers have been served since inception, including 297,000 new customers in the second quarter.

-- The number of active customers (3) grew by 13% to 2.1 million.

-- The average annual spend per active customer (3) was $188.

Other Financial Highlights:

-- Fulfillment and order processing expenses were up slightly to 10% of net sales, from 9.7%.

-- Inventory turned at an annualized rate of 15 times during the quarter.

(2) Net sales from repeat customers excludes wholesale OTC andWeil-related CNS net sales and reflects only the activity of customersmaking purchases through the Web sites of drugstore.com and itssubsidiaries.

(3) Active customer base reflects those customers who havepurchased at least once within the last 12 months. Both the activecustomer base (a trailing 12-month number) and average annual spendper active customer exclude net sales and orders generated by thecompany's wholesale OTC and CNS fulfillment relationship with Weil,and reflect only the activity of customers making purchases throughthe Web sites of drugstore.com and its subsidiaries.

Conference Call

Investors, analysts, and other interested parties are invited tojoin the drugstore.com(TM) quarterly conference call on Thursday, July27, 2006, at 5:00 p.m. ET (2:00 p.m. PT). To participate, callersshould dial 800-366-7640 (international callers should dial303-275-2170) five minutes beforehand. Investors may also listen tothe conference call live at www.drugstore.com (under CorporateInformation), by clicking on the "audio" hyperlink. A replay of thecall will be available through Saturday, July 29, 2006, at800-405-2236 (enter pass code 11065826) or internationally at303-590-3000 (enter pass code 11065826) beginning two hours aftercompletion of the call.

Non-GAAP Measures

To supplement the consolidated financial statements presented inaccordance with GAAP, drugstore.com, inc. uses the non-GAAP measure ofadjusted EBITDA, defined as earnings before interest, taxes,depreciation, and amortization of intangible assets and non-cashmarketing expenses, adjusted to exclude the impact of stock-basedcompensation expense. This non-GAAP measure is provided to enhance theuser's overall understanding of the company's current financialperformance. Management believes that adjusted EBITDA, as defined,provides useful information to the company and to investors byexcluding certain items that may not be indicative of the company'score operating results. In addition, because drugstore.com, inc. hashistorically provided EBITDA measures to investors, managementbelieves that including EBITDA measures provides consistency in thecompany's financial reporting. However, adjusted EBITDA should not beconsidered in isolation, or as a substitute for, or as superior to,net income/loss, cash flows, or other consolidated loss or cash flowdata prepared in accordance with GAAP, or as a measure of thecompany's profitability or liquidity. Although adjusted EBITDA isfrequently used as a measure of operating performance, it is notnecessarily comparable to other similarly titled captions of othercompanies due to differences in methods of calculation. Netincome/loss is the closest financial measure prepared by the companyin accordance with GAAP in terms of comparability to adjusted EBITDA.

drugstore.com, inc. also uses non-GAAP measures in which wholesaleOTC and CNS sales are excluded from OTC segment sales data. Thesenon-GAAP measures are provided to enhance the user's overallunderstanding of the company's financial performance in the OTCsegment. Management believes that these reporting metrics provideuseful information to the company and to investors by excludingcertain items that may not be indicative of the company's coreoperating results in the OTC segment. By excluding wholesale OTC andCNS sales from OTC sales data, the company can more effectively assessthe buying behavior of, and the company's financial performance withrespect to, its own core OTC customers (those customers makingnonprescription purchases through Web sites owned by drugstore.com,inc. and its subsidiaries). However, these non-GAAP measures shouldnot be considered in isolation, or as a substitute for, or as superiorto, OTC segment sales data prepared in accordance with GAAP, or as ameasure of the company's overall performance in the OTC segment. OTCsegment sales measures are the closest financial measures prepared bythe company in accordance with GAAP in terms of comparability to OTCsegment sales measures that exclude wholesale OTC and CNS sales.

About drugstore.com, inc.

drugstore.com, inc. (NASDAQ:DSCM) is a leading online provider ofhealth, beauty, vision, and pharmacy products. The drugstore.com(TM)online store provides a convenient, private, and informative shoppingexperience that encourages consumers to purchase products essential tohealthy, everyday living. The online store offers thousands ofbrand-name personal health care products at competitive prices; afull-service, licensed retail pharmacy; and a wealth of health-relatedinformation, buying guides, and other tools designed to help consumersmake informed purchasing decisions. Consumers can personalize theirshopping experiences with shopping lists, e-mail reminders forreplenishing regularly used products, and private e-mail access topharmacists and beauty experts for questions.

drugstore.com, inc. has been awarded the Verified InternetPharmacy Practice Sites (VIPPS) certification by the NationalAssociation of Boards of Pharmacy (NABP) as a fully licensed facilityexercising competent, safe pharmacy practices in compliance withfederal and state laws and regulations.

The financial results contained in this press release arepreliminary and unaudited. In addition, this press release containsforward-looking statements regarding future events or the futurefinancial and operational performance of drugstore.com, inc. Wordssuch as "targets," "expects," "believes," "anticipates," "intends,""may," "will," "plan," "continue," "forecast," "remains," "would,""should," and similar expressions, are intended to identifyforward-looking statements. Forward-looking statements are based oncurrent expectations, are not guarantees of future performance andinvolve assumptions, risks, and uncertainties. Actual performance maydiffer materially from those contained or implied in suchforward-looking statements. Risks and uncertainties that could lead tosuch differences could include, among other things: effects of changesin the economy, changes in consumer spending, fluctuations in thestock market, changes affecting the Internet, online retailing andadvertising, difficulties establishing our brand, and building acritical mass of customers, the unpredictability of future revenuesand expenses and potential fluctuations in revenues and operatingresults, risks related to business combinations and strategicalliances, possible tax liabilities relating to the collection ofsales tax, consumer trends, the level of competition, seasonality, thetiming and success of expansion efforts, changes in senior management,risks related to systems interruptions, possible governmentalregulation and the ability to manage a growing business. Additionalinformation regarding factors that potentially could affect thebusiness, financial condition and operating results of drugstore.com,inc. is included in the company's periodic filings with the SEC onForms 10-K, 10-Q and 8-K. drugstore.com, inc. expressly disclaims anyintent or obligation to update any forward-looking statement, exceptas otherwise specifically stated by it.
drugstore.com, inc.
Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)


Three Months Ended Six Months Ended
------------------------- -------------------------
July 2, July 3, July 2, July 3,
2006 2005 2006 2005
----------- ----------- ----------- -----------

Net sales $ 102,436 $ 96,892 $ 206,545 $ 196,465

Costs and
expenses: (1) (2)
Cost of sales 79,945 77,036 161,834 156,372
Fulfillment and
order
processing 10,239 9,366 20,416 19,651
Marketing and
sales 6,322 7,038 15,299 14,001
Technology and
content 4,003 3,034 7,945 5,966
General and
administrative 4,025 4,311 8,319 8,740
Amortization of
intangible
assets 531 752 1,061 1,553
----------- ----------- ----------- -----------
Total costs and
expenses 105,065 101,537 214,874 206,283
----------- ----------- ----------- -----------

Operating loss (2,629) (4,645) (8,329) (9,818)

Interest income,
net 436 340 843 519
----------- ----------- ----------- -----------

Net loss $ (2,193) $ (4,305) $ (7,486) $ (9,299)
----------- ----------- ----------- -----------
Basic and diluted
net loss per
share $ (0.02) $ (0.05) $ (0.08) $ (0.10)
=========== =========== =========== ===========
Weighted average
shares
outstanding used
to compute basic
and diluted net
loss per share 93,136,203 92,228,222 93,052,927 88,857,994
=========== =========== =========== ===========

(1) Set forth below are the amounts of stock-based compensation by
operating function recorded in the Statements of Operations:

Fulfillment and
order processing $ 154 $ - $ 375 $ -
Marketing and
sales 257 16 581 159
Technology and
content 262 1 534 5
General and
administrative 880 388 1,766 1,089
----------- ----------- ----------- -----------
$ 1,553 $ 405 $ 3,256 $ 1,253
=========== =========== =========== ===========

(2) Set forth below are the amounts of depreciation by operating
function recorded in the Statements of Operations:

Fulfillment and
order processing $ 386 $ 454 $ 780 $ 1,395
Marketing and
sales 1 - 1 -
Technology and
content 1,049 535 2,002 1,042
General and
administrative 112 115 223 269
----------- ----------- ----------- -----------
$ 1,548 $ 1,104 $ 3,006 $ 2,706
=========== =========== =========== ===========

SUPPLEMENTAL INFORMATION: Gross Profit and Gross Margin Information:

Three Months Ended Six Months Ended
------------------- -------------------
(In thousands, unless July 2, July 3, July 2, July 3,
otherwise indicated) 2006 2005 2006 2005
-------- -------- -------- --------

Net sales $102,436 $ 96,892 $206,545 $196,465
Cost of sales 79,945 77,036 161,834 156,372
-------- -------- -------- --------
Gross profit $ 22,491 $ 19,856 $ 44,711 $ 40,093
======== ======== ======== ========
Gross margin 22.0% 20.5% 21.6% 20.4%
======== ======== ======== ========


SUPPLEMENTAL INFORMATION: Reconciliation of OTC net sales, cost of
sales, gross profit, and gross margin to Core OTC net sales, cost of
sales, gross profit and gross margin (See Note 3 below):

Three Months Ended
-----------------------------
July 2, April 2, July 3,
2006 2006 2005
-------- -------- --------
(In thousands)
Over-the-Counter (OTC):
Net sales $ 47,254 $ 49,006 $ 43,130
CNS 612 683 1,847
Wholesale OTC - - 1,826
-------- -------- --------
Core OTC net sales $ 46,642 $ 48,323 $ 39,457
======== ======== ========

Cost of sales $ 32,633 $ 34,663 $ 30,987
CNS 52 (16) 880
Wholesale OTC - - 1,588
-------- -------- --------
Core OTC cost of sales $ 32,581 $ 34,679 $ 28,519
======== ======== ========

Gross profit $ 14,621 $ 14,343 $ 12,143
CNS 560 699 967
Wholesale OTC - - 238
-------- -------- --------
Core OTC gross profit $ 14,061 $ 13,644 $ 10,938
======== ======== ========

Gross margin 30.9% 29.3% 28.2%
CNS 91.5% 102.3% 52.4%
Wholesale OTC - - 13.0%
-------- -------- --------
Core OTC gross margin 30.1% 28.2% 27.7%
======== ======== ========

NOTE 3: Supplemental information related to the company's core OTC
net sales, cost of sales, gross profit, and gross margin for
the three months ended July 2, 2006, April 2, 2006 and July 3,
2005 is presented for informational purposes only and is not
prepared in accordance with generally accepted accounting
principles. Effective November 9, 2005, the company terminated
its wholesale OTC fulfillment agreement with Amazon.com, Inc.
without any material obligations for either party following
the termination. On December 31, 2005, the company entered
into a fulfillment agreement with Weil Lifestyle, LLC,
resulting in Weil-related CNS net sales (which make up the
substantial majority of CNS net sales) being recorded on a net
basis after that date. All CNS sales were previously recorded
on a gross basis.


SUPPLEMENTAL INFORMATION: Segment Information:

Three Months Ended
----------------------------
July 2, April 2, July 3,
2006 2006 2005
-------- -------- -------
Net sales:
Over-the-Counter (OTC) $ 47,254 $ 49,006 $43,130
Mail-order pharmacy 17,405 18,300 18,416
Local pick-up pharmacy 25,329 24,213 23,953
Vision 12,448 12,590 11,393
-------- -------- -------
$102,436 $104,109 $96,892
Cost of sales:
Over-the-Counter (OTC) $ 32,633 $ 34,663 $30,987
Mail-order pharmacy 14,968 15,845 15,933
Local pick-up pharmacy 22,721 21,588 21,262
Vision 9,623 9,793 8,854
-------- -------- -------
$ 79,945 $ 81,889 $77,036
Gross profit:
Over-the-Counter (OTC) 14,621 14,343 12,143
Mail-order pharmacy 2,437 2,455 2,483
Local pick-up pharmacy 2,608 2,625 2,691
Vision 2,825 2,797 2,539
-------- -------- -------
$ 22,491 $ 22,220 $19,856
======== ======== =======
Gross margin:
Over-the-Counter (OTC) 30.9% 29.3% 28.2%
Mail-order pharmacy 14.0% 13.4% 13.5%
Local pick-up pharmacy 10.3% 10.8% 11.2%
Vision 22.7% 22.2% 22.3%
-------- -------- -------
22.0% 21.3% 20.5%
======== ======== =======
Variable order costs:
Over-the-Counter (OTC) $ 4,385 $ 4,328 $ 4,330
Mail-order pharmacy 1,588 1,602 1,670
Local pick-up pharmacy 1,038 992 1,020
Vision 648 661 651
-------- -------- -------
7,659 7,583 7,671
Contribution margin:
Over-the-Counter (OTC) $ 10,236 $ 10,015 $ 7,813
Mail-order pharmacy 849 853 813
Local pick-up pharmacy 1,570 1,633 1,671
Vision 2,177 2,136 1,888
-------- -------- -------
$ 14,832 $ 14,637 $12,185
======== ======== =======


SUPPLEMENTAL INFORMATION: Reconciliation of Net Loss to Adjusted
EBITDA Profit (Loss) (See Note 4 below):

Three Months Ended Six Months Ended
------------------ -----------------
(In thousands, unless otherwise July 2, July 3, July 2, July 3,
indicated) 2006 2005 2006 2005
------- ------- ------- -------
Net loss $(2,193) $(4,305) $(7,486) $(9,299)
Amortization of intangible assets 531 752 1,061 1,553
Amortization of non-cash
marketing 572 572 1,145 1,145
Stock-based compensation 1,553 405 3,256 1,253
Depreciation 1,548 1,104 3,006 2,706
Interest income, net (436) (340) (843) (519)
------- ------- ------- -------
Adjusted EBITDA profit (loss) $ 1,575 $(1,812) $ 139 $(3,161)
======= ======= ======= =======

NOTE 4: Supplemental information related to the company's adjusted
EBITDA profit (loss) for the three and six months ended July
2, 2006, and July 3, 2005, is presented for informational
purposes only and is not prepared in accordance with generally
accepted accounting principles. Adjusted EBITDA income (loss)
is defined as loss before interest, taxes, depreciation, and
amortization of intangible assets and non-cash marketing
expense, adjusted to exclude the impact of stock-based
compensation expense.


SUPPLEMENTAL INFORMATION: Reconciliation of Forecasted Q3 2006 and FY
2006 Net Loss Range to Forecasted Q3 2006 and FY 2006 Adjusted EBITDA
Range

Range Calculated As: Three Months Ended Twelve Months Ended
October 1, 2006 December 31, 2006
(In thousands, unless -------------------- --------------------
otherwise indicated) Range High Range Low Range High Range Low
---------- --------- ---------- ---------
Net loss $ (3,500) $ (4,200) $(13,000) $(14,700)
Amortization of intangible
assets 530 530 2,100 2,100
Amortization of non-cash
marketing 575 575 2,300 2,300
Stock-based compensation 1,625 1,725 6,300 6,500
Depreciation 1,660 1,760 6,400 6,800
Interest income, net (390) (390) (1,600) (1,500)
--------- -------- -------- --------
Adjusted EBITDA $ 500 $ - $ 2,500 $ 1,500
========= ======== ======== ========


drugstore.com, inc.
Consolidated Balance Sheets
(in thousands, except share data)

July 2, January 1,
2006 2006 (5)
--------- ----------
(unaudited) (audited)
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 15,912 $ 20,291
Marketable securities 23,780 26,172
Accounts receivable, net of allowances 36,986 34,214
Inventories 20,156 23,468
Prepaid marketing expenses 2,290 2,387
Other current assets 2,256 2,583
--------- ----------
Total current assets 101,380 109,115

Fixed assets, net 16,375 15,839
Other intangible assets, net 6,375 7,427
Goodwill 32,202 32,202
Prepaid marketing expenses and other 4,895 5,980
--------- ----------
Total assets $ 161,227 $ 170,563
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 52,481 $ 58,177
Accrued compensation 4,532 3,426
Accrued marketing expenses 3,492 3,382
Other current liabilities 1,585 1,751
Current portion of long-term debt 1,981 2,029
--------- ----------
Total current liabilities 64,071 68,765

Long-term debt, less current portion 1,797 2,685
Deferred income taxes 945 945
Other long-term liabilities 1,754 1,897

Stockholders' equity:
Common stock, $.0001 par value, stated at
amounts paid in:
Authorized shares - 250,000,000
Issued and outstanding shares -
93,221,630 and 92,904,652 as of July 2,
2006 and January 1, 2006, respectively 837,462 833,589
Accumulated other comprehensive loss (1) (3)
Accumulated deficit (744,801) (737,315)
--------- ----------
Total stockholders' equity 92,660 96,271
--------- ----------
Total liabilities and stockholders'
equity $ 161,227 $ 170,563
========= ==========

NOTE 5: Certain prior year amounts have been reclassified to
conform to the current year presentation.


drugstore.com, inc.
Consolidated Statements of Cash Flows
(in thousands)
Six Months Ended
-------------------
July 2, July 3,
2006 2005
-------- --------
(unaudited)
Operating activities:
Net loss $ (7,486) $ (9,299)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 3,006 2,706
Amortization of marketing and sales agreements 1,145 1,145
Amortization of intangible assets 1,061 1,553
Stock-based compensation 3,256 1,253
Other, net 13 100
Changes in:
Accounts receivable (2,772) 2,021
Inventories 3,312 (591)
Prepaid marketing expenses and other 364 (306)
Accounts payable, accrued expenses and other
liabilities (4,789) (1,711)
-------- --------
Net cash used in operating activities (2,890) (3,129)
-------- --------
Investing activities:
Purchases of marketable securities (12,906) (33,477)
Sales and maturities of marketable securities 15,300 15,325
Purchases of fixed assets (3,326) (2,374)
-------- --------
Net cash used in investing activities (932) (20,526)
-------- --------
Financing activities:
Proceeds from exercise of stock options and
employee stock purchase plan 617 1,101
Proceeds from private placement, net - 25,961
Proceeds from term loan, line of credit and
asset financings - 1,000
Principal payments on capital lease and term
loan obligations (1,174) (712)
-------- --------
Net cash provided by (used in) financing
activities (557) 27,350
-------- --------
Net increase (decrease) in cash and cash
equivalents (4,379) 3,695
Cash and cash equivalents, beginning of
period 20,291 15,491
-------- --------
Cash and cash equivalents, end of period $ 15,912 $ 19,186
======== ========