DRUGSTORE COM INC, S-1/A, 1999-07-08

DRUGSTORE COM INC
S-1/A, 1999-07-08
DRUG STORES AND PROPRIETARY STORES

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As filed with the Securities and Exchange Commission on July 8, 1999

Registration 333-78813
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

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DRUGSTORE.COM, INC.
(Exact name of registrant as specified in its charter)

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<CAPTION>
Delaware 5912 04-3416255
<S> <C> <C>
(State or other
jurisdiction of
incorporation
or (Primary Standard Industrial (I.R.S. Employer
organization) Classification Code Number) Identification Number)
</TABLE>

13920 Southeast Eastgate Way, Suite 300
Bellevue, Washington 98005
(425) 372-3200
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)

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Peter M. Neupert
President and Chief Executive Officer
drugstore.com, inc.
13920 Southeast Eastgate Way, Suite 300
Bellevue, Washington 98005
(425) 372-3200
(Name, address, including zip code, and telephone number, including area code,
of agent for service)

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Copies to:
Joshua L. Green Neil J. Wolff
John H. Sellers Yoichiro Taku
Adam J. Rosenberg Shelly Dolev
Kevin G. Montler WILSON SONSINI GOODRICH & ROSATI
VENTURE LAW GROUP Professional Corporation
A Professional Corporation 650 Page Mill Road
2800 Sand Hill Road Palo Alto, California
Menlo Park, CA 94025 (650) 493-9300
(650) 854-4488

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Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this registration statement.

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If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

----------------

The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this
registration statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until this registration
statement shall become effective on such date as the Commission, acting
pursuant to said Section 8(a), may determine.

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<PAGE>

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities and we are not soliciting offers to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS (Subject to Completion)

Issued July 8, 1999

5,000,000 Shares

[LOGO OF DRUGSTORE.COM]

COMMON STOCK

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drugstore.com, inc. is offering 5,000,000 shares of common stock. This is our
initial public offering and no public market currently exists for our shares.
We anticipate that the initial public offering price will be between $9.00 and
$11.00 per share.

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Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "DSCM."

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Investing in our common stock involves risks. See "Risk Factors" beginning on
page 7.

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PRICE $ A SHARE

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<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public Commissions drugstore.com
-------- ------------- -------------
<S> <C> <C> <C>
Per Share................... $ $ $
Total....................... $ $ $
</TABLE>

The Securities and Exchange Commission and state securities regulators have not
approved or disapproved these securities, or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.

drugstore.com, inc. has granted the underwriters the right to purchase up to an
additional 750,000 shares to cover over-allotments. Morgan Stanley & Co.
Incorporated expects to deliver the shares to purchasers on , 1999.

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MORGAN STANLEY DEAN WITTER

DONALDSON, LUFKIN & JENRETTE

THOMAS WEISEL PARTNERS LLC

, 1999
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The first page of the gatefold includes:

drugstore.com
What Every Body Needs-TM-
[PICTURE OF DRUGSTORE.COM HOMEPAGE]
Lines pointing to specific items on the picture of the homepage connect to the
following text:

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<CAPTION>
<S> <C>
Five stores in one: health, beauty, wellness, Detailed product, topical and health
personal care and pharmacy. information to make purchase decisions.

Personalized service, shopping lists and Licensed pharmacy with home delivery.
reminders.

Choose from thousands of products in A high-quality selection of brand-name and
drugstore.com. specialty products organized in easy-to-shop
departments.
Shop for high-quality items in privacy.
</TABLE>

The following text is placed to the left of the picture of the homepage:
CONVENIENCE AND PRIVACY

drugstore.com has created a leading online drugstore and information site where
customers can shop in privacy from the convenience of their home or office.
More than a buying experience, drugstore.com offers useful information to assist
in the thinking and buying process.

Our store is designed to make What Every Body Needs easier for our customers to
acquire. At drugstore.com, customers never have to park the car, stand in line
or bump into nosy neighbors.

FIVE STORES IN ONE

drugstore.com is five stores in one, offering health, beauty, wellness, personal
care and pharmacy products, which we believe offers a superior customer
experience not found at store-based retailers. Through the Internet,
drugstore.com offers:

. Convenient, personalized service
. Shopping 24 hours a day, seven days a week
. Helpful information to make purchase decisions
. Secure credit card payment
. Direct delivery to home or office
. Private shopping from home or work
. Licensed pharmacy
. Personal access to pharmacists to answer questions
. Specialized customer care
[LOGO] drugstore.com-TM-
What Every Body Needs-TM-
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The second page of the gatefold includes:

drugstore.com
Five Stores in One

The following text is placed at the top left of the page:
A FAMILIAR, COMFORTABLE WAY TO SHOP
Our store is designed to be a familiar, comfortable place with product
categories organized like the aisles and shelves of a traditional drugstore,
beauty counter or wellness store. Customers can easily browse through the store
departments, quickly view promotions and featured products and select products
according to their brand or unique attributes.

[PICTURE OF THE BEAUTY PAGE]
[PICTURE OF THE HEALTH PAGE]
[PICTURE OF THE BOUTIQUE PAGE]

The following text appears under the picture of the Health page:
HEALTH
Along with browsing for health tips and information, customers can quickly
compare and purchase antacids, pain relievers, and family planning, first aid
and other health products.

The following text appears under the picture of the Beauty page:
BEAUTY
Customers can find their favorite beauty products, and our Ask Your Beauty
Expert feature answers their questions via e-mail.

The following text appears under the picture of the Boutique page:
BOUTIQUE
Combining the prestige of department-store beauty counters with online shopping
convenience, the boutique offers high-end cosmetics, fragrance and skin and spa
products.

[LOGO]
The following text appears on the same line as the logo and spans both the
second and third pages of the gatefold:
drugstore.com-TM-
WHAT EVERY BODY NEEDS-TM-

The third page of the gatefold includes:

[WATERMARK OF THE LOGO]
[PICTURE OF THE PERSONAL CARE PAGE]

The following text appears to the right of the Personal Care page:

-2-
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PERSONAL CARE
drugstore.com provides fast, convenient purchase of toothpaste, shampoo,
tampons, diapers, shaving needs and more.
[PICTURE OF THE WELLNESS PAGE]
[PICTURE OF THE PHARMACY PAGE]
[PICTURE OF THE DRUG INDEX PAGE]

The following text appears below the picture of the Wellness page:
WELLNESS

drugstore.com offers a wide, high-quality selection of wellness products,
including vitamins, supplements, herbs and homeopathy and other natural
products.

The following text appears below the picture of the Pharmacy page:
PHARMACY
Licensed pharmacists fill/refill prescriptions, which are then delivered to the
customer's door. Our pharmacists can provide personal guidance, by phone or e-
mail, about prescription usage.

The following text appears below the picture of the Drug Index page:
DRUG INDEX
In the pharmacy's Drug Index, customers can get easy access to information about
particular medications, including prices and usage.

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TABLE OF CONTENTS

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Page Page
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<S> <C> <C> <C>
Prospectus Summary.................. 4 Management........................ 50
Risk Factors........................ 7 Certain Relationships and Related
Sale of Shares to Amazon.com........ 22 Transactions..................... 58
Use of Proceeds..................... 22 Principal Stockholders............ 61
Dividend Policy..................... 22 Description of Capital Stock...... 63
Capitalization...................... 23 Shares Eligible for Future Sale... 66
Dilution............................ 24 Underwriters...................... 68
Selected Consolidated Financial Legal Matters..................... 70
Data............................... 25 Experts........................... 70
Management's Discussion and Analysis Where You Can Find More
of Financial Condition and Results Information...................... 70
of Operations...................... 26 Index to Consolidated Financial
Business............................ 33 Statements....................... F-1
</TABLE>

You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of the
prospectus or of any sale of the common stock.

3
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PROSPECTUS SUMMARY

You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our Consolidated Financial Statements and Notes to Consolidated
Financial Statements appearing elsewhere in this prospectus.

drugstore.com

International Data Corporation estimates that worldwide business-to-consumer
sales over the Internet will increase from approximately $11 billion in 1998 to
approximately $93 billion by 2002. The Internet has also become an important
personal tool for accessing health and medical information. According to a
recent Forrester Research report, 31.6% of Internet users surveyed had shopped
for healthcare products online in the previous six months.

We believe there is a significant market opportunity for an online store
that can offer consumers an enhanced shopping experience for health, beauty,
wellness, personal care and pharmacy products. We seek to attract and retain
consumers by emphasizing the following key attributes:

. Convenience. We feature 24 hour a day access to our user-friendly Web
store, direct home or office delivery, a personalized shopping list and
confidential access to a personal medication profile.

. Selection. With over 17,000 SKUs (stock keeping units, a term used in
the retail industry to describe distinct products), we believe we offer
a significantly greater number of products than are available in a
typical traditional chain drugstore.

. Information. We have assembled a broad array of product information. We
offer full product packaging information, extensive drug information,
and a Solutions area, which includes buying guides, reference
information, shopping advisors and beauty information.

. Communication. We can communicate with customers on a regular basis
through the convenience of e-mail. We also offer our popular "Ask Your
Pharmacist" and "Ask Your Beauty Expert" features.

. Privacy. Consumers can shop in the privacy of their own homes or offices
and can obtain answers to questions that they might otherwise be
uncomfortable asking in public.

Our objective is to become one of the world's leading retailers of health,
beauty, wellness, personal care and pharmacy products. Key elements of our
strategy include: strengthening the drugstore.com brand, continuously improving
our Web store and service, developing strategic relationships, and taking
advantage of repeat purchasing patterns. In addition, we will also continue to
make significant investments in technology and distribution.

Consistent with our strategy of developing strategic relationships, we
recently entered into relationships with Rite Aid Corporation and General
Nutrition Companies, Inc. (GNC). Potential benefits of our Rite Aid
relationship may include additional revenue and traffic generated by Rite Aid
customers who may visit our Web site, the pharmacy benefit coverage provided by
the insurance companies and pharmacy benefit management companies (PBMs) with
which Rite Aid has a relationship, including PCS Health Systems, Inc., the co-
promotion and co-branding activities both companies will undertake and our
ability to offer Rite Aid customers the opportunity to order refills of their
existing Rite Aid prescriptions on our Web site and receive local delivery at

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Rite Aid stores nationwide or delivery to the customer's home or office. The
benefits of our GNC relationship include the opportunity to be the exclusive
online provider of GNC-branded products and the reciprocal co-promotion of each
party's products in traditional and online marketing efforts.

We face many risks and challenges in our business. Some consumers may prefer
to shop at traditional retail stores, especially consumers who do not have easy
access to the Internet or who need products immediately. As part of our
relationship with Rite Aid, we have agreed not to operate physical stores. An
investment in our common stock involves risks and uncertainties, including the
fact that we are an early stage company in a new market and that we expect
continuing losses for the forseeable future. See "Risk Factors" below for
further information.

The Offering

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Common stock offered....................... 5,000,000 shares
Common stock to be outstanding after the
offering.................................. 42,791,000 shares
Use of proceeds............................ We intend to use the proceeds for general
corporate purposes, including working
capital and capital expenditures. See "Use
of Proceeds."
Proposed Nasdaq National Market symbol..... DSCM
</TABLE>

The number of shares of our common stock to be outstanding immediately after
the offering is based on the number of shares outstanding at July 4, 1999,
including the sale of shares of common stock equal to $10,000,000 divided by
the initial public offering price to Amazon.com in a private placement
transaction to be closed concurrently with the closing of this offering and
including the sale of 12,282,599 shares of Series E preferred stock to Rite Aid
and GNC on July 8, 1999. This number does not include 8,329,000 shares of our
common stock subject to options and warrants outstanding or reserved for
issuance under our stock plans at July 4, 1999. In addition, except as
otherwise noted, all information in this prospectus (1) gives effect to the
conversion of all outstanding shares of preferred stock into shares of common
stock effective upon the closing of the offering, (2) assumes no exercise of
the underwriters' overallotment option, (3) assumes no exercise of an
outstanding warrant to purchase 10,000 shares of our common stock and (4)
excludes the anticipated issuance of 200,000 shares of common stock to a
charitable foundation that we intend to establish.

drugstore.com(TM), the drugstore.com logo, the boutique(TM), What Every Body
Needs(TM), Where Every Body Shops(TM), What Your Body Needs(TM), and HEALTH .
BEAUTY . WELLNESS(TM) are our trademarks. This prospectus also includes trade
dress, trade names, trademarks and service marks of other companies. Use or
display by drugstore.com of other parties' trademarks, trade dress or products
is not intended to and does not imply a relationship with, or endorsement or
sponsorship of drugstore.com by, the trademark or trade dress owners.

5
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Summary Consolidated Financial Data

The balance sheet data displayed in the "pro forma" column reflects the
issuance of 12,282,599 shares of Series E preferred stock issued in July 1999
in exchange for $10 million in cash and other consideration, including
exclusive marketing commitments and other obligations valued at $112.8 million
based on the estimated fair value of $10.00 per share. The "pro forma as
adjusted" column reflects our capitalization as of July 4, 1999 with
adjustments to give effect to:

. the conversion of all shares of outstanding preferred stock into
34,468,000 shares of common stock upon the closing of this offering; and

. the receipt of the estimated proceeds from the sale of 5,000,000 shares
of our common stock at an assumed initial public offering price of
$10.00 per share, after deducting the underwriting discount and
estimated offering expenses, including the sale of $10 million of our
common stock to Amazon.com. See "Use of Proceeds" for a description of
how we intend to use the net proceeds of this offering.

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<CAPTION>
Period from
April 2, 1998
(Inception) through Six Months
December 31, Ended July 4,
1998 1999
------------------- -------------
(in thousands, except share
and per share data)
<S> <C> <C>
Consolidated Statement of Operations Data:
Net sales................................... $ -- $ 4,202
Gross profit (loss)......................... -- (1,349)
Total operating expenses.................... 7,664 28,690
Operating loss.............................. (7,664) (30,039)
Net loss.................................... (7,490) (29,046)
Pro forma basic and diluted net loss per
share (1).................................. $ (.92) $ (1.40)
Weighted average shares outstanding used to
compute pro forma basic and diluted net
loss per share (1)......................... 8,167,570 20,796,875
</TABLE>

<TABLE>
<CAPTION>
At July 4, 1999
---------------------------
Pro Pro Forma
Actual Forma as Adjusted
------- ------- -----------
(in thousands)
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents.......................... $68,087 $78,087 $133,924
Working capital.................................... 60,734 70,734 126,571
Total assets....................................... 84,736 207,562 263,399
Capital lease obligations, less current portion.... 1,099 1,099 1,099
Total stockholders' equity......................... 72,564 195,390 250,840
</TABLE>
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(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of weighted average shares used to
compute pro forma net loss per share amounts.

We were incorporated in Delaware in April 1998. Our principal executive
offices are located at 13920 Southeast Eastgate Way, Suite 300, Bellevue,
Washington 98005, and our telephone number is (425) 372-3200. Our World Wide
Web site is www.drugstore.com. The information contained on our Web site is not
part of this prospectus.

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RISK FACTORS

You should carefully consider the risks described below, together with all
of the other information included in this prospectus, before making an
investment decision. If any of the following risks actually occurs, our
business, financial condition or operating results could be materially
adversely affected. In such case, the trading price of our common stock could
decline, and you may lose all or part of your investment.

Risks Related to Our Business

We Are an Early Stage Company in a New and Rapidly Evolving Market, Which
Makes It Difficult for Investors to Determine Whether We Will Accomplish
Our Objectives

Because drugstore.com was founded in April 1998 and we only began selling
products in February 1999, we have a limited operating history on which
investors can base an evaluation of our business strategy. We have limited
insight into trends that may emerge and affect our business. An investor in
our common stock must consider the risks and difficulties frequently
encountered by early stage companies, as well as the risks we face due to our
participation in a new and rapidly-evolving market. These challenges include
our:

. Need to increase our brand awareness;

. Need to attract and retain customers at a reasonable cost;

. Dependence on Web site and transaction processing performance and
reliability;

. Need to compete effectively;

. Need to establish ourselves as an important participant in the evolving
market for healthcare products and services on the Internet; and

. Need to establish and develop relationships in the healthcare industry,
particularly in the areas of reimbursement and managed care.

Consumers of Health, Beauty, Wellness, Personal Care and Pharmacy Products
May Not Accept Our Solution, Which Would Reduce Our Revenues and Prevent Us
From Becoming Profitable

If we do not attract and retain a high volume of online customers to our
store at a reasonable cost, we will not be able to increase our revenues or
achieve profitability. We may not be able to convert a large number of
customers from traditional shopping methods to online shopping for health,
beauty, wellness, personal care and pharmacy products. Even if we are
successful at attracting online customers, we expect it will take several
years to build a critical mass of these customers. Specific factors that could
prevent widespread customer acceptance include:

. Shipping charges, which do not apply to shopping at traditional
drugstores;

. Delivery time associated with Internet orders, as compared to the
immediate receipt of products at a physical store;

. Pricing that does not meet customer expectations of "finding the lowest
price on the Internet;"

. Additional steps and delays in ensuring insurance coverage for
prescription products;

. Lack of coverage of customer prescriptions by some insurance carriers;

. Lack of consumer awareness of our online pharmacy;

. Customer concerns about the security of online transactions and the
privacy of their personal health information;

. Product damage from shipping or shipments of wrong or expired products
from our fulfillment partners or other vendors, resulting in a failure
to establish customers' trust in buying drugstore items online;

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. Delays in responses to customer inquiries or in deliveries to customers;

. Inability to serve the acute care needs of customers, including
emergency prescription drugs and other urgently needed products; and

. Difficulties in returning or exchanging orders.

We Expect Significant Increases in Our Operating Expenses and Continuing
Losses for the Foreseeable Future

We incurred net losses of $36.5 million for the period from inception
through July 4, 1999. We have not achieved profitability. We only began
selling products in February 1999 and cannot be certain that we will obtain
enough customer traffic or a high enough volume of purchases to generate
sufficient revenues and achieve profitability. We believe that we will
continue to incur operating and net losses for the foreseeable future and that
the rate at which we will incur such losses will increase significantly from
current levels. We intend to increase our operating expenses substantially as
we:

. Increase our sales and marketing activities, particularly advertising
efforts;

. Provide our customers with promotional benefits, such as selling
selected products or offering shipping below our actual costs;

. Increase our general and administrative functions to support our growing
operations;

. Expand our customer and pharmacist support organizations to better serve
customer needs;

. Develop enhanced technologies and features to improve our Web site;

. Enhance our distribution fulfillment processes; and

. Possibly buy or build our own distribution facilities.

Because we will spend these amounts before we receive any incremental
revenues from these efforts, our losses will be greater than the losses we
would incur if we developed our business more slowly. In addition, we may find
that these efforts are more expensive than we currently anticipate, which
would further increase our losses.

We May Not Succeed in Establishing the drugstore.com Brand, Which Would
Adversely Affect Customer Acceptance and Our Revenues

Due to the early stage and competitive nature of the online market for
drugstore products, if we do not establish our brand quickly, we may lose the
opportunity to build a critical mass of customers. Promoting and positioning
our brand will depend largely on the success of our marketing efforts and our
ability to provide consistent, high quality customer experiences. To promote
our brand, we will incur substantial expense in our advertising efforts on
major Internet destinations such as Amazon.com, America Online, Excite and
Yahoo! and other Web sites our customers are likely to visit, as well as other
forms of media such as television and magazines. We will also need to spend
money to attract and train customer service personnel. If these brand
promotion activities do not yield increased revenues, we will incur additional
losses.

We Expect Our Quarterly Financial Results to Fluctuate And Our Early Stage
of Development Limits Our Ability to Predict Revenues and Expenses
Precisely

Historical trends and quarter-to-quarter comparisons of our operating
results are not a good indicator of our future performance. It is likely that
in some future quarter our operating results may be below the expectations of
public market analysts and investors. In this event, the price of our common
stock may fall. Our revenues and operating results are expected to vary
significantly from quarter to quarter due to a number of factors, including:

. Demand for our products;

. Our ability to attract visitors to our Web store and convert those
visitors into customers;

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. The frequency of repeat purchases by customers;

. Shifts in the nature and amount of publicity about us or our
competitors;

. Changes in the growth rate of Internet usage;

. Average order size;

. The mix of products sold;

. Our ability to enhance our technology to accommodate any future growth
in our operations or customers;

. Our ability, and that of our fulfillment partners, to ensure sufficient
product supply;

. Changes in our pricing policies or the pricing policies of our
competitors;

. Changes in government regulation;

. The availability of reimbursement for pharmacy products; and

. Costs related to potential acquisitions of technology or businesses.

Our operating expenses are largely based on anticipated revenue trends and
a high percentage of our expenses are fixed in the short term. As a result, a
delay in generating or recognizing revenue for any reason could result in
substantial additional operating losses. The volume and timing of orders of
health, beauty, wellness, personal care and pharmacy products on our Web store
are difficult to predict because the online market for such products is in its
infancy. Due to the limited operating history of our Web store, we do not have
a material amount of repeat business from regular customers. Because our Web
site is designed to encourage repeat business and we do not yet have
sufficient historical data on how successful this strategy will be, we cannot
currently forecast revenue from regular customers or overall anticipated
revenue trends.

A portion of our revenues may also be seasonal in nature, especially with
respect to the sale of certain beauty products, which depend to some extent on
seasonal product changes and seasonal purchasing patterns. Consumer "fads" and
other changes in consumer trends may cause shifts in purchasing patterns,
resulting in significant fluctuations in our operating results from one
quarter to the next. Our limited operating history makes it difficult to fully
assess the impact of these factors.

Limited Insurance Reimbursement Coverage May Reduce Our Ability to Sell
Pharmacy Products Online, Which Would Reduce Our Revenues

To obtain reimbursement on behalf of our customers for the prescription
products that they purchase on our Web site, we need to obtain contracts with
numerous insurance companies and PBMs. Other than our contract with PCS Health
Systems, Inc., which is a 10-year agreement, many of our agreements are short-
term and may be terminated with less than 30 days' prior notice. Our ability
to obtain additional contracts with other insurance companies and PBMs, or
retain our existing contracts for an extended period of time, is uncertain for
the following reasons:

. Many of these companies are in the early stages of evaluating the impact
of the Internet and online pharmacies on their businesses. These
companies may delay their decisions to contract with online pharmacies or
may decide to develop their own Internet capabilities that may compete
with us.

. Many insurance companies have existing contracts with chain drugstores
and PBMs that have announced their intentions to establish online
pharmacies.

. Some insurance companies and PBMs will likely contract with only one or a
limited number of online pharmacies. If our online competitors obtain
these contracts and we do not, we would be at a competitive disadvantage.

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In addition, we must process each insurance application individually, which
may raise the costs of processing prescription orders and delay our order
processing time. Customers may not initially embrace our online insurance
coverage procedure.

We Depend on a Limited Number of Distribution Partners; If They Do Not
Perform, We Will Not Be Able to Effectively Ship Orders

We rely to a large extent on rapid distribution by third parties. We
currently purchase all of our pharmaceutical products from one vendor,
RxAmerica L.L.C. and in the future may be required to purchase all of our
pharmaceutical products from Rite Aid once we establish our own distribution
center. We also purchase a substantial majority of our nonpharmaceutical
products from one vendor, Walsh Distribution, Inc., which accounted for 78% of
our nonpharmaceutical cost of sales from launch of our Web store to July 4,
1999. Our business could also be significantly disrupted if RxAmerica, Rite
Aid or Walsh Distribution were to breach their contracts or suffer adverse
developments that affect their ability to supply products to us. In addition,
RxAmerica is a joint venture owned by American Stores Company (which was
recently acquired by Albertson's, Inc.) and Longs Drugs, both of which are
potential competitors of drugstore.com, and actual competitors with Rite Aid,
one of our principal stockholders and business partners. If for any reason
RxAmerica, Rite Aid or Walsh Distribution is unable or unwilling to supply
products to us in sufficient quantities and in a timely manner, we may not be
able to secure alternative fulfillment partners on acceptable terms in a
timely manner, or at all.

Because we rely on third parties to fulfill orders, we depend on their
systems for tracking inventory and financial data. If our distribution
partners' systems fail or are unable to scale or adapt to changing needs, or
if we cannot integrate information systems with any new distributors, we may
not have adequate, accurate or timely inventory or financial information.

We also rely on third-party carriers for shipments to and from distribution
facilities. We are therefore subject to the risks, including employee strikes
and inclement weather, associated with our distribution partners and of our
carriers' ability to provide product fulfillment and delivery services to meet
our distribution and shipping needs. Failure to deliver products to our
customers in a timely and accurate manner would harm our reputation, the
drugstore.com brand and our results of operations.

Increasing Our Product Distribution Capacity Will Require Significant
Investments in Cash and Management Resources

We expect to establish our own distribution center within the next 12
months to achieve greater control over the distribution process and to ensure
adequate supplies of products to our customers. Opening one or more
distribution centers will require significant capital investments in
facilities and equipment, will require us to hire and train a significant
number of new employees, will require us to establish a significant number of
direct relationships with manufacturers and could divert management attention
from other issues. In addition, we may be unable to obtain products on terms
as favorable as our distribution partners. We will need to develop or license
distribution software to ensure timely and accurate shipments. In addition, if
we establish our own pharmacy operations we will become subject to additional
regulatory requirements and related costs.

To obtain funds for this expansion, we may need to raise funds through the
issuance of equity, equity-related or debt securities or through obtaining
credit from financial institutions in addition to the funds we are raising in
the offering. We cannot be certain that such additional financing will be
available to us on favorable terms when required, or at all. In addition, if
we issue equity or equity-related securities, such issuance would dilute the
ownership interest of existing stockholders and could adversely affect our
stock price.

Pharmacy Errors Could Produce Liability

Pharmacy errors relating to prescriptions, dosage and other aspects of the
medication dispensing process can produce liability for us that our insurance
may not cover. For example, a study of community pharmacies appearing in the
December 1995 issue of American Pharmacy found that 24% of prescriptions
contained

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dispensing errors and 4% of prescriptions contained errors that were
clinically significant. Because we distribute pharmaceutical products directly
to the consumer, we are the most visible participant in the medication
distribution chain and therefore have more exposure to liability claims.

Our pharmacists are required by law to offer counseling, without additional
charge, to our customers about medication, dosage, delivery systems, common
side effects and other information deemed significant by the pharmacists. Our
pharmacists may have a duty to warn customers regarding any potential adverse
effects of a prescription drug if the warning could reduce or negate such
effects. This counseling is in part accomplished through e-mail and inserts
included with the prescription, which may increase the risk of
miscommunication because the customer is not personally present or may not
have provided all relevant information. We also post product information on
our Web store. Providing information on pharmaceutical and other products
creates the potential for claims to be made against us for negligence,
personal injury, wrongful death, product liability, malpractice, invasion of
privacy or other legal theories based on our product or service offerings. Our
general liability, product liability and professional liability insurance may
not cover potential claims of this type or may not be adequate to protect us
from all liability that may be imposed.

Pharmacy Errors Could Produce Adverse Publicity, Which Could Inhibit
Customer Acceptance and Our Revenues

Pharmacy errors either by drugstore.com or our competitors may produce
significant adverse publicity either for us or the entire online pharmacy
industry. Because of the significant amount of recent press coverage on
Internet retailing, we believe that we will be subject to a higher level of
media scrutiny than other pharmacy product channels. The amount of negative
publicity that we or the online pharmacy industry receive as a result of
pharmacy or prescription processing errors could be disproportionate in
relation to the negative publicity received by other pharmacies making similar
mistakes. We have no control over the pharmacy practices of our competitors,
and we cannot ensure that our pharmacists or our prescription processing will
be able to operate without error. We believe customer acceptance of our online
shopping experience is based in large part on consumer trust, and negative
publicity could erode such trust, or prevent it from growing. This could
result in an immediate reduction in the amount of orders we receive and
adversely affect our revenue growth.

We Face the Risk of Systems Interruptions and Capacity Constraints on Our
Web Site, Possibly Resulting in Adverse Publicity, Revenue Losses and
Erosion of Customer Trust

The satisfactory performance, reliability and availability of our recently-
opened Web site, transaction processing systems and network infrastructure are
critical to our reputation and our ability to attract and retain customers and
to maintain adequate customer service levels. Any future systems interruption
that results in the unavailability of our Web site or reduced order
fulfillment performance could result in negative publicity and reduce the
volume of goods sold and the attractiveness of our Web store, which could
negatively affect our revenues. From time to time, we have experienced
temporary system interruptions for a variety of reasons, including power
failures, software bugs and an overwhelming number of visitors trying to reach
our Web site. We may not be able to correct any problem in a timely manner.
Because we outsource certain aspects of our system and because some of the
reasons for a systems interruption may be outside of our control, we also may
not be able to exercise sufficient control to remedy the problem quickly or at
all.

We opened our site for customers in February 1999 and to the extent that
customer traffic grows substantially, we will need to expand the capacity of
our systems to accommodate a larger number of visitors. Any inability to scale
our systems may cause unanticipated system disruptions, slower response times,
degradation in levels of customer service, impaired quality and speed of order
fulfillment, or delays in reporting accurate financial information. We are not
certain that we will be able to project the rate or timing of increases, if
any, in the use of our Web site accurately or in a timely manner to permit us
to effectively upgrade and expand our transaction-processing systems or to
integrate smoothly any newly developed or purchased modules with our existing
systems.

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We Have Grown Very Rapidly, and We Need to Manage Changing and Expanding
Operations

We have rapidly and significantly expanded our operations, and anticipate
that we will continue to expand. From July 1998 to July 4, 1999 we grew from 3
to 245 employees. This growth has placed, and our anticipated future
operations will continue to place, a significant strain on our management
systems and resources. We will not be able to implement our business strategy
in a rapidly evolving market without an effective planning and management
process. We will not be able to increase revenues unless we continue to
improve our transaction-processing, operational, financial and managerial
controls and reporting systems and procedures, expand, train and manage our
work force and manage multiple relationships with third parties. Many of our
senior management have no prior senior management experience at public
companies, and none of our executive officers have prior management experience
in the healthcare or retail drugstore industry.

Expanding the Breadth and Depth of Our Product and Service Offerings Is
Expensive and Difficult, and We May Receive No Benefit From Our Expansion

We intend to expand the breadth and depth of our product and service
offerings by promoting new or complementary products or sales formats. We
cannot be certain that these new offerings will generate sufficient revenues
for the costs involved. Expansion of our offerings in this manner could
require significant additional expenditures and could strain our management,
financial and operational resources. For example, we may need to incur
significant marketing expenses, develop relationships with new fulfillment
partners or manufacturers, or comply with new regulations. We cannot be
certain that we will be able to expand our product and service offerings in a
cost-effective or timely manner. Furthermore, any new product or service
offering or sales format that is not favorably received by consumers could
damage the reputation of our brand. The lack of market acceptance of such
efforts or our inability to generate satisfactory revenues from such expanded
offerings to offset their cost could harm our business.

We have an agreement with Amazon.com that prohibits us from selling
advertising to, linking our Web site to or promoting on our Web site any
company that sells products or services competitive with those which
Amazon.com offers or which Amazon.com is preparing to produce or market. While
we retain the ability to sell products and services in these markets
ourselves, this prohibition would limit our ability to work with other
companies in the markets for books, music products, video products, software,
magazines, consumer electronics, gift centers or registries, and auctions. If
Amazon.com expands into other areas, this expansion may further limit the
number of companies we can promote on our Web site.

Our Limited Relationship With Amazon.com May Restrict Our Activities

Our limited relationship with Amazon.com may restrict our activities and is
subject to change. We entered into a technology license and advertising
agreement in August 1998 with Amazon.com, currently our largest stockholder.
Jeffrey P. Bezos, Amazon.com's chairman of the board and chief executive
officer, is a member of our board of directors. Our relationship with
Amazon.com has received significant media attention, but the parties'
obligations to provide support to each other are limited. Under the agreement,
each party has committed to providing the other with advertising on our
respective Web sites through the term of the agreement.

We have also agreed not to sell advertising on our Web site to, link our
Web site to or promote on our Web site any company that sells products or
services competitive with those which Amazon.com offers or which Amazon.com is
preparing to produce or market. We are currently restricted with respect to
books, music products, video products, gift centers, and auctions. If
Amazon.com expands into other areas, this expansion may further limit the
number of companies we can promote on our Web site. If we were acquired by a
competitor of Amazon.com and Amazon.com did not vote in favor of the
transaction, we would lose our rights to advertise on Amazon.com's Web site
and to use Amazon.com's technology (if we are then using any).

In addition, due to Amazon.com's significant ownership of our common stock,
it will be able to significantly influence all matters requiring approval by
our stockholders, including the election of directors and the approval

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of mergers or other business combination transactions. For more information
about our relationship with Amazon.com, see "Business--Relationship with
Amazon.com." See also "Executive Officers and Directors" for background on
Jeffrey P. Bezos, "Certain Relationships and Related Transactions" for a
description of our agreements with Amazon.com and "Principal Stockholders" for
a description of Amazon.com's stock ownership relative to other stockholders.

Our Relationships with Rite Aid and GNC are Complex and Involve Many Risks
Which May Restrict Our Activities and Ability to Deal with Others

In June 1999, we entered into a series of agreements with Rite Aid and GNC.
These agreements involve many aspects of our business and include the sale of
equity securities to these companies as well as various arrangements relating
to the operation of our respective Web sites, the fulfillment of orders and
the extension of Rite Aid's insurance relationships to cover prescriptions
processed by us. This type of arrangement is complex and will require a great
deal of effort to operate successfully. As a result, there are many risks
related to these arrangements, including some that we may not have foreseen.
It is difficult to assess the likelihood of occurrence of these risks,
including the lack of success of the overall arrangement to meet the parties'
objectives. In the event that we do not realize the intended benefits of these
relationships, we will have expended a great deal of time and effort that
could have been directed to more beneficial activities. In addition, customer
perceptions and our business may be adversely impacted if these relationships
are not successful.

We must integrate Rite Aid's pharmacy product ordering system with our Web-
based systems so consumers can order their pharmacy products on our Web site
and pick them up at a Rite Aid store. Integrating different information
systems is technically difficult and may be delayed, which would delay our
receipt of revenues from these sales and could adversely affect customer
acceptance of online pharmacy orders. While Rite Aid has committed to
promoting drugstore.com in its stores and in its advertising, we do not
control the choice of ads that will feature us and this form of advertising
may not result in additional drugstore.com customers. While the Rite Aid
relationship substantially broadens our ability to provide prescription
medications to consumers with insurance reimbursement plans, it may not allow
all of our potential customers to purchase these medications from
drugstore.com and receive insurance reimbursement, which could adversely
affect consumer perceptions and our revenues.

We have agreed not to promote any other traditional chain drugstore or
operate one ourselves. We have also agreed not to contract with another
traditional retail store to fill pharmacy product orders we receive unless a
Rite Aid store is not conveniently located. These restrictions could limit our
flexibility and ability to grow our business if our relationship with Rite Aid
does not develop successfully.

Due to Rite Aid's significant ownership of our common stock, it will be
able to significantly influence all matters requiring approval by our
stockholders, including the election of directors and the approval of mergers
or other business combination transactions.

For more information about our relationships with Rite Aid and GNC, see
"Business--Relationships with Rite Aid" and "Business--Relationship with GNC."
See also "Certain Relationships and Related Transactions" for a description of
our agreements with Rite Aid and GNC and "Principal Stockholders" for a
description of Rite Aid's and GNC's stock ownership relative to other
stockholders.

We Depend on Strategic Relationships to Attract Customers

We believe that our ability to attract customers, facilitate broad market
acceptance of our products and the drugstore.com brand and enhance our sales
and marketing capabilities depends on our ability to develop and maintain
strategic relationships with portals, distributors, Amazon.com, Rite Aid and
GNC. If we are unable to develop or maintain key relationships, we may have
difficulty attracting customers.

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We Face Uncertainty Related to Pharmaceutical Costs and Pricing, Which
Could Affect Our Revenues and Margins

We expect that pharmacy sales will account for a significant percentage of
our total sales. Sales of our products will depend in part on the availability
of reimbursement from third-party payors such as government health
administration authorities, private health insurers, health maintenance
organizations (HMOs), PBMs and other organizations. Because these
organizations are traditionally focused on reduced cost to employer groups,
whereas we are focused more on direct customer service, we must devote time
and resources to develop third-party payor confidence in our approach.

In addition, third-party payors are increasingly challenging the price and
cost-effectiveness of medical products and services. The efforts of third-
party payors to contain costs will place downward pressures on gross margins
from sales of prescription drugs. Our revenues from prescription drug sales
may also be affected by health care reform initiatives of federal and state
governments, including proposals designed to significantly reduce spending on
Medicare, Medicaid and other government programs, changes in programs
providing for reimbursement for the cost of prescription drugs by third-party
payors and regulatory changes related to the approval process for prescription
drugs. Such initiatives could lead to the enactment of federal and state
regulations that may adversely impact our prescription drug sales.

We cannot be certain that our products or services will be considered cost
effective or that adequate third-party reimbursement will be available to
enable us to maintain price levels sufficient to realize adequate profit
margins.

We Face Intense Competition From Both Traditional Retailers and Online
Stores

We compete in a market that is highly competitive and expect competition to
intensify in the future. We currently or potentially compete with a variety of
companies, many of which have significantly greater financial, technical,
marketing and other resources. These competitors include (1) various online
stores that sell pharmaceutical as well as over-the-counter drug and health,
wellness, beauty and personal care items; (2) PBMs that sell pharmaceuticals
directly; and (3) existing drugstores. Most of these drugstores, which include
national, regional and local drugstore chains, discount drugstores,
supermarkets, combination food and drugstores, discount general merchandise
stores, mass market retailers, independent drugstores and local merchants,
have existed for a longer period, have greater financial resources, have
established marketing relationships with leading manufacturers and
advertisers, and have secured greater presence in distribution channels. Some
of these companies may also commence or expand their presence on the Internet.
We also compete with hospitals, HMOs and mail order prescription drug
providers, all of whom are or may begin offering products and services over
the Internet. Finally, we are aware of numerous other smaller entrepreneurial
companies that are focusing significant resources on developing and marketing
products and services that will compete directly with those offered at
drugstore.com.

We believe that there may be a significant advantage in establishing a
large customer base before our competitors do so. If we fail to attract and
retain a large customer base and our competitors establish a more prominent
market position relative to ours, this could inhibit our ability to grow.

We also believe we may face a significant competitive challenge from our
competitors forming alliances with each other. For instance, one of our direct
online competitors may form a partnership with a major PBM, major HMO or chain
drugstore. The combined resources of these partnerships could pose a
significant competitive challenge to drugstore.com. In addition, certain PBMs
and HMOs could form alliances with our competitors that would prevent them
from also entering into relationships with drugstore.com. Our inability to
partner with a major PBM or HMO could be a major competitive disadvantage to
us.

We believe the principal factors that will draw end users to an online
shopping application include brand availability, selection, personalized
services, convenience, price, accessibility, customer services, quality of
search tools, quality of content, and reliability and speed of fulfillment for
products ordered. We will have little or no control over how successful our
competitors are in addressing these factors. In addition, with little
difficulty, our online competitors can duplicate many of the products,
services and content offered on our site.

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Increased competition could result in price reductions, fewer customer
orders, fewer search queries served, reduced gross margins and loss of market
share.

Our Systems and Operations, and Those of Our Distributors, Are Vulnerable
to Natural Disasters and Other Unexpected Problems

Substantially all of our computer and communications hardware is located at
our leased facility in Bellevue, Washington and our systems infrastructure is
hosted at an Exodus Communications facility in Tukwila, Washington. Our
systems and operations are vulnerable to damage or interruption from fire,
flood, power loss, telecommunications failure, earthquakes and similar events.
In addition, our servers are vulnerable to computer viruses, physical or
electronic break-ins and similar disruptions, which could lead to
interruptions, delays, loss of data or the inability to accept and fulfill
customer orders. We do not currently have redundant systems or a formal
disaster recovery plan and do not carry sufficient business interruption
insurance to compensate for losses that may occur. Our current fulfillment
partners, Walsh and RxAmerica, are both located in Texas and also face these
risks. In particular, RxAmerica only has a single location and no back-up
facility.

We depend on the efficient operation of Internet connections from customers
to our systems. These connections, in turn, depend on the efficient operation
of Web browsers, Internet service providers and Internet backbone service
providers, all of which have had periodic operational problems or experienced
outages. Any system delays, failures or loss of data, whatever the cause,
could reduce customer satisfaction with our applications and services and harm
our sales.

We retain confidential customer and patient information in our processing
centers. Therefore, it is critical that our facilities and infrastructure
remain secure and that our facilities and infrastructure are perceived by the
marketplace to be secure. A material security breach could damage our
reputation or result in liability to us.

Governmental Regulation of the Healthcare and Pharmacy Industries Could
Affect Our Business

Our business is subject to extensive federal, state and local regulations,
many of which are specific to pharmacies and the sale of over-the-counter
drugs. Please see "Business--Governmental Regulation" for detailed information
about these regulations. Regulations in this area often require subjective
interpretation, and we cannot be certain that our attempts to comply with
these regulations will be deemed sufficient by the appropriate regulatory
agencies. Violations of any regulations could result in various civil and
criminal penalties, including suspension or revocation of our licenses or
registrations, seizure of our inventory, or monetary fines, which could
adversely effect our operations.

We are also subject to laws and regulations regarding homeopathic drugs,
and we may face enforcement actions, lawsuits or claims asserting that we have
not complied with these laws and regulations. As we expand our product and
service offerings, more of our products and services will likely be subject to
regulation by the FDA, which regulates drug advertising and promotion.
Complying with FDA regulations is time consuming, burdensome and expensive,
and could delay our introduction of new products or services.

The U.S. House of Representatives Committee on Commerce and the General
Accounting Office are currently investigating online pharmacies and online
prescribing. We believe that any regulations resulting from the investigations
will likely result in increased reporting and monitoring requirements, which
could increase our expenses. Other legislation and regulations currently being
considered at the federal and state level could affect our business, including
legislation or regulations relating to confidentiality of patient records,
electronic access and storage as well as the inclusion of prescription drugs
as a Medicare benefit. In addition, various state legislatures are considering
new legislation related to the regulation of nonresident pharmacies.
Compliance with new laws or regulations could increase our expenses.

The Health Insurance Portability and Accountability Act of 1996 mandates
the use of standard transactions, standard identifiers, security and other
provisions by the year 2000. Regulations have been proposed to

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implement these requirements, and we are designing our applications to comply
with the proposed regulations. However, until these regulations become final,
possible changes in these regulations could cause us to use additional
resources and lead to delays as we revise our Web site and operations.

Until recently, Health Care Financing Administration guidelines prohibited
transmission of Medicare eligibility information over the Internet. We are
also subject to extensive regulation relating to the confidentiality and
release of patient records. Additional legislation governing the distribution
of medical records exists or has been proposed at both the state and federal
level. It may be expensive to implement security or other measures designed to
comply with any new legislation. Moreover, we may be restricted or prevented
from delivering patient records electronically. This could have an adverse
impact on our ability to gain and retain customers.

We are assisting the National Association of Boards of Pharmacy (NABP), a
coalition of state pharmacy boards, in developing a program, the Verified
Internet Pharmacy Practice Sites (VIPPS), as a model for self-regulation for
online pharmacies. We intend to comply with the VIPPS criteria for
certification, and compliance with these requirements could require
substantial expenses, which could increase our losses.

We Must Attract and Retain Experienced Personnel and We Rely on Senior
Management

We intend to continue to hire a significant number of additional sales,
support and marketing personnel, as well as pharmacists and software
developers. Competition for these individuals is intense, and we may not be
able to attract, assimilate or retain additional highly qualified personnel in
the future. Our future success also depends upon the continued service of our
executive officers and senior management. None of our employees is bound by an
employment agreement for any specific term. We do not have "key person" life
insurance policies covering any of our employees. In addition, none of the
members of our senior management team have prior experience in the healthcare
industry or in drugstore operations.

Protection of Our Intellectual Property Is Limited and Uncertain

We rely or may in the future rely on a combination of patent, trademark,
trade secret and copyright law and contractual restrictions to protect the
proprietary aspects of our technology. These afford only limited protection
for our intellectual property and trade secrets. Despite our efforts to
protect our proprietary rights, unauthorized parties may attempt to copy
aspects of our sales formats or to obtain and use information that we regard
as proprietary.

In February 1999, we filed an application for a U.S. trademark registration
for "drugstore.com." We may be unable to secure this registration. It is also
possible that our competitors or others will adopt service names similar to
ours, thereby impeding our ability to build brand identity and possibly
leading to customer confusion. In addition, there could be potential trade
name or trademark infringement claims brought by owners of other registered
trademarks or trademarks that incorporate variations of the term
drugstore.com. Any claims or customer confusion related to our trademark, or
our failure to obtain trademark registration, would negatively affect our
business.

Litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets and domain name and determine
the validity and scope of the proprietary rights of others. If third parties
prepare and file applications in the United States that claim trademarks used
or registered by us, we may oppose those applications and be required to
participate in proceedings before the U.S. Patent and Trademark Office to
determine priority of rights to the trademark, which could result in
substantial costs to us. Any litigation or adverse priority proceeding could
result in substantial costs and diversion of resources and could seriously
harm our business and operating results. Finally, we may in the future sell
our products internationally, and the laws of many countries do not protect
our proprietary rights to as great an extent as do the laws of the United
States. Many countries have a "first-to-file" trademark registration system.
As a result, we may be prevented from registering or using our trademarks in
certain countries if third parties have previously filed applications to
register or have registered the same or similar trademark. Our means of
protecting our proprietary rights may not be adequate, and our competitors
could independently develop similar technology.

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We May Not Be Able to Protect Our Domain Names

We currently hold the Internet domain name "drugstore.com," as well as
various other related names. Domain names generally are regulated by Internet
regulatory bodies. The regulation of domain names in the United States and in
foreign countries is subject to change. Regulatory bodies could establish
additional top-level domains, appoint additional domain name registrars or
modify the requirements for holding domain names. As a result, we may not
acquire or maintain the "drugstore.com" domain name in all of the countries in
which we conduct business.

The relationship between regulations governing domain names and laws
protecting trademarks and similar proprietary rights is unclear. Therefore, we
could be unable to prevent third parties from acquiring domain names that
infringe or otherwise decrease the value of our trademarks and other
proprietary rights.

We May Face Liability for Content on Our Web Site

Because we post product information and other content on our Web site, we
face potential liability for negligence, copyright, patent, trademark,
defamation, indecency and other claims based on the nature and content of the
materials that we post. Such claims have been brought, and sometimes
successfully pressed, against Internet content distributors. In addition, we
could be exposed to liability with respect to the unauthorized duplication of
content or unauthorized use of other parties' proprietary technology. Although
we maintain general liability insurance, our insurance may not cover potential
claims of this type or may not be adequate to indemnify us for all liability
that may be imposed. Any imposition of liability that is not covered by
insurance or is in excess of insurance coverage could harm our business.

We May Be Found to Infringe Proprietary Rights of Others

Third parties may claim infringement by us with respect to past, current or
future technologies. We expect that participants in our markets will be
increasingly subject to infringement claims as the number of services and
competitors in our industry segment grows. Any such claim, whether meritorious
or not, could be time-consuming, result in costly litigation, cause service
upgrade delays or require us to enter into royalty or licensing agreements.
Such royalty or licensing agreements might not be available on terms
acceptable to us or at all.

We Face Additional Potential Stock-Based Compensation Related to Our
Relationship with TriNet

In August 1998, we began a co-employment arrangement involving all of our
personnel with TriNet VCO, an independent company. Under the co-employment
arrangement, we pay a percentage of compensation per co-employee (in addition
to compensation costs) to TriNet to cover payroll processing and related taxes
and insurance. On March 31, 1999, the Financial Accounting Standards Board
(FASB) issued an Exposure Draft of a FASB Interpretation, Accounting for
Certain Transactions involving Stock Compensation-- an interpretation of APB
Opinion No. 25. Such FASB Exposure Draft, if adopted in its current form,
could be interpreted to indicate that employees subject to co-employment
arrangements, would not be considered our employees for purposes of applying
APB No. 25. On June 2, 1999, we terminated this co-employment arrangement. If
additional clarification regarding the definition of an employee is not
provided in the final pronouncement, we may be required to establish a new
measurement date for stock options granted after December 15, 1998 to these
employees for the purpose of accounting for stock options under APB No. 25. If
a new measurement date is required to be established, we would recognize the
deferred stock-based compensation which would be amortized as stock-based
compensation over the remaining vesting periods of the options. We estimate
that this charge would aggregate approximately $4.2 million, which would be
recognized beginning with the fourth quarter of fiscal 1999, the estimated
date the final pronouncement will be effective, and ending in 2004.

Year 2000 Issues Could Affect Our Business

Any failure of our material systems, our vendors' material systems or the
Internet to be year 2000 compliant would have material adverse consequences
for us. Such consequences would include difficulties in operating our

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Web site effectively, taking product orders, making product deliveries or
conducting other fundamental parts of our business. We are currently assessing
the year 2000 readiness of the software, computer technology and other
services that we use which may not be year 2000 compliant. At this time, we
have not yet developed a contingency plan to address situations that may
result if our vendors or we are unable to achieve year 2000 compliance. The
cost of developing and implementing such a plan, if necessary, could be
significant. We also understand that at least one of our distributors,
RxAmerica, has not yet completed its assessment of the year 2000 readiness of
its software, computer technology and other services or finalized any
contingency plan to address year 2000 problems that may arise.

We also depend on the year 2000 compliance of the computer systems and
financial services used by consumers. A significant disruption in the ability
of consumers to reliably access the Internet or portions of it or to use their
credit cards would have an adverse effect on demand for our products and
services. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Year 2000" for a further description of the issues we
face with regard to the year 2000.

We Are Controlled by Officers, Directors and Existing Stockholders

Executive officers, directors and entities affiliated with them will, in
the aggregate, beneficially own approximately 58.6% of our outstanding common
stock following the completion of this offering. These stockholders, if acting
together, would be able to significantly influence all matters requiring
approval by our stockholders, including the election of directors and the
approval of mergers or other business combination transactions. In addition,
after this offering, Amazon.com will beneficially own approximately 27.4% and
Rite Aid will beneficially own 21.8%, of our outstanding common stock.
Therefore, Amazon.com and Rite Aid will each be able to significantly
influence all matters requiring approval by our stockholders, including the
election of directors and the approval of mergers or other business
combination transactions. Amazon.com's and Rite Aid's substantial equity
stakes in drugstore.com could also make us a much less attractive acquisition
candidate to potential acquirors, because either Amazon.com or Rite Aid alone
could have sufficient votes to prevent the tax-free treatment of an
acquisition. See "Principal Stockholders" for a description of Amazon.com's
and Rite Aid's stock ownership relative to other stockholders.

Our Net Sales Would Be Harmed if We Experience Significant Credit Card
Fraud

A failure to adequately control fraudulent credit card transactions would
harm our net sales and results of operations because we do not carry insurance
against this risk. Under current credit card practices, we are liable for
fraudulent credit card transactions because we do not obtain a cardholder's
signature.

Certain Antitakeover Provisions and Significant Equity Ownership by
Amazon.com and Rite Aid Could Preclude an Acquisition

Provisions of our certificate of incorporation, bylaws, Washington law and
Delaware law could make it more difficult for a third party to acquire us,
even if doing so would be beneficial to our stockholders. Further, because
Amazon.com and Rite Aid each own a significant percentage of our capital
stock, a competitor of Amazon.com or Rite Aid as well as other potential
acquirors could determine not to merge with or acquire us. In addition, if we
were acquired by an Amazon.com competitor and Amazon.com did not vote in favor
of the transaction, we would lose our rights to promotional placements on
Amazon.com's website, and to use Amazon.com's technology (if we are then using
any). The potential loss of these rights could inhibit offers to acquire us.

Risks Related to Internet Commerce

We Depend on Continued Use of the Internet and Growth of the Online
Drugstore Market

Our future revenues and profits, if any, substantially depend upon the
widespread acceptance and use of the Internet as an effective medium of
business and communication by our target customers. Rapid growth in the

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use of and interest in the Internet has occurred only recently. As a result,
acceptance and use may not continue to develop at historical rates, and a
sufficiently broad base of consumers may not adopt, and continue to use, the
Internet and other online services as a medium of commerce.

In addition, the Internet may not be accepted as a viable long-term
commercial marketplace for a number of reasons, including potentially
inadequate development of the necessary network infrastructure or delayed
development of enabling technologies and performance improvements. Our success
will depend, in large part, upon third parties maintaining the Internet
infrastructure to provide a reliable network backbone with the speed, data
capacity, security and hardware necessary for reliable Internet access and
services.

Further, the online market for drugstore products is in its infancy. The
market is significantly less developed than the online market for books,
auctions, music, software and numerous other consumer products. Even if use of
the Internet and electronic commerce continues to increase, the rate of
growth, if any, of the online drugstore market could be significantly less
than the online market for other products. Our rate of revenue growth could
therefore be significantly less than other online merchants.

Our Sales Could be Negatively Affected if We Are Required to Charge Taxes
on Purchases

We do not collect sales or other similar taxes in respect of goods sold by
drugstore.com, except from purchasers located in Washington and Texas.
However, one or more states or the federal government may seek to impose sales
tax collection obligations on out-of-state companies (such as drugstore.com)
which engage in or facilitate online commerce, and a number of proposals have
been made at the state and local level that would impose additional taxes on
the sale of goods and services through the Internet. Such proposals, if
adopted, could substantially impair the growth of electronic commerce, and
could adversely affect our opportunity to derive financial benefit from such
activities. Moreover, a successful assertion by one or more states or the
federal government that we should collect further sales or other taxes on the
sales of products through drugstore.com could negatively affect our revenues
and business.

If We Do Not Respond to Rapid Technological Changes, Our Services Could
Become Obsolete and Our Business Would Be Seriously Harmed

As the Internet and online commerce industry evolve, we must license
leading technologies useful in our business, enhance our existing services,
develop new services and technology that address the increasingly
sophisticated and varied needs of our prospective customers and respond to
technological advances and emerging industry standards and practices on a
cost-effective and timely basis. We may not be able to successfully implement
new technologies or adapt our Web store, proprietary technology and
transaction-processing systems to customer requirements or emerging industry
standards. If we are unable to do so, it could adversely impact our ability to
build the drugstore.com brand and attract and retain customers.

Governmental Regulation of the Internet and Data Transmission Over the
Internet Could Affect Our Business

Laws and regulations directly applicable to communications or commerce over
the Internet are becoming more prevalent. The most recent session of the U.S.
Congress resulted in Internet laws regarding children's privacy, copyrights,
taxation and the transmission of sexually explicit material. The European
Union recently enacted its own privacy regulations. In particular, many
government agencies and consumers are focused on the privacy and security of
medical and pharmaceutical records. The law of the Internet, however, remains
largely unsettled, even in areas where there has been some legislative action.
It may take years to determine whether and how existing laws such as those
governing privacy, libel and taxation apply to Internet stores such as ours.
The rapid growth and development of the market for online commerce may prompt
calls for more stringent consumer protection laws, both in the United States
and abroad, that may impose additional burdens on companies conducting
business online and in particular companies that fill prescriptions maintain
medical or pharmaceutical records. The adoption or modification of laws or
regulations relating to the Internet business could adversely affect our
ability to attract and serve customers.

19
<PAGE>

Risks Related to this Offering

Our Stock Price Will Fluctuate After This Offering, Which Could Result in
Substantial Losses for Investors

Although the initial public offering price will be determined based on
several factors, the market price for our common stock will vary from the
initial offering price after this offering. This could result in substantial
losses for investors. The market price of our common stock may fluctuate
significantly in response to a number of factors, some of which are beyond our
control. These factors include:

. Quarterly variations in operating results;

. Changes in financial estimates by securities analysts;

. Announcements by us or our competitors, of new products, significant
contracts, acquisitions or strategic relationships;

. Publicity about our company, our products and services, our competitors,
or e-commerce in general;

. Additions or departures of key personnel;

. Any future sales of our common stock or other securities; and

. Stock market price and volume fluctuations of publicly-traded companies
in general and Internet-related companies in particular.

The trading prices of Internet-related companies and e-commerce companies
in particular have been especially volatile and many are at or near historical
highs. Investors may be unable to resell their shares of our common stock at
or above the offering price. In the past, securities class action litigation
has often been brought against a company following periods of volatility in
the market price of its securities. We may be the target of similar litigation
in the future. Securities litigation could result in substantial costs and
divert management's attention and resources, which could seriously harm our
business and operating results.

Future Sales of Shares by Existing Stockholders Could Affect Our Stock
Price

If our stockholders sell substantial amounts of our common stock in the
public market following this offering, the market price of our common stock
could fall, potentially resulting in substantial losses to investors. Such
sales also might make it more difficult for us to sell equity or equity-
related securities in the future at a time and price that we deem appropriate.
Based on shares outstanding as of July 4, 1999, upon completion of this
offering, we will have outstanding 42,791,000 shares of common stock, assuming
no exercise of the underwriters' over-allotment option. Other than the shares
of common stock sold in this offering, no shares will be eligible for sale in
the public market immediately. Holders of 37,791,000 shares will be subject to
agreements with the underwriters or us that restrict their ability to transfer
their stock for 180 days from the date of this prospectus. After these
agreements expire, an additional 17,769,268 shares will be eligible for sale
in the public market assuming no exercise of options. See "Shares Eligible for
Future Sale" for a further description regarding shares that will become
eligible for sale at future dates after this offering.

New Stockholders Will Incur Substantial Dilution as a Result of This
Offering

The initial public offering price is expected to be substantially higher
than the book value per share of our outstanding common stock. As a result,
investors purchasing common stock in this offering will incur immediate
substantial dilution. In addition, we have issued options to acquire common
stock at prices significantly below the initial public offering price. To the
extent such outstanding options are ultimately exercised, there will be
further dilution to investors in this offering. See "Dilution" for a more
detailed description of how new stockholders will incur dilution.

20
<PAGE>

Special Note Regarding Forward-Looking Statements

This prospectus contains forward-looking statements. These statements
relate to future events or our future financial performance. In some cases,
you can identify forward-looking statements by terminology such as may, will,
should, expect, plan, intend, anticipate, believe, estimate, predict,
potential or continue, the negative of such terms or other comparable
terminology. These statements are only predictions. Actual events or results
may differ materially. In evaluating these statements, you should specifically
consider various factors, including the risks outlined in the Risk Factors
section above. These factors may cause our actual results to differ materially
from any forward-looking statement.

Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of the
forward-looking statements. We are under no duty to update any of the forward-
looking statements after the date of this prospectus to conform such
statements to actual results or to changes in our expectations.

21
<PAGE>

SALE OF SHARES TO AMAZON.COM

Concurrently with the closing of this offering, we are selling in a
separate private placement transaction a number of shares of our common stock
equal to $10,000,000 divided by the initial public offering price to
Amazon.com at a price per share equal to the initial public offering price.
Such offering is made in connection with a letter agreement we entered into
with Amazon.com. As of July 4, 1999, Amazon.com owned 10,733,523 shares of our
capital stock. Jeffrey P. Bezos, chairman of the board and chief executive
officer of Amazon.com, is a director of drugstore.com. See "Business--
Relationship with Amazon.com," "Management," "Certain Relationships and
Related Transactions" and "Principal Stockholders" for further discussion of
our relationship with Amazon.com.

USE OF PROCEEDS

Our net proceeds from the sale of the shares of common stock we are
offering hereby are estimated to be $45.5 million, assuming an initial public
offering price of $10.00 per share and after deducting the estimated
underwriting discounts and commissions and estimated offering expenses. If the
underwriters' over-allotment option is exercised in full, we estimate that our
net proceeds will be approximately $52.4 million.

The principal purposes of this offering are to increase our working
capital, to create a public market for our common stock, to facilitate our
future access to the public capital markets, and to increase our visibility in
the retail marketplace. We expect to use up to approximately 50% of the net
proceeds of this offering for capital expenditures associated with technology
and system upgrades and the establishment of our distribution operations. We
have no specific plans for the remaining proceeds. The remainder of the net
proceeds will be used for general corporate purposes and working capital. This
allocation is only an estimate and we may adjust it as necessary to address
our operational needs in the future. We may also use a portion of the net
proceeds to acquire complementary technologies or businesses; however, we
currently have no commitments or agreements and are not involved in any
negotiations with respect to any such transactions. Pending use of the net
proceeds of this offering, we intend to invest the net proceeds in interest-
bearing, investment grade securities.

DIVIDEND POLICY

We have never declared or paid cash dividends on our capital stock. We
currently intend to retain all available funds and any future earnings for use
in the operation and expansion of our business and do not anticipate paying
any cash dividends in the foreseeable future.

22
<PAGE>

CAPITALIZATION

The following table sets forth our capitalization as of July 4, 1999 on an
actual, pro forma and pro forma as adjusted basis:

. The "actual" column reflects our capitalization as of July 4, 1999,
without any adjustments to reflect subsequent events or anticipated
events;

. The "pro forma" column reflects the issuance of 12,282,599 shares of
Series E preferred stock issued in July 1999 in exchange for $10 million
in cash and other consideration, including exclusive advertising
commitments and other obligations valued at $112.8 million based on the
estimated fair value of $10.00 per share; and

. The "pro forma as adjusted" column reflects our capitalization as of
July 4, 1999 with adjustments to give effect to (1) the conversion of
all shares of outstanding preferred stock into 34,468,000 shares of
common stock upon the closing of this offering; (2) the receipt of the
estimated proceeds from the sale of our common stock offered hereby
(after deducting the estimated offering expenses and underwriting
discounts and commissions), including the sale of shares of our common
stock to Amazon.com; and (3) the change in the par value and the
authorized number of shares and upon the completion of this offering.

This table should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the
consolidated financial statements and related notes thereto included elsewhere
in this prospectus.
<TABLE>
<CAPTION>
At July 4, 1999
---------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- ----------- -----------
(unaudited) (unaudited)
(in thousands)
<S> <C> <C> <C>
Capital lease obligations, less current
portion..................................... $ 1,099 $ 1,099 $ 1,099
Stockholders' equity:
Convertible preferred stock, $.001 par value
actual and pro forma, $.0001 pro forma as
adjusted; authorized 60,000,000 shares
actual and pro forma and 10,000,000 shares
pro forma as adjusted
Series A--issued and outstanding: 10,000,000
shares actual and pro forma and none pro
forma as adjusted.......................... 7,986 7,986 --
Series B--issued and outstanding: 5,446,268
shares actual and pro forma and none pro
forma as adjusted.......................... 18,237 18,237 --
Series C--issued and outstanding: 4,472,844
shares actual and pro forma and none pro
forma as adjusted.......................... 34,981 34,981 --
Series D--issued and outstanding: 2,266,289
shares actual and pro forma and none pro
forma as adjusted.......................... 44,982 44,982 --
Series E--issued and outstanding: none
actual, 12,282,599 shares pro forma and
none pro forma as adjusted................. -- 122,826 --
Common stock, $.001 par value actual and pro
forma, $.0001 pro forma as adjusted;
authorized 250,000,000 actual, pro forma
and pro forma as adjusted; issued and
outstanding 2,323,000 shares actual and pro
forma and 42,791,000 pro forma as adjusted
(1)........................................ 2 2 4
Additional paid-in capital.................. 9,109 9,109 293,569
Deferred stock-based compensation........... (6,197) (6,197) (6,197)
Accumulated deficit......................... (36,536) (36,536) (36,536)
-------- -------- --------
Total stockholders' equity............... 72,564 195,390 250,840
-------- -------- --------
Total capitalization................... $ 73,663 $196,489 $251,939
======== ======== ========
</TABLE>
- --------

(1) Excludes (a) 8,319,000 shares of common stock reserved for issuance under
drugstore.com's stock option and stock purchase plans, of which 3,032,809
shares were subject to outstanding options as of July 4, 1999 at a
weighted average exercise price of $1.77 per share, (b) 10,000 shares of
common stock issuable upon exercise of an outstanding warrant at an
exercise price of $7.83 per share and (c) 750,000 shares issuable to the
underwriters at their option to cover over-allotments of shares and (d)
the anticipated issuance of 200,000 shares common stock to a charitable
foundation that we intend to establish. See "Management--Incentive Stock
Plans," "Description of Capital Stock" and Note 5 and 7 of Notes to
Consolidated Financial Statements.

23
<PAGE>

DILUTION

The pro forma net tangible book value of drugstore.com as of July 4, 1999
was $67.3 million or approximately $2.75 per share. Pro forma net tangible
book value per share represents the amount of drugstore.com's total tangible
assets less total liabilities, divided by the number of shares of common stock
outstanding, after giving effect to the conversion of all shares of
outstanding preferred stock into 22,185,401 shares of common stock upon the
closing of this offering. Dilution in pro forma net tangible book value per
share represents the difference between the amount per share paid by
purchasers of shares of common stock in the offering made hereby and the net
tangible book value per share of common stock immediately after the completion
of this offering. After giving effect to (1) the sale of the shares of common
stock offered by us hereby at an assumed initial public offering price of
$10.00 per share and after deducting the underwriting discount and estimated
offering expenses payable by us, (2) the issuance of 12,282,599 shares of
Series E preferred stock issued in July 1999 in exchange for $10 million in
cash and other consideration, including exclusive advertising commitments and
other obligations valued at $112.8 million based on the estimated fair value
of $10.00 per share and (3) the sale of $10,000,000 of shares of common stock
to Amazon.com at an assumed initial public offering price of $10.00 per share,
the net tangible book value of drugstore.com at July 4, 1999 would have been
$132.8 million or approximately $3.10 per share. This represents an immediate
increase in net tangible book value of $.35 per share to existing stockholders
as of July 4, 1999 and an immediate dilution of $6.90 per share to new
investors of common stock in this offering. The following table illustrates
this dilution on a per share basis:

<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................. $10.00
Pro forma net tangible book value per share as of July 4,
1999......................................................... $2.75
Decrease per share attributable to Series E preferred
stockholders................................................. (.65)
Increase per share attributable to Amazon.com................. .21
Increase per share attributable to new investors(1)........... .79
-----
Net tangible book value per share after the offering and the
sale of shares to Amazon.com(1)................................ 3.10
------
Dilution per share to new investors(1).......................... $ 6.90
======
</TABLE>
- --------

(1) This table excludes (a) 8,319,000 shares of common stock reserved for
issuance under drugstore.com's stock option and stock purchase plans, of
which 3,032,809 shares were subject to outstanding options as of July 4,
1999 at a weighted average exercise price of $1.77 per share, (b) 10,000
shares of common stock issuable upon exercise of outstanding warrants at
an exercise price of $7.83 per share, (c) 750,000 shares issuable to
underwriters at their option to cover over-allotment of shares and (d)
excludes the anticipated issuance of 200,000 shares of common stock to a
charitable foundation that we intend to establish. See "Capitalization,"
"Management--Incentive Stock Plans," "Description of Capital Stock" and
Note 5 and 7 of Notes to Consolidated Financial Statements.

The following table sets forth, as of July 4, 1999, the differences between
the number of shares of common stock purchased from drugstore.com, the total
consideration paid and the average price per share paid by existing holders of
common and preferred stock, by Amazon.com and by the new investors, before
deducting the underwriting discount and estimated offering expenses payable by
drugstore.com, at the assumed initial public offering price of $10.00 per
share.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
--------------------- ----------------------- Price
Number Percentage Amount Percentage Per Share
---------- ---------- ------------ ---------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockhold-
ers(1)................. 24,508,401 57.3% $106,359,000 36.8% $4.34
Series E stockholders... 12,282,599 28.7 122,826,000 42.5 10.00
Amazon.com.............. 1,000,000 2.3 10,000,000 3.4 10.00
New investors(1)........ 5,000,000 11.7 50,000,000 17.3 10.00
---------- ----- ------------ -----
Total................. 42,791,000 100.0% $289,185,000 100.0%
========== ===== ============ =====
</TABLE>
- --------
(1) The number of shares held by new public investors will be 5,000,000 or
approximately 11.7% (5,750,000 shares, or approximately 13.2%, if the
underwriters' over-allotment option is exercised in full) of the total
number of shares of common stock outstanding after this offering. See
"Principal Stockholders."

24
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements of
drugstore.com and the Notes thereto included elsewhere in this prospectus. The
consolidated statement of operations data set forth below for the period from
April 2, 1998 (inception) to December 31, 1998 and the selected consolidated
balance sheet data as of December 31, 1998 have been derived from the audited
financial statements of drugstore.com included elsewhere in this prospectus,
which have been audited by Ernst & Young LLP, Independent Auditors. The
unaudited financial data as of July 4, 1999 and for the periods ended June 30,
1998 and July 4, 1999 are derived from unaudited consolidated financial
statements. The unaudited financial statements include all adjustments,
consisting of normal recurring accruals, which we consider necessary for a
fair presentation of the results of operations for this period. The historical
results are not necessarily indicative of results to be expected for any
future period. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

<TABLE>
<CAPTION>
Period from Period from Six Months
April 2, 1998 April 2, 1998 Ended
(Inception) to (Inception) to July 4,
December 31, 1998 June 30, 1998 1999
----------------- -------------- -----------
(unaudited) (unaudited)
(in thousands, except share
and per share data)
<S> <C> <C> <C>
Consolidated Statement of
Operations Data:
Net sales......................... $ -- $ -- $ 4,202
Cost of sales..................... -- -- 5,551
--------- ------- ----------
Gross profit (loss)............. -- -- (1,349)
Operating expenses:
Marketing and sales............. 3,092 -- 16,517
Product development............. 2,178 104 5,942
General and administrative...... 1,894 79 3,955
Amortization of stock-based
compensation................... 500 39 2,276
--------- ------- ----------
Total operating expenses...... 7,664 222 28,690
--------- ------- ----------
Operating loss.................... (7,664) (222) (30,039)
Other income (expense):
Interest income................. 177 -- 1,033
Interest expense................ (3) -- (40)
--------- ------- ----------
Net loss.......................... $ (7,490) $ (222) $ (29,046)
========= ======= ==========
Basic and diluted net loss per
share............................ $ (13.71) $ (4.42) $ (28.95)
========= ======= ==========
Pro forma basic and diluted net
loss per share(1)................ $ (.92) $ (.45) $ (1.40)
========= ======= ==========
Weighted average shares
outstanding used to compute
basic and diluted net loss per
share............................ 546,149 50,211 1,003,152
========= ======= ==========
Weighted average shares
outstanding used to compute
pro forma basic and diluted net
loss per share(1)................ 8,167,570 494,031 20,796,875
========= ======= ==========
<CAPTION>
December 31, July 4,
1998 1999
-------------- -----------
(in thousands)
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents........................... $14,408 $ 68,087
Working capital..................................... 17,050 60,734
Total assets........................................ 22,517 84,736
Capital lease obligations, less current portion..... 975 1,099
Total stockholders' equity.......................... 19,347 72,564
</TABLE>
- --------
(1) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the determination of the number of weighted average shares
used to compute pro forma net loss per share amounts.

25
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the
Consolidated Financial Statements and the related Notes contained elsewhere in
this prospectus. The following discussion contains forward-looking statements
that involve risks and uncertainties. Our actual results could differ
materially from the results contemplated by these forward-looking statements
as a result of certain factors, including those discussed below and elsewhere
in this prospectus.

Overview

drugstore.com is a leading online drugstore: a retail store and information
site for health, beauty, wellness, personal care and pharmacy products and
information. We offer a larger selection of products than typical store-based
retailers at competitive prices, along with a wealth of health-related
information, buying guides and other tools designed to help consumers make
more educated purchasing decisions.

We were incorporated in April 1998 and commercially launched our Web site
on February 24, 1999. From the period from inception through the commercial
launch of our site, our primary activities consisted of:

. Developing our business model;

. Raising funds and developing strategic alliances;

. Designing and developing our Web site;

. Recruiting and training employees;

. Selecting our fulfillment partners and integrating their systems and
processes with ours;

. Negotiating advertising contracts with several of the major Web portals;
and

. Developing the drugstore.com brand.

Since the commercial launch of our site, we have continued these operating
activities and have also focused on building sales momentum, expanding our
product offerings, building vendor relationships, promoting our brand name,
improving the efficiency of our order fulfillment processes and establishing
customer service operations.

All customer orders are processed through our Web store and either billed
to the customer's credit card or, in the case of prescriptions covered by
insurance, billed to third parties. With respect to sales attributable to
third party payors, sales of pharmaceutical products are recorded at the net
amount to be received from third parties. Generally, we collect cash from
credit card sales in two to five days from the date ordered. To date, amounts
billed to third parties have been insignificant; however, we expect such
third-party billings, as a percent of total prescription billings, to increase
over time if we are able to obtain additional contracts with PBMs. We recently
entered into an agreement with PCS, a leading PBM as measured by the number of
claimed covered lives.

We routinely offer promotional discounts and coupons to customers. In
addition, if a customer is not satisfied with a particular product or service
we provide, we generally refund all or a portion of the sale.

Currently, we purchase all of our pharmaceutical products from RxAmerica
and a substantial majority of our nonpharmaceutical products from Walsh. For
the six months ended July 4, 1999, 78% of the nonpharmaceutical cost of sales
represented products purchased from Walsh. Products are purchased from
RxAmerica and Walsh after the customer submits an order. We maintain an
inventory of nonpharmaceutical products that are not available from Walsh. In
the future, we intend to establish our own distribution center for
pharmaceutical and nonpharmaceutical products that will require us to increase
our inventory levels substantially.

We have incurred net losses of $36.5 million from inception to July 4,
1999. We believe that we will continue to incur net losses for the foreseeable
future and that the rate at which we will incur such losses will increase
significantly from current levels.

26
<PAGE>

We have a limited operating history on which to base an evaluation of our
business and prospects. Our prospects must be considered in light of the
risks, expenses, and difficulties encountered by companies in their early
stage of development, particularly companies in new and rapidly-evolving
markets, such as e-commerce. See "Risk Factors" for a more complete
description of the many risks we face.

In view of our limited operating history and the rapidly evolving nature of
our business, we believe that period-to-period comparisons of our operating
results are not meaningful and should not be relied upon as an indication of
future performance. It is likely that in some future quarter our operating
results may fall below the expectations of securities analysts and investors.
In this event, the trading price of our common stock may fall significantly.

Net Sales. Net sales consist of product sales and charges to customers for
outbound shipping and handling and are net of allowances for product returns,
promotional discounts and coupons. Net sales of pharmaceutical products are
recorded at the net amount to be received from customers and third parties. We
recognize product and shipping revenues when the related product is shipped.
In the future, the level of our sales will depend on a number of factors
including, but not limited to, the following:

. The number of customers we are able to obtain;

. The frequency of our customers' purchases;

. The quantity and mix of products our customers purchase;

. The price we charge for our products;

. The amount we charge for shipping;

. The extent of sales promotions and discounts we offer;

. The extent of reimbursement available from third-party payors;

. The level of customer returns we experience; and

. The seasonality that we may experience in our business.

Cost of Sales and Gross Margins. Cost of sales consists primarily of the
costs of products sold to customers and outbound and inbound shipping costs.
We expect cost of sales to increase in absolute dollars to the extent that our
sales volume increases. We may in the future expand or increase the coupons
and discounts we offer to our customers and may otherwise alter our pricing
structures and policies. Such changes may negatively affect gross margins. Our
gross margin will fluctuate based on a number of factors, including, but not
limited to, the following:

. The cost of our products, including the extent of purchase volume
discounts that we are able to obtain from suppliers;

. Our pricing strategy relative to the cost of our products;

. The mix of products our customers purchase;

. The mix of cash payments vs. insurance reimbursement for our pharmacy
products;

. Our shipping pricing strategy relative to the cost of shipping;

. Our distribution and fulfillment strategy if we decide to open our own
distribution centers; and

. The extent to which we are able to control product damage, shrinkage and
expiration though inventory management practices.

Marketing and Sales Expenses. Marketing and sales expenses consist
primarily of advertising and promotional expenditures, distribution expenses,
including order processing and fulfillment charges, equipment and supplies,
and payroll and related expenses for personnel engaged in marketing,
merchandising, customer service and distribution and fulfillment activities.
We intend to continue to pursue an aggressive branding and marketing campaign
and, therefore, expect marketing and sales expenses to increase significantly
in absolute

27
<PAGE>

dollars. Marketing and sales expenses may also vary considerably from quarter
to quarter, depending on the timing of our advertising campaigns. To the
extent that our sales volume increases in future periods, we expect marketing
and sales expenses to increase in absolute dollars as we expand our
distribution and fulfillment activities. This includes the costs of staffing
and developing a distribution center we intend to establish to accommodate
such increases in sales volume.

Product Development Expenses. Product development expenses consist
primarily of payroll and related expenses for Web site development and
information technology personnel, Internet access and hosting charges and Web
site content and design expenses.

Over the next several months, we plan to continue to work on a significant
number of development projects that will result in increased product
development expenses. Such projects include, but are not limited to:

. Enhancing and developing our systems as necessary to operate an
independent distribution center;

. Enhancing and developing our systems as necessary to provide for in-
store prescription pickup at Rite Aid stores;

. Enhancing our Web site to display additional product offerings,
including GNC products; and

. Other Web site product and content enhancements.

We believe that continued investment in product development is critical to
attaining our strategic objectives and, as a result, we expect product
development expenses to increase significantly in absolute dollars.

General and Administrative Expenses. General and administrative expenses
consist of payroll and related expenses for executive and administrative
personnel, corporate facility expenses, professional services expenses, travel
and other general corporate expenses. We expect general and administrative
expenses to increase in absolute dollars as we expand our staff and incur
additional costs related to the anticipated growth of our business and being a
public company. In addition, prior to the consummation of this offering, we
will donate approximately 200,000 shares of our common stock to a foundation
established by us. Upon such donation, we will recognize general and
administrative expense in an amount equal to the fair value of the donated
common stock.

Amortization of Stock-based Compensation. We recorded total deferred stock-
based compensation of $2,746,000 for the period from April 2, 1998 (inception)
to December 31, 1998 and $6,227,000 for the six months ended July 4, 1999 in
connection with stock options granted and restricted stock issued during such
periods. The deferred stock-based compensation amounts represent the
difference between the exercise price of stock option grants and the deemed
fair value of our common stock at the time of such grants. In the case of
restricted stock, the deferred stock-based compensation represents the
difference between the purchase price of the restricted stock and the deemed
fair value of our common stock on the date of purchase. Such amounts are
amortized to expense over the vesting periods of the applicable agreements,
resulting in amortization of stock-based compensation totaling $500,000 for
the period from April 2, 1998 (inception) to December 31, 1998 and $2,276,000
for the six months ended July 4, 1999. The amortization expense relates to
options awarded to employees in all operating expense categories. Deferred
stock-based compensation for stock options and restricted stock issued through
July 4, 1999 that will be subsequently recognized as expense for each of the
next six fiscal years is estimated to be as follows:

<TABLE>
<CAPTION>
Fiscal Year Amount
------------ --------------
(in thousands)
<S> <C>
1999 $2,035
2000 2,303
2001 1,229
2002 549
2003 70
2004 11
</TABLE>

28
<PAGE>

We have outsourced our payroll processing and other aspects related to our
employee benefits programs under a co-employment arrangement with TriNet VCO,
an independent company. On March 31, 1999, the Financial Accounting Standards
Board (FASB) issued an Exposure Draft of a FASB Interpretation, Accounting for
Certain Transactions involving Stock Compensation-- an interpretation of APB
Opinion No. 25. Such FASB Exposure Draft, if adopted in its current form,
could be interpreted to indicate that employees subject to co-employment
arrangements, would not be considered employees for purposes of applying APB
No. 25. On June 2, 1999, we terminated this co-employment arrangement. If
additional clarification regarding the definition of an employee is not
provided in the final pronouncement, we may be required to establish a new
measurement date for stock options granted after December 15, 1998 to these
employees for the purpose of accounting for stock options under APB No. 25. If
a new measurement date is required to be established, we would recognize the
deferred stock-based compensation which would be amortized as stock-based
compensation over the remaining vesting periods of the options. We estimate
that this charge would aggregate approximately $4.2 million, which would be
recognized beginning with the fourth quarter of fiscal 1999, the estimated
date the final pronouncement will be effective, and ending in 2004. Such
amortization could have a material adverse effect on our operating results.

Interest Income and Expense. Interest income consists of earnings on our
cash and cash equivalents and interest expense consists of interest associated
with capital lease obligations.

Income Taxes. There was no provision or benefit for income taxes for any
period since inception due to our operating losses. As of December 31, 1998,
we had $6,737,000 of net operating loss carryforwards for federal income tax
purposes, which expire beginning in 2018. In 1999, due to the issuance and
sale of preferred stock, we incurred ownership changes pursuant to applicable
regulations in effect under the Internal Revenue Code of 1986, as amended.
Therefore, our use of losses incurred through the date of these ownership
changes will be limited during the carryforward period. We estimate that the
use of the approximately $6.7 million of net operating losses incurred through
December 31, 1998 as well as losses incurred subsequent thereto until the date
of ownership change, would be limited to approximately $4.1 million per year
in order to offset future taxable income. To the extent that any single-year
loss is not utilized to the full amount of the limitation, such unused loss is
carried over to subsequent years until the earlier of its utilization or the
expiration of the relevant carryforward period. We have provided a full
valuation allowance on the deferred tax asset, consisting primarily of such
net operating loss carryforwards, because of uncertainty regarding its
realizability. See Note 4 of Notes to Consolidated Financial Statements.

Quarterly Results of Operations

Because we were a development stage company during 1998 and have a short
operating history, we believe that period-to-period comparisons prior to 1999
are less meaningful than an analysis of recent quarterly operating results.
Accordingly, we are providing a discussion and analysis of our results of
operations that is focused on the five quarters ended July 4, 1999.

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<PAGE>

The following table sets forth unaudited quarterly statement of operations
data for the five quarters ended July 4, 1999. This unaudited quarterly
information has been derived from our unaudited financial statements and, in
the opinion of management, include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of such information
in accordance with generally accepted accounting principles. The operating
results for any quarter are not necessarily indicative of the operating
results for any future period.

<TABLE>
<CAPTION>
Quarter Ended
-----------------------------------------------
June 30, Sept. 30, Dec. 31, Apr. 4, July 4,
1998 1998 1998 1999 1999
-------- --------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Net sales...................... $ -- $ -- $ -- $ 652 $ 3,550
Cost of sales.................. -- -- -- 672 4,879
----- ------- ------- -------- --------
Gross profit (loss).......... -- -- -- (20) (1,329)
Operating expenses:
Marketing and sales.......... -- 313 2,779 5,189 11,328
Product development.......... 104 522 1,552 2,713 3,229
General and administrative... 79 521 1,294 1,731 2,224
Amortization of stock-based
compensation................ 39 171 290 884 1,392
----- ------- ------- -------- --------
Total operating expenses... 222 1,527 5,915 10,517 18,173
----- ------- ------- -------- --------
Operating loss................. (222) (1,527) (5,915) (10,537) (19,502)
Other income (expense):
Interest income.............. -- 36 141 332 701
Interest expense............. -- -- (3) (14) (26)
----- ------- ------- -------- --------
Net loss....................... $(222) $(1,491) $(5,777) $(10,219) $(18,827)
===== ======= ======= ======== ========
</TABLE>

Net Sales and Cost of Sales. We commercially launched our Web site on
February 24, 1999. There were no net sales or cost of sales prior to the
quarter ended April 4, 1999. The negative gross margins experienced in the
quarters ended April 4, 1999 and July 4, 1999 were primarily the result of
promotional sales discounts associated with the commercial launch of the Web
site. We expect to continue to offer various types of promotional discounts
for the foreseeable future as a strategy to attract new customers.
Accordingly, we may continue to experience negative margins in future periods.

Marketing and Sales. Marketing and sales expenses increased in each of the
four quarters ended July 4, 1999, primarily due to expenses associated with
the addition of marketing and sales personnel. Additionally, we recognized
$1.0 million and $2.3 million of marketing expenses related to advertising
costs under our technology license and marketing agreement with Amazon.com in
the quarters ended April 4, 1999 and July 4, 1999, respectively. We also
increased our advertising on the major Web portals, including AOL, Excite and
Yahoo!, in the quarters ended April 4, 1999 and July 4, 1999 in connection
with the commercial launch of our Web site. In the quarter ended July 4, 1999
we commenced a television, radio and billboard advertising campaign as part of
our strategy to develop our brand. We expect to continue to pursue an
aggressive branding and marketing campaign for the foreseeable future and
expect such expenditures to increase accordingly.

Product Development. Product development expenses increased in each of the
four quarters ended July 4, 1999, primarily due to increased expenses
associated with the addition of product development personnel and additional
use of consultants and contract labor.

General and Administrative. General and administrative expenses increased
in each of the four quarters ended July 4, 1999 primarily due to increased
expenses associated with the addition of general and administrative personnel,
additional professional fees and the cost of corporate facilities.

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<PAGE>

Amortization of Stock-based Compensation. Amortization of stock-based
compensation increased in each of the four quarters ended July 4, 1999,
primarily due to the grant of stock options to new employees in the four
quarters ended July 4, 1999 as well as an increase in the difference between
the grant price and the deemed fair value of our common stock, particularly in
the quarter ended April 4, 1999. In the period from April 2, 1998 (inception)
to December 31, 1998, employees in the marketing and sales, product
development and general and administrative expense categories accounted for
approximately 24%, 24% and 52% of amortization of stock-based compensation,
respectively. In the six months ended July 4, 1999, employees in the marketing
and sales, product development and general and administrative expense
categories accounted for approximately 41%, 32% and 27% of amortization of
stock-based compensation, respectively.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through private
sales of preferred stock which, through July 4, 1999, yielded net cash
proceeds of $97.2 million.

Net cash used in operating activities was $18.5 million for the six months
ended July 4, 1999, and $6.3 million in the period from April 2, 1998
(inception) to December 31, 1998. Net cash used in operating activities for
each of these periods primarily consisted of net losses and during the six
months ended July 4, 1999, increases in inventories.

Net cash used in investing activities was $3.2 million for the six months
ended July 4, 1999, and $1.5 million in the period from April 2, 1998
(inception) to December 31, 1998. Net cash used in investing activities for
each of these periods primarily consisted of leasehold improvements and
purchases of equipment and systems, including computer equipment and fixtures
and furniture.

Net cash provided by financing activities was $75.3 million for the six
months ended July 4, 1999, and $22.3 million in the period from April 2, 1998
(inception) to December 31, 1998. Net cash provided by financing activities
during each of those periods primarily consisted of proceeds from the issuance
of preferred stock.

As of July 4, 1999 we had $68.1 million of cash and cash equivalents. As of
that date, our principal commitments consisted of obligations outstanding
under operating leases and marketing agreements with certain

Web portals, including Yahoo!, America Online and Excite, aggregating
approximately $22.1 million through 2005. Although we have no material
commitments for capital expenditures, we anticipate a substantial increase in
our capital expenditures and lease commitments consistent with anticipated
growth in operations, infrastructure and personnel. By the end of 1999, we
intend to establish our own distribution center to ensure greater control over
the distribution process and to ensure adequate supplies of products to our
customers. This will require significant capital investments in facilities and
equipment. For the remainder of 1999, we expect to devote substantial
expenditures toward technology and systems upgrades to support a new
distribution center and our ability to provide in-store prescription pick up
at Rite Aid stores.

We currently anticipate that the net proceeds of this offering, together
with our available funds, will be sufficient to meet our anticipated needs for
working capital and capital expenditures through at least the next 12 months.
We may need to raise additional funds prior to the expiration of such period
if, for example, we pursue business or technology acquisitions or experience
operating losses that exceed our current expectations. If we raise additional
funds through the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to those of the
rights of our common stock and our stockholders may experience additional
dilution. We cannot be certain that additional financing will be available to
us on acceptable terms when required, or at all.

Year 2000

Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of
the upcoming change in the century. If not corrected, many

31
<PAGE>

computer software applications could fail or create erroneous results by, at
or beyond the year 2000. We use software, computer technology and other
services internally developed and provided by third-party vendors that may
fail due to the year 2000 phenomenon. For example, we are dependent on the
financial institutions involved in processing our customers' credit card
payments for Internet services and a third party that hosts our servers. We
are also dependent on telecommunications vendors to maintain our network and
the United States Postal Service and other third-party carriers to deliver
products to customers.

We are in the process of reviewing the year 2000 compliance of our
internally developed proprietary software. This review has included testing to
determine how our systems will function at and beyond the year 2000. We expect
to complete these tests during the summer of 1999. Since inception, we have
internally developed substantially all of the systems for the operation of our
Web site. These systems include the software used to provide our Web site's
search, customer interaction, and transaction-processing and distribution
functions, as well as monitoring and back-up capabilities. Based upon our
assessment to date, we believe that our internally developed proprietary
software is year 2000 compliant.

We are currently assessing the year 2000 readiness of our third-party
supplied software, computer technology and other services, which include
software for use in our accounting, database and security systems. As part of
the assessment of the year 2000 compliance of these systems, we have sought
assurances from these vendors that their software, computer technology and
other services are year 2000 compliant. We have expensed amounts incurred in
connection with year 2000 assessment since our inception through April 4,
1999. Such amounts have not been material. We expect this assessment process
to be completed during the summer of 1999. Based upon the results of this
assessment, we will develop and implement, if necessary, a corrective action
plan with respect to third-party software, third-party vendors and computer
technology and services that may fail to be year 2000 compliant. We expect to
complete any required actions during the summer of 1999. At this time, the
expenses associated with this assessment and potential corrective action plan
that may be incurred in the future cannot be determined. The failure of our
software and computer systems or those of our third-party suppliers to be year
2000 compliant could have a material adverse effect on us.

The year 2000 readiness of the general infrastructure necessary to support
our operations is difficult to assess. For example, we depend on the integrity
and stability of the Internet to provide our services. We also depend on the
year 2000 compliance of the computer systems and financial services used by
consumers. Thus, the infrastructure necessary to support our operations
consists of a network of computers and telecommunications systems located
throughout the world and operated by numerous unrelated entities and
individuals, none of which has the ability to control or manage the potential
year 2000 issues that may impact the entire infrastructure. Our ability to
assess the reliability of this infrastructure is limited and relies solely on
generally available news reports, surveys and comparable industry data. Based
on these sources, we believe most entities and individuals that rely
significantly on the Internet are reviewing and attempting to remediate issues
relating to year 2000 compliance, but it is not possible to predict whether
these efforts will be successful in reducing or eliminating the potential
negative impact of year 2000 issues. A significant disruption in the ability
of consumers to reliably access the Internet or portions of it or to use their
credit cards would have an adverse effect on demand for our products and
services.

At this time, we have not yet developed a contingency plan to address
situations that may result if we or our vendors are unable to achieve year
2000 compliance. Such contingency plan is currently expected to be developed
in the fall of 1999 and will depend on a number of factors, including (1) the
results of our Year 2000 review and assessment, (2) the extent of the
corrective actions that have been implemented and (3) the status of our
distribution facilities that we currently intend to establish. The cost of
developing and implementing such a plan, if necessary, could be significant.
Any failure of our material systems, our vendors' material systems, our
customers' computers, or the Internet to be year 2000 compliant could have
negative consequences for us. Such consequences could include difficulties in
operating our Web site effectively, taking customer orders, making product
deliveries or conducting other fundamental parts of our business.

32
<PAGE>

BUSINESS

Overview

drugstore.com is a leading online drugstore: a retail store and information
site for health, beauty, wellness, personal care and pharmacy products. As of
July 4, 1999, we have sold our products to approximately 168,000 customers. We
designed our store to provide a convenient, private and informative shopping
experience that encourages consumers to purchase products essential to
healthy, everyday living. Our Web site can be accessed 24 hours a day, seven
days a week from anywhere that a consumer has Internet access. We offer a
larger selection of products than typical store-based retailers, along with a
wealth of health-related information, buying guides and other tools designed
to help consumers make more educated purchasing decisions. Our shopping lists
and e-mail reminders are designed to make it easier for our customers to
regularly purchase their preferred products. We believe that our online store
provides a customer with a superior shopping experience, making buying What
Every Body Needs(TM) less of a chore.

Industry Background

The Growth of the Internet and Electronic Commerce

The Internet has become an important medium for communicating, finding
information and purchasing products and services. International Data
Corporation (IDC) estimates that there were approximately 51 million Web users
in the United States at the end of 1998 and, although we cannot be certain of
any future growth, IDC anticipates this number will grow to approximately 135
million users by the end of 2002. We believe this increased usage is due to a
number of factors including:

. The large installed base of personal computers in the workplace and
home;

. Advances in the performance and reductions in the cost of personal
computers and modems;

. Improvements in the ease of use and security of the Internet;

. The availability of a broader range of online products, information and
services; and

. Growing awareness among consumers and businesses of the benefits of
online shopping.

The Internet has unique and powerful characteristics that differentiate it
from traditional distribution channels and have facilitated its use as a
purchasing medium. IDC estimates that worldwide business-to-consumer sales
over the Internet will increase from approximately $11 billion in 1998 to
approximately $93 billion by 2002; however, we cannot be certain that such
projection will be achieved. We believe consumers using the Internet to
purchase goods expect a more information-intensive experience than when they
shop at a traditional retail store. We believe the ability to obtain relevant,
up-to-date information makes the consumer better prepared to make a purchase.
Accessing the Internet from a computer in the home or office allows a consumer
to easily scroll through and search articles, pages of product data and
related topics. This allows consumers to research and then purchase products
at their convenience.

Healthcare Trends on the Internet

Healthcare is one of the largest segments of the U.S. economy, representing
an annual expenditure of roughly $1 trillion, and health and medical
information is one of the fastest growing areas of interest on the Internet.
According to a recent Forrester Research report, 31.6% of Internet users
surveyed had shopped for healthcare products online in the previous six
months. Cyber Dialogue estimates that the number of adults in the United
States searching online for health and medical information will grow from
approximately 17.1 million during the 12 month period ended July 1998 to
approximately 30.0 million during the twelve month period ending July 2000;
however, we cannot be certain that such projection will be achieved.

33
<PAGE>

The drugstore.com Market

The market we address can be divided into five primary categories: health,
beauty, wellness, personal care and pharmacy. Many products in this market are
personal (being used on a person's skin or in a person's body) and essential,
and often are purchased repeatedly. In this market, vendors frequently
introduce new products, and consumers seek comprehensive product information.
Consumers currently shop for these products primarily in chain drugstores
(such as Walgreen's, CVS, Rite Aid and Eckerd), mass market retailers (such as
Wal-Mart, Kmart and Target), supermarkets, warehouse clubs and independent
drugstores. However, category-specific retailers and catalogs also serve each
of these categories. Overall, distribution of products in our primary market
categories is fragmented.

Key aspects of the primary categories of the drugstore.com market are as
follows:

Health. The health category includes over-the-counter remedies (such as
cough, cold, allergy and pain relief medications), first aid, medical devices
for home healthcare, contraceptives and other products related to the body's
health needs. Based on estimates from Information Resources, Inc. and Frost &
Sullivan, we believe that sales of health products in the U.S. we currently
offer grew from approximately $15.0 billion in 1996 to approximately $16.3
billion in 1998. We believe that the aging U.S. population, along with a
greater portion of prescription drugs becoming available as over-the-counter
medications, will contribute to growth in this market category. Consumers in
the health category often seek significant amounts of product information to
determine which products will meet their health needs. Consumers generally buy
health products from chain drugstores, mass market retailers, supermarkets,
and warehouse clubs as well as from locally-owned, independent drugstores and
convenience stores. Representative brands carried in our health product
category include Advil, Tylenol, Pepcid, Bausch & Lomb and Metamucil.

Beauty. The beauty category includes cosmetics, fragrances and a variety of
skin care products. Based on estimates from Information Resources, Inc. and
Frost & Sullivan, we believe that sales of beauty products in the U.S. we
currently offer grew from approximately $10.7 billion in 1996 to approximately
$12.8 billion in 1998. Some of the factors driving consumer demand for beauty
products include regular and seasonal new product introductions, as well as
changing fashion trends. Consumers often seek advice regarding these trends or
the functionality of new products. The beauty category can be broadly
classified into two subcategories: mass market and prestige products.
Consumers for mass market beauty products typically purchase such products in
mass market retailers, drugstores and supermarkets. Consumers for prestige
products generally shop in department stores (such as Nordstrom, Macys, May
and Dillard's), beauty specialty stores (such as Aveda or Sally's), or spas
and salons (such as Elizabeth Grady or Elizabeth Arden). Representative brands
carried in our beauty product category include Revlon, L'Oreal, Cover Girl,
Neutrogena and Peter Thomas Roth.

Wellness. The wellness category includes vitamins, nutritional supplements,
herbs, homeopathy, and other natural products. Based on estimates from various
sources including Information Resources, Inc., Frost & Sullivan, Packaged
Facts and Beyond Data, we believe that sales of wellness products in the U.S.
we currently offer totaled approximately $11.0 billion in 1998 and is
currently growing at an annual rate of over 15%. We believe that increasing
consumer interest in nutritional and wellness products to improve physical and
mental well-being has contributed to growth in this category. We believe
supplemental product information is important to these consumers because they
are interested in the intended physiological effects of these products.
Consumers can obtain these products at chain drugstores, mass market
retailers, supermarkets, warehouse clubs, and specialty stores as well as
through catalogs or online vitamin and nutrition stores. Representative brands
carried in our wellness product category include Centrum, One-A-Day, Nature
Made, Twinlab, Natrol and Nature's Way. We will also soon be offering GNC
wellness products.

Personal Care. The personal care market category includes products related
to hair, body and eye care, shaving, oral hygiene and feminine needs. Based on
estimates from Information Resources, Inc. and Frost & Sullivan, we believe
that sales of personal care products in the U.S. we currently offer grew from
approximately $20.7 billion in 1996 to approximately $23.5 billion in 1998.
New product introductions drive

34
<PAGE>

most of the growth in this category. The personal care category is comprised
of a number of different product groups that consumers typically shop for at
mass market retailers, chain drugstores, supermarkets, warehouse clubs and
specialty stores. Representative brands carried in our personal care product
category include Gillette, Colgate, Johnson & Johnson, Rogaine and Pampers.

Pharmacy. Based on estimates from various sources including Information
Resources, Inc., Frost & Sullivan, and the National Association of Chain Drug
Stores we believe that the pharmacy category in the U.S. we address totaled
approximately $101.2 billion in 1998 and is currently growing at an annual
rate of approximately 14.8%. This category consists of prescription medication
for chronic illnesses, such as high blood pressure, osteoporosis and
depression, which represents approximately 73% of the U.S. prescription drug
market according to Advanstar Communications. AC Nielsen and IMS Health
estimate that out of the $101.7 billion of prescription sales, over 75%, or
$76.4 billion are distributed through retail channels. The number of
prescriptions written for chronic illnesses is expected to continue to grow
due to an aging population and the increasing utilization of pharmaceuticals
in medical management. The principal source of pharmaceuticals for chronic
illnesses has been retail pharmacies. However, over the past ten years, mail
order pharmacies have become an increasingly important source of
pharmaceuticals for chronic illnesses. Forrester Research estimates that as of
February 1999, 13% of HMO prescriptions will be filled by a mail-order
pharmacy by the end of 1999.

Limitations on Traditional Channels of Distribution

Traditional channels of retail distribution for health, beauty, wellness,
personal care and pharmacy products have many limitations, including:

Inconvenience. Consumers often view shopping for many of these products as
a chore. Shopping at a physical store can be highly inconvenient. It generally
involves time-consuming activities such as making a trip to the store, finding
a parking space, searching for the desired products, and waiting in line to
fill a prescription or make a purchase. This process can be especially
difficult for customers with disabilities or parents with young children. To
increase convenience for consumers, traditional store-based retailers often
need to open new stores, which is time-consuming and expensive. Each new store
results in significant investments in inventory, real estate, building
improvements and the hiring and training of store personnel. The required
investment may limit the ability of traditional store-based retailers to serve
geographic areas that are not densely populated. Also, an existing store may
face substantial added costs if it attempts to build more parking spaces or
hire more clerks in order to reduce parking and waiting inconveniences.

Narrow Selection. Consumers value the opportunity to select items from a
broad range of products that best fit their needs. However, consumers must
often choose from a narrow product selection at traditional store-based
retailers. Stores may not carry a full range of products, especially prestige,
specialty or regional products, or carry a full assortment of sizes. Desired
items may be out of stock. Overcoming these difficulties can be prohibitively
expensive for traditional retail stores, usually due to shelf space
limitations, the cost of carrying inventory and the resulting need to allocate
inventory dollars to popular products. To the extent that mass market
retailers allocate physical store space to items such as alcohol, lawn
furniture, motor oil and snack foods, they may have to reduce the number of
health, beauty, wellness and personal care products that they offer. Product
selection in traditional store-based retailers cannot be tailored to
individual needs because it is driven by aggregate demand.

Limited Information and Communication. Consumers buying health, beauty,
wellness, personal care and pharmacy products often seek information and
knowledgeable advice to assist them in making purchasing decisions. Many
traditional store-based retailers do not provide consumers with access to
useful product information or readily-available on-site experts who can
provide helpful advice. Employees at traditional store-based retailers,
especially supermarkets and mass market retailers, may have limited if any
interaction with their customers. Often there is no direct contact, except at
the check-out line. Customers may also face difficulties following up with
questions after a purchase. While traditional store-based retailers could take
steps to increase the availability of customized information and on-site
experts, such steps would involve substantial investments

35
<PAGE>

in printing and training. In addition, it is difficult for a traditional
retail store to use information about a particular consumer to personalize
that consumer's shopping experience.

Lack of Privacy. Because many health, beauty, wellness, personal care and
pharmacy products are inherently personal, consumers often desire ways to
preserve the anonymity of their purchases and the confidentiality of the
information transferred in the buying process. Many consumers may feel
uncomfortable purchasing certain drugstore products, such as birth control
devices, feminine care products, and incontinence products, in a traditional
retail store. Many consumers have encountered the unpleasant experience of
placing such a product on a checkout stand's conveyor belt in front of store
clerks and other waiting customers. Consumers may hesitate to ask store
personnel questions about which product best meets a need, or how to use a
product, especially if either the question or the answer is embarrassing or
may be overheard by others. Overcoming this limitation is very difficult for
traditional retail stores because the consumer must visit a physical store
frequented by other customers and must interact in person with store
employees.

The markets for health, beauty, wellness, personal care and pharmacy
products have grown despite the lack of convenience, selection, information
and privacy associated with a trip to a traditional store-based retailer.
Consequently, we believe there is a significant market opportunity for an
online store that can offer consumers an enhanced shopping experience through
convenient and private access to detailed information about a broad range of
products, and an easy way to buy them.

The drugstore.com Solution

We are a leading online drugstore: a retail store and information site for
health, beauty, wellness, personal care and pharmacy products. We designed our
store to provide a convenient, private and informative shopping experience
that encourages consumers to purchase products essential to healthy, everyday
living. We believe our online store provides customers with a superior
shopping experience, making buying What Every Body NeedsTM less of a chore.

We draw and retain consumers by emphasizing key attributes of our store:

Convenience. Our user-friendly Web store may be reached from wherever the
shopper has Internet access, such as the shopper's home or office. Further
convenience advantages at our store include:

. Shopping 24 hours a day, seven days a week;

. Direct delivery to the shopper's home or office, avoiding the need for a
trip to a physical store;

. A personal shopping list for every customer, allowing for quick and easy
reordering in future visits;

. Simplified searching for products and information using advanced search
technology;

. Confidential access by a customer to his or her individual medication
profiles at any time; and

. Ability to purchase and send products easily to others.

In addition, we expect to offer Rite Aid customers the ability to order
refills of their existing Rite Aid prescriptions on our Web site and pick them
up at a local Rite Aid store.

Selection. Because we do not have inventory or shelf-space limitations, we
believe we offer a significantly greater number of products than are available
in a traditional chain drugstore. Not only do we offer traditional chain
drugstore items (prescription drugs, over-the-counter medications and personal
care), we offer a broad selection of health, beauty and wellness products.
Many traditional chain drugstores do not carry a wide range of these products.
We believe that we offer the largest selection of drugstore products available
on the Internet, offering over 17,000 SKU's (excluding pharmacy items). We are
also the only online retailer that may offer GNC wellness products, which we
expect to begin offering this year.

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<PAGE>

Information. Because the Web has become an increasingly important tool for
researching healthcare topics, we believe that providing useful information is
a critical aspect of enabling consumers to make informed purchasing decisions.
We have assembled a broad array of information on our Web site that can enable
our consumers to make informed purchasing decisions. This information is
produced both in-house and by third-party expert sources and is focused on key
aspects of our market segments. Consumers can either access our information
directly, through a number of content features on our Web site, or can get
free help directly from our advisors and experts by contacting them through e-
mail. Our information services include:

. Full Product Packaging Information. Almost every product available on
our Web site can be viewed in an expanded format where all package
information, including ingredients, directions and warnings, can be read
next to an enlarged photograph of the product. We believe we are the
only online retailer to provide all the information that is normally
found on the products' packaging.

. Solutions. Our Solutions area provides an easy way for customers to find
the information they need to make an informed purchasing decision. It
includes buying guides, reference information, shopping advisors and
beauty information.

. Easy Access to Drug Information and Personalized Pharmacy
Advice. Consumers can access our extensive drug information library
directly at our Web site, anytime at their own convenience. Patient
information and drugstore.com drug prices can be accessed via our drug
index. We provide information to help consumers understand generic drug
alternatives. We also provide health- and pharmacy-related editorial
content in our online Solutions area. Our pharmacists can provide
personal guidance by phone or e-mail to ensure that each customer
understands the correct usage, possible side effects and expected
beneficial outcomes of a prescription or an over-the-counter medication.

Communication. We can communicate with customers on a regular basis through
the convenience of e-mail. In addition to our Ask Your Pharmacist and Ask Your
Beauty Expert features, we offer the following means of communication with our
store:

. Reminders. We have the ability to e-mail a customer when a prescription
or non-prescription product is about to run out, reminding him or her to
order a replacement product or a prescription refill. Customers simply
tell us how often they need a product and we can send them a notice
before it is scheduled to run out.

. Specialized Customer Care. To ensure timely and high-quality customer
service, we have established specialty teams within the drugstore.com
customer care department. Our Web site, product and insurance
specialists respond to customer e-mails and calls that are related to
shopping orders, insurance, prices, and shipping. Once an order is
made, customers can view order-tracking information on our Web site.

. Personalized Communications. As customers use our Web site, they can
provide us with information about their buying preferences and habits.
We can use this information to develop personalized communications and
deliver useful newsletters, special offers and new product announcements
to our customers via e-mail and other means. In addition, we use e-mail
to alert customers to important developments and merchandising
initiatives.

Privacy. Customers can shop in the privacy of their own homes or offices.
When shopping at a physical store, many shoppers feel embarrassed or
uncomfortable buying items that may reveal personally-sensitive aspects of
their health or lifestyle to store personnel or other shoppers. Shoppers at
drugstore.com avoid these problems. Through features such as Ask Your
Pharmacist and Ask Your Beauty Expert, customers can obtain answers to
questions that they would otherwise be uncomfortable asking in public.

Although we believe we offer significant advantages over traditional chain
drugstores, certain customers may feel that traditional chain drugstores offer
several advantages over our service, and we may not be able to meet the needs
of some customers. For example, we cannot serve emergency needs and we cannot
serve

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customers who do not have access to the Internet. Some customers may also
prefer to touch and see products in person, rather than view them on a
computer screen or prefer to talk to a pharmacist in person. Some customers
may also have general concerns about the privacy and security of information
transmitted over the Internet and will therefore prefer to shop in physical
stores. See "Risk Factors--Consumers of Health, Beauty, Wellness, Personal
Care and Pharmacy Products May Not Accept Our Solution, Which Would Reduce Our
Revenues and Prevent Us From Becoming Profitable" for a further description of
the challenges we face in this area.

Business Strategy

Our objective is to become one of the world's leading retailers of health,
beauty, wellness, personal care and pharmacy products. To achieve our
objective, we intend to attract a growing base of customers and provide them a
superior shopping experience. Key elements of our strategy include:

Strengthen the drugstore.com Brand. We intend to establish drugstore.com as
the leading consumer brand for buying health, beauty, wellness, personal care
and pharmacy products. To date, we have promoted our Web site on major
Internet destinations such as Amazon.com, America Online, Excite and Yahoo!,
as well as on other sites our customers are likely to visit, including
ThirdAge, InteliHealth, OnHealth, Medscape and Women.com. To further
strengthen our brand, we intend to cultivate a reputation for excellent
quality of service and continue to pursue an aggressive marketing strategy,
both through the Internet and traditional media, as well as through our
relationships with Rite Aid and GNC.

Continuously Improve Our Web Store and Service. We seek to combine wide
product selection and helpful information with the unique aspects of the
Internet to deliver a convenient and personalized shopping experience. We
strive to develop long-term relationships with our customers to build loyalty
and encourage repeat purchases. To improve our site, we intend to continue to
expand our product selection and enhance our existing offerings such as
shopping lists, individual medication profiles, e-mail reminders and targeted
special offers, as well as develop new personalization features as we learn
more about our customers and their needs. In addition, as part of our
relationship with Rite Aid, we expect to offer Rite Aid customers the ability
to order refills of their Rite Aid prescriptions on our Web site and pick them
up at a local Rite Aid store or have them delivered to the customer's home or
office.

Take Advantage of Repeat Purchasing Patterns. We intend to maximize repeat
purchases by our customers. To achieve this objective, we have developed
personalized tools and features that are designed to allow consumers to
satisfy their replenishment purchasing needs easily. We believe that our focus
on prescriptions for chronic conditions and products that must be regularly
replenished will allow us to benefit from repeat purchase patterns. We also
plan to continue to expand the functionality of our Web site to further
facilitate repeat purchases.

Maintain Our Technology Focus and Expertise. We intend to use technology to
enhance our product and service offerings and take advantage of the benefits
of the Internet. We have developed a proprietary, scalable architecture
designed to support secure and reliable online shopping in an intuitive easy-
to-navigate format. We intend to seek ways to increase the efficiency of
pharmacy transaction processing and order fulfillment activities. We also
intend to develop features to further personalize the consumer's shopping
experience and enhance the customer's ability to find products and useful
information.

Ensure Quick and Efficient Distribution. We intend to continuously increase
the automation and efficiency of our fulfillment and distribution activities.
For example, we will seek ways to improve the efficiency of the prescription
fulfillment process in areas such as receiving prescriptions from doctors and
billing the customer or his or her insurance company. In addition, because we
currently outsource our distribution operations, we intend to work with our
distributors and vendors to find more ways to ensure prompt deliveries to our
customers. As part of this effort, we are currently reviewing and formulating
our long-term distribution strategy, which will include establishing our own
distribution center. Our goals in this area include reducing shipping costs,
ensuring adequate future capacity and ensuring reliable and prompt deliveries
to our customers.

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Enhance and Form Key Relationships. We intend to enhance our existing
strategic relationships with leading product manufacturers, content providers
and insurance and pharmacy benefit management companies, as well as develop
new strategic relationships. We also believe relationships with leading
insurance and pharmacy benefit management companies, including our new
relationship with PCS, will enhance customer awareness of our Web site and
enable an even greater number of our customers to obtain reimbursement for
their prescriptions filled through our store. We also believe having strong
relationships with product manufacturers will enable us to provide more and
better product information to our customers. In addition, as part of our long-
term distribution strategy, we may need to develop direct manufacturer
relationships to ensure the availability of adequate volumes of products
ordered by our customers. We also intend to continue to pursue key
relationships with leading providers of health, beauty and wellness
information. We believe this strategy will enhance our product offerings and
allow us to serve more customers.

Shopping at drugstore.com

Shoppers at drugstore.com see a home page that highlights our five product
departments, as well as editorial content and promotions. A shopper can browse
through the store by clicking on the permanently displayed department names,
move directly to a department's home page and view promotions and featured
products. All product lists allow a shopper to select products based on brand
or unique attributes of the category, such as tartar control or whitening for
toothpaste, or color for lipstick or eye shadow. Shoppers can also search the
site by entering text in the search box at the top of any page.

A customer can select products to purchase by clicking on the "buy" button
in the product list. The products are then added to the customer's shopping
bag. If a customer needs more information to make a purchase, we supply
interactive tools and content to aid in the decision, such as:

. Solutions. Our Solutions area provides an easy way for customers to find
the information they need to make an informed purchasing decision. Some
of the components of the Solutions area include:

Shopping Advisors. Our shopping advisors consist of interactive
tools to help consumers find the right products for their needs. We
currently feature a cold and cough advisor, a skin care advisor and
a vitamin and supplement advisor. Through an easy-to-use interactive
format, a customer provides information about what he or she needs,
and the advisor provides information that enables the customer to
choose the appropriate product.

Buying Guides. Our buying guides help consumers make informed buying
decisions. We currently feature buying guides on condoms, birth
control pills, cold and cough medicine, toothpaste, shampoo and
sunscreen. The buying guides provide helpful information about the
key benefits and characteristics of each of these products.

. Shopping List. Returning customers can easily view their previous
purchases by consulting their personalized shopping lists. The shopping
lists make buying regularly-replenished items even easier to purchase
because the customer can move products into their shopping bag directly
from their personalized shopping list, without browsing the site. If
requested by the customer, we also send e-mail reminders to consumers
when items on their lists are scheduled to run out and need to be
replenished.

. Quick Lists. Our Quick Lists feature provides customers a starting point
for finding frequently used products for different product categories,
such as a medicine cabinet, beauty essentials and a travel bag. Within
each product category, the customer can choose a specific product and
move the product into his or her shopping bag. The customer can then
move directly from his or her shopping bag back to the Quick Lists and
choose another product or list.

. Ask Your Pharmacist. Our Ask Your Pharmacist feature allows customers to
ask our pharmacists questions about over-the-counter and wellness
products as well as prescription drugs.

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. Ask Your Beauty Expert. Our Ask Your Beauty Expert feature allows
customers to ask our beauty experts questions about beauty needs. Our
beauty experts respond to questions via e-mail and seek to answer
questions within one business day.

. Getting Help. From every page of our Web site, a customer can click on a
"help" button to go to our customer care area. In this area, we assist
customers in searching for, shopping for, ordering and returning our
products. In addition, we provide customers with answers to the most
frequently asked questions and encourage our visitors to send us
feedback and suggestions via e-mail.

When the customer finishes selecting the desired products, he or she goes
to checkout. The only information required to checkout is an e-mail
identification, password (to protect account privacy), shipping address and a
valid credit card number. All of this information is maintained in a secure
format and remains available for the customer's future access.

Pharmacy Services

The pharmacy services at drugstore.com are provided by experienced clinical
professionals using advanced information technologies. We employ licensed
pharmacists who ensure private, personal customer service. Through our
prescription drug dispensing partner, RxAmerica, we are able to ship
prescription products to all 50 U.S. states. See "--Distribution and Order
Fulfillment" for a further description of our relationship with RxAmerica. We
are also working with Rite Aid to enable Rite Aid customers to order refills
of their prescriptions on our Web site and pick them up at any of the over
3,800 Rite Aid stores in the United States or have them delivered to their
home or office. In addition, we are an active participant in the development
of the National Association of Boards of Pharmacy's Verified Internet Pharmacy
Practice Sites program. This new program will set standards for Internet
pharmacies and inform the public of those Web sites that have agreed to comply
with these standards.

Services. We seek to provide a high level of responsiveness and customer
support. In addition to our extensive drug information, specialized customer
care features and refill reminders, our pharmacy services include:

. Ask Your Pharmacist. Our Ask Your Pharmacist feature allows customers to
ask our pharmacists questions about medication, dosage, delivery
systems, common side effects and other information about prescription
drugs and health-related products. Our pharmacists seek to provide an
initial answer via e-mail within one business day.

. Private Access to drugstore.com Prescription History. Customers who fill
their prescriptions at drugstore.com can access their secure, individual
medication profiles at any time. A written patient information document
accompanies all medications dispensed to drugstore.com customers. This
service enables customers to maintain a record of their prescription
purchases for clinical, insurance and tax reporting purposes.

Filling Prescriptions. We only accept prescriptions from licensed health
care providers. We do not prescribe medications or otherwise practice
medicine. We focus on dispensing medications used by consumers on a chronic
basis. Advanstar Communications, Inc. estimates that such medications
comprised approximately 73% of all prescription drugs taken in the United
States in 1998. For acute care needs, meaning when a customer has a single
episode of a short-term illness or an exacerbation of a chronic condition in
either case requiring immediate attention, we recommend that customers pick up
their prescriptions from a local pharmacy because the treatment of acute care
needs are extremely time sensitive and the delivery time required by online
purchases could be too slow for the customer's needs. Medications used for
acute care needs include antibiotics and pain medications. We also do not
dispense certain controlled substances known as Schedule II pharmaceuticals at
this time because there are increased risks associated with their
dispensation, such as fraud, illegal resale of prescription drugs, and special
storage shipping and handling requirements. Schedule II Pharmaceuticals are
drugs classified by the Controlled Substance Act of 1970 as having a high
potential for abuse, such as opiates

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(including morphine) and products that contain oxycodone stimulants (including
amphetamine and methylphenidate) and depressants (including secobarbital and
amobarbital). We accept, verify and cross-check prescriptions much like
traditional retail and mail service pharmacies:

. Accepting Prescriptions. For new prescriptions, customers can direct
their physicians to call or fax their prescriptions to us at 1-800-
DRUGSTORE, or request that we contact their physician directly to obtain
prescription information. For transfers, customers can direct their
pharmacy to transfer their prescriptions or request us to contact their
pharmacy to transfer the prescription to drugstore.com. For refills,
customers may order directly from our Web site or respond to one of our
e-mail refill reminders.

. Verifying Prescriptions. Our pharmacists verify the validity and
completeness of prescription drug orders utilizing the same methodology
as community-based pharmacists. The standard practice for verification
of prescription drug orders is that the pharmacist will contact the
physician's office by telephone or fax if there is any reason to
question the validity, accuracy or authenticity of any order. In
addition, our pharmacists call and verify the validity of prescription
drug orders for allowable controlled substances, i.e., Schedule III-V
drugs. In addition, our pharmacists verify that all legally required
information is recorded on the prescription drug order and utilize a
database to verify physician identifying information, if necessary.

. Drug Utilization Review. To use our prescription drug services, all
customers are asked to provide our pharmacists with information
regarding drug allergies, current medical conditions and current
medications. Our pharmacists use advanced technologies to cross-check
every prescription against the information we receive from the customer
for drug-, disease- and allergy-drug interactions.

Payment. Customers may pay for their prescriptions with cash, by credit
card or by entering insurance information that shows that they are covered by
a managed care organization, insurance plan or PBM with whom we have a
contract. To date, a substantial majority of our prescriptions have been
submitted by cash paying customers. However, as a result of our relationship
with Rite Aid, we will be able to fill prescriptions for most customers with
pharmacy benefits covered by a plan accepted by Rite Aid. In addition, we will
participate in substantially all of the current and future retail pharmacy
networks managed by PCS, one of the leading pharmacy benefit management
companies in the United States that claims to provide pharmacy benefit
management services for more than 50 million individuals in the United States.

Pharmacy Supply. All of our pharmaceutical products are currently supplied
by RxAmerica. We intend to establish our own distribution center within the
next 12 months. Once the distribution center is established, we are obligated
to purchase all of our pharmaceutical products from Rite Aid, unless we are
able to obtain better overall terms from another vendor. This purchase
commitment will continue for the term of the Rite Aid relationship.

Marketing and Promotion of Our Site

Our marketing and promotion strategy is designed to build brand
recognition, increase customer traffic to our store, add new customers, build
strong customer loyalty, maximize repeat purchases and develop incremental
revenue opportunities.

Our advertising campaigns target both online and traditional audiences and
are designed to promote an enhanced customer experience. Our online
advertising efforts have been focused on highly-visited Internet portals,
health-related Web sites and other highly-visited Web sites. We also have
strategic relationships with Amazon.com, Rite Aid and GNC, who all promote our
Web site. We believe that the marketing benefits of our relationship with
Amazon.com include their promotion of our site and the beneficial aspects of
our being associated with one of the premier e-commerce companies. In
addition, Rite Aid has agreed to include drugstore.com in a significant
portion of Rite Aid's own advertisements, as well as on shopping bags,

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prescription vial caps, in-store signs and permanent links from its Web site.
In addition, we advertise on America Online, Excite and Yahoo!, as well on
other sites where our customers are likely to visit, including ThirdAge,
InteliHealth, OnHealth, Medscape and Women.com. We also extend our market
presence through our Associates Program, which enables associated Web sites to
make our products and services available to their audiences through a link to
our Web site. We intend to continue to use the unique resources of the
Internet as a means of marketing in an effort to drive traffic and repeat
purchases. We have also used traditional marketing and promotion efforts,
including special product promotions, print advertising in USA Today,
television and radio advertising in selected markets, promotional press
releases and public appearances by our executives. We intend to further
intensify our advertising efforts through traditional media channels to
continue building our brand recognition.

Merchandising Strategy

We believe that the breadth and depth of our product selection, together
with the flexibility of our online store and our range of helpful and useful
shopping services, enables us to pursue a strong merchandising strategy.
Aspects of this strategy include:

Easy Access to a Wide Selection of Products. Our easy-to-use Web site and
robust search capabilities enable customers to browse our product selection by
brand, age, product and price, as well as combinations of these categories.
For example, a customer can easily search for all aspirin products or for
Tylenol for children without consulting store personnel or searching
traditional store shelves. Combination searching allows customers to find
desired items easily among our large selection of products.

Dynamic Product Offering. Our online store gives us flexibility to change
featured products or promotions without having to alter the physical layout of
a store. We are also able to dynamically adjust our product mix in response to
changing customer demand, new seasons or upcoming holidays and introduce
special promotions.

Specialty Stores. We are establishing specialty stores in each of our
product categories. Our first specialty store, the boutique, sells high-end
cosmetics. Our next specialty store will be the GNC LiveWell Store, which will
be dedicated to GNC nutritional products and other products typically sold in
GNC stores. We will be the exclusive distributor of GNC brand products on the
Internet subject to our meeting performance parameters during the third and
fifth years of the relationship.

Extensive Product Information. A key component of our merchandising
strategy is the ability to use information as a tool for consumers. We combine
manufacturer information with editorial information or buying guides to allow
customers to make more informed buying decisions and to more easily comparison
shop for products. In addition, our Web site allows us to market products to
customers in many different ways, such as by product category or by product
characteristics, such as price or ingredients.

Targeted Promotions. We have the ability to offer products to individual
customers based on their affinities or conditions. In addition, we can present
merchandise to a customer tailored to personal interests and shopping
histories. We also cross-sell a brand across our departments to promote
impulse buying by customers. For example, we might promote mothers' products
in our Pregnancy and Infant Center.

Sampling. We have programs that allow us to provide samples of products to
customers as trials. We may also use sampling to work with manufactures to
introduce new products.

Information Objectives

Our editorial strategy is to present helpful, value-added information to
consumers in a readable, user-friendly format. Our editors create, source and
maintain health, beauty, wellness, personal care and pharmacy related content
for our Web site. Our editors assemble content to provide both reference and
product-related information. To date, we have established relationships with
several leading information providers who provide content for our site. We
will continue to direct our editorial efforts toward enhancing existing
features as well as

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sourcing new content to help our customers. For example, we expect to expand
our health and affinity centers beyond our first center, the Pregnancy and
Infant Center, to new centers focused on specific interest areas such as
allergy, fitness or diabetes. We also plan to expand the health and affinity
centers to provide consumers a forum to provide feedback or recommendations on
products.

Delivery of Our Customer's Orders

We currently outsource our distribution and order fulfillment operations on
a non-exclusive basis through Walsh, RxAmerica and other vendors. We carry
minimal inventory relative to our total sales and rely to a large extent on
rapid distribution from these vendors.

Walsh Distribution accounted for 78% of our cost of sales for health,
beauty, wellness and personal care products from inception to July 4, 1999.
Walsh packages for shipment all customer orders, including drugstore.com
inventory purchased directly from other vendors that Walsh holds for us at
their facility. We staff our own customer care specialists at the Walsh
facility to monitor quality control and order fulfillment. Walsh provides
inventory and services under a supply and services agreement that has a three
year term (through January 2002). This agreement may be terminated earlier by
us upon accelerated payment of minimum fees that would not exceed
approximately $2,500,000.

We currently purchase all of our pharmaceutical products from one vendor,
RxAmerica, in accordance with a pharmacy services agreement. Our pharmacists
perform all aspects of the prescription fulfillment process and all aspects of
customer service, except for the physical filling and packaging of
prescription drugs, which is performed by RxAmerica pharmacists. We staff our
own pharmacists, pharmacy technicians and customer care specialists at the
RxAmerica facility. As of April 30, 1999, RxAmerica employed approximately 25
pharmacists to fill and package prescriptions and help manage quality
assurance. RxAmerica is licensed and in good standing in the State of Texas
and in every other state as a nonresident pharmacy, as required by law. The
pharmacy services agreement with RxAmerica has a one-year term (to February
2000) and will automatically renew for additional one-year terms unless either
party notifies the other that it wishes to terminate the agreement at the end
of the initial term or a successive term. The agreement is non-exclusive and
does not prevent us from using other vendors for pharmaceutical products,
although we have not done so to date. When we establish our own distribution
center, we will be obligated to buy our pharmaceutical products from Rite Aid,
unless we are able to obtain better overall terms from other vendors.

Our warehouse management system, which is integrated with RxAmerica's and
Walsh's information systems, provides us real-time data on inventory
receiving, shipping, inventory quantities and inventory location. This enables
us to notify customers on a real-time basis if the product is in stock. In
addition, we offer an order tracking system for our customers on our Web site.

The inventories of RxAmerica and Walsh consist of items typically found in
traditional chain drugstores. We charge our customers a shipping charge that
covers all or a portion of our expenses of shipping. Walsh purchases
substantially all of its inventory directly from the manufacturers of the
products. RxAmerica purchases its pharmaceutical products from a variety of
manufacturers as well as wholesalers.

We offer a variety of shipping options, including next-day delivery for
orders received during the business week. We ship to anywhere in the United
States served by the United Parcel Service or the U.S. Postal Service.
Priority orders are flagged and expedited through our fulfillment processes.
For non-prescription product orders received before 9:00 p.m. Central time
Monday through Friday or before 5:00 p.m. Central time on Saturday, our goal
is to ship the product the same day. For prescription products, our goal is to
ship the product as soon as the prescription has been verified and our
pharmacists have completed drug utilization review.

In addition, Rite Aid customers will be able to order refills of their Rite
Aid prescriptions online at our Web site either for delivery through the mail
to their homes or for pickup at their choice of any one of the over 3,800 Rite
Aid stores.

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Customer Care

We believe that a high level of customer service and support is critical to
retaining and expanding our customer base. Our customer care specialists are
currently available from 6:00 a.m. to 10:00 p.m. Pacific time, Monday to
Friday, on Saturdays from 9:00 a.m. to 6:00 p.m. Pacific time, and on Sundays
from 9:00 a.m. to 4:00 p.m. Pacific time to provide assistance via e-mail or
phone. We intend to expand this availability to 24 hours a day, seven days a
week. We strive to answer all customer inquiries within 24 hours. Our customer
care specialists handle questions about orders and how to use our Web site,
assist customers in finding desired products and register customers' credit
card information over the telephone. Our customer care specialists are a
valuable source of feedback regarding user satisfaction. Our Web site also
contains a customer care page that outlines store policies and provides
answers to frequently asked questions. In addition, our pharmacists can
provide advice to our customers about medication, dosage, delivery systems,
common side effects and other information about prescription drugs.

Operations and Technology

We have implemented a broad array of services and systems for site
management, searching, customer interaction, transaction processing and
fulfillment. We use a set of software applications for:

. Accepting and validating customer orders;

. Organizing, placing and managing orders with vendors and fulfillment
partners;

. Receiving product and assigning it to customer orders; and

. Managing shipment of products to customers based on various ordering
criteria.

These services and systems use a combination of our own proprietary
technologies and commercially available, licensed technologies. We focus our
internal development efforts on creating and enhancing the specialized,
proprietary software that is unique to our business. In order to enhance the
online and offline experience for Rite Aid and drugstore.com customers, we
intend to integrate certain of our information and pharmacy systems with Rite
Aid's. Rite Aid has granted us a nonexclusive, fully-paid license to the Rite
Aid systems that will be integrated with our systems, subject to third party
rights to such technology.

We also have a technology license and advertising agreement with Amazon.com
under which we mutually agreed to license certain existing and future
technology used in the operation of our Web sites as long as we do not use the
technology to compete with each other. We currently are not using any
Amazon.com technology but could do so in the future if it would benefit us.
See "--Relationship with Amazon.com" for a further description of our
agreements with Amazon.com.

Our core merchandise catalog, customer interaction, order collection,
fulfillment and back-end systems are proprietary to drugstore.com, but are
available to Amazon.com under our agreement with them. Our software platform
and architecture are integrated with an Oracle database system. The systems
were designed to provide real-time connectivity to the distribution center
systems for pharmacy and the non-pharmacy products. These include an
inventory-tracking system, real-time order tracking system, executive
information system and replenishment system. Our Internet servers use Verisign
digital certificates to help conduct secure communications and transactions.
Our systems infrastructure is hosted at Exodus Communications in Tukwila,
Washington, which provides communication lines from multiple providers
including UUNet and AT&T, as well as 24 hour monitoring and engineering
support. Exodus has its own generators and multiple back up systems in
Tukwila.

We maintain customer care centers in our Bellevue, Washington office and in
our prescription distribution facility in Fort Worth, Texas and use a real
time interactive voice response system with transfer capabilities between our
customer care centers in Bellevue, Washington and Fort Worth, Texas. We also
operate a toll-free number, 1-800-DRUGSTORE, through which customers can place
orders and receive information. In addition,

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customers who choose not to transmit their credit card information via the
Internet have the option of submitting their credit card information by
telephone.

We incurred $2.2 million in product development expenses in the period from
inception to December 31, 1998 and $5.9 million during the six months ended
July 4, 1999. We anticipate that we will continue to devote significant
resources to product development in the future as we add new features and
functionality to our Web site.

Competition

The online commerce market is new, rapidly evolving and intensely
competitive. In particular, the health, beauty, wellness, personal care and
pharmacy categories are intensely competitive and are also highly fragmented,
with no clear dominant leader in any of our market categories. Our competitors
can be divided into several groups: chain drugstores, such as Walgreen's, CVS
and Eckerd; mass market retailers such as Wal-Mart, Kmart and Target;
supermarkets, such as Safeway, Albertson's and Kroger; warehouse clubs; online
retailers of health, beauty, wellness, personal care and/or pharmaceutical
products; mail order pharmacies; prescription benefits managers, such as
Express Scripts and Merck-Medco; Internet-portals and online service providers
that feature shopping services such as America Online, Yahoo!, Excite and
Lycos; cosmetics departments at major department stores, such as Nordstrom,
Macys and Bloomingdale's; and hair salons. Each of these competitors operate
within one or more of the health, beauty, wellness, personal care and pharmacy
product categories. In addition, nearly all of our competitors have, or have
announced their intention to have, the capability to accept orders for
products online. In particular, Walgreen's, CVS, Albertson's and Wal-Mart
already are accepting prescription refill or other orders on their Web sites.

We believe that the following are principal competitive factors in our
market:

. Brand recognition;

. Selection;

. Convenience;

. Price;

. Web site performance and accessibility;

. Customer service;

. Quality of information services; and

. Reliability and speed of order shipment.

Many of our current and potential traditional store-based and online
competitors have longer operating histories, larger customer or user bases,
greater brand recognition and significantly greater financial, marketing and
other resources than we do. Many of these current and potential competitors
can devote substantially more resources to their Web site and systems
development than we can. In addition, larger, well-established and well-
financed entities may acquire, invest in or form joint ventures with online
competitors or drugstore retailers as the use of the Internet and other online
services increases.

Some of our competitors may be able to secure products from vendors on more
favorable terms, fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than we can. Traditional
store-based retailers also enable customers to see and feel products in a
manner that is not possible over the Internet. Traditional store-based
retailers can also sell products to address immediate, acute care needs, which
we and other online sites cannot do. Some of our competitors such as
Walgreen's and Wal-mart have significantly greater experience in selling
drugstore products.

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Relationship with Amazon.com

We have a strategic relationship with Amazon.com whereby Amazon.com
advertises our Web service. We believe that the benefits of our relationship
with Amazon.com include their advertising our Web site and the beneficial
aspects of our being associated with one of the premier e-commerce companies.
Amazon.com is our largest shareholder, and Jeffrey P. Bezos, Amazon.com's
chairman of the board and chief executive officer is a member of our board of
directors. As part of our relationship with Amazon.com, we entered into a
technology license and advertising agreement. This agreement extends for ten
years and can be terminated for breach or in the event that we are acquired by
a competitor of Amazon.com. This agreement contains provisions generally
relating to the sharing of technology and technical support; however, we have
decided to develop our own technology and there has been no exchange of
technology by either party to date. Specifically, this agreement provides for
the license of substantially all of each company's technology to the other for
use within their respective businesses that may be developed through August
10, 2008. Neither company may use the other's technology to compete against
the other. In addition, each party has committed to providing the other with
advertising on our respective Web sites through the term of the agreement as
mutually agreed upon. In addition, we agreed not to place advertisements
competitive to Amazon.com's business on our site. We have also agreed not to
sell advertising on our Web site to, link our Web site to, or promote on our
Web site any company that sells products or services competitive with those
which Amazon.com offers or which Amazon.com is preparing to produce or market.
We are currently restricted with respect to books, music products, video
products, gift centers, and auctions. If Amazon.com expands into other areas
this may further limit the companies we can promote on our Web site. If we are
acquired by an Amazon.com competitor and Amazon.com does not vote in favor of
the transaction, we would lose our rights to advertise on Amazon.com's
website, to restrict Amazon.com's ability to compete in the online drugstore
business, and to use Amazon.com's technology (if we are then using any). See
"Executive Officers and Directors," "Certain Relationships and Related
Transactions" and "Principal Stockholders" for further background on Amazon's
relationship with us.

Relationship With Rite Aid

In June 1999, we entered into a strategic relationship with Rite Aid. Under
the relationship, Rite Aid customers will be able to refill existing Rite Aid
prescriptions at our site and either use our standard delivery options or pick
up the prescriptions at the more than 3,800 Rite Aid stores nationwide. In
addition, Rite Aid and drugstore.com will promote each other's services both
online and offline, including a link from Rite Aid's Web site to our Web site.
We believe that potential benefits of our relationship with Rite Aid may
include additional revenue and traffic generated by Rite Aid customers who may
visit our Web site, the pharmacy benefit coverage provided by the insurance
companies and PBMs with which Rite Aid has a relationship, including PCS, and
the co-promotion and co-branding activities both companies will undertake. In
connection with this relationship, Rite Aid also became one of our largest
stockholders, holding approximately 25.4% of our outstanding common stock
prior to this offering. We expect that Martin L. Grass, Rite Aid's chairman of
the board and chief executive officer, will become a member of our board of
directors after completion of this offering.

As part of the relationship, both Rite Aid and drugstore.com agreed to
certain exclusivity provisions that will limit drugstore.com's ability to
promote or affiliate with any other physical retail drugstore and from
operating a traditional physical drugstore, and will preclude Rite Aid from
offering or selling products or services on the Internet other than through
our Web site. In addition, the agreement provides that if we establish our own
distribution center, we will be obligated to purchase all of our
pharmaceutical requirements from Rite Aid unless we are able to obtain better
overall terms from another vendor. The agreement contains additional
provisions providing for the licensing by Rite Aid to drugstore.com of
information technology systems and the integration of the information
technology and pharmacy systems of the two companies. This agreement extends
for ten years, but can be terminated for breach prior to such time. See
"Executive Officers and Directors," "Certain Relationships and Related
Transactions" and "Principal Stockholders" for further background on
Rite Aid's relationship with us.

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<PAGE>

Relationship With GNC

In June 1999, we entered into a relationship with General Nutrition
Companies, Inc. (GNC) whereby we will be the exclusive online provider of GNC-
branded products. We have the exclusive right to sell GNC's nutrition products
over the Internet, including the PharmAssure brand of pharmacist recommended
vitamins and nutritional supplements, subject to our meeting performance
parameters based on traffic to our Web site and sales of GNC products in the
third and fifth year of the relationship. As long as we have the exclusive
right to distribute GNC's products over the Internet, we will not promote any
other retail health food store or operate a physical retail health food store.
If the exclusivity provisions of the agreement terminate, we have the non-
exclusive right to sell these products for the remaining term of the
agreement. As part of this relationship, we will create a separate part of our
Web site called the GNC LiveWell Store that is dedicated to selling on a
consignment basis GNC products. In connection with this relationship, GNC
acquired approximately 8.0% of our outstanding common stock prior to this
offering. GNC and drugstore.com also agreed to co-promote each other's
products and services in both their traditional and online marketing efforts,
including GNC's placement of a link to our Web site on their Web site. The
agreement extends for ten years, but can be terminated for breach prior to
such time. GNC recently announced it has agreed to be acquired by Royal Numico
N.V., a European maker of nutrition products. See "Certain Relationships and
Related Transactions" and "Principal Stockholders" for further background on
GNC's relationship with us.

Governmental Regulation

Our business is subject to extensive federal, state and local regulations,
many of which are specific to pharmacies and the sale of over-the-counter
drugs. For example, pursuant to the Omnibus Budget Reconciliation Act of 1990
and related state and local regulations, our pharmacists are required to offer
counseling, without additional charge, to our customers about medication,
dosage, delivery systems, common side effects, adverse effects or interactions
and therapeutic contraindications, proper storage, prescription refill, and
other information deemed significant by the pharmacists. We are also subject
to federal, state and local licensing and registration regulations with
respect to, among other things, our pharmacy operations.

We are subject to requirements under the Controlled Substances Act and
federal Drug Enforcement Agency regulations, as well as related state and
local laws and regulations, relating to our pharmacy operations, including
registration, security, recordkeeping, and reporting requirements related to
the purchase, storage and dispensing of controlled substances, prescription
drugs, and certain over-the-counter drugs. Under the Food, Drug & Cosmetic Act
of 1938 (the FDCA), a drug recognized in Homeopathic Pharmacopeia of the
United States must meet all compendial standards, or it will be considered
misbranded or adulterated. Because we sell homeopathic remedies, we are
required to comply with the FDCA.

The U.S. House of Representatives Committee on Commerce and the General
Accounting Office are currently investigating online pharmacies and online
prescribing, especially focused on those who prescribe drugs online and on
pharmacies that fill invalid prescriptions, including those that are written
online. The committee requested that the General Accounting Office undertake a
formal review of a number of issues pertaining to online pharmacies, including
an assessment of mechanisms to ensure that online pharmacies are obeying the
various state and federal regulations for the industry. Because we make every
effort only to fulfill valid prescriptions and we do not prescribe drugs, we
believe that our business will not be negatively affected by any regulations
that result from the investigations. However, we believe that any regulations
resulting from the investigations will likely result in increased reporting
and monitoring requirements.

The National Association of Boards of Pharmacy (NABP), a coalition of state
pharmacy boards, is in the process of developing a program, the Verified
Internet Pharmacy Practice Sites (VIPPS), as a model for self-regulation for
online pharmacies. We are assisting the NABP with the development of the VIPPS
program and intend to comply with its criteria for certification.

Legislation and regulations currently being considered at the federal and
state level could affect our business, including legislation or regulations
relating to confidentiality of patient records, electronic access and

47
<PAGE>

storage. In addition, various state legislatures are considering new
legislation related to the regulation of nonresident pharmacies. The Health
Insurance Portability and Accountability Act of 1996 mandates the use of
standard transactions, standard identifiers, security and other provisions by
the year 2000. Regulations have been proposed to implement these requirements,
and we are designing our applications to comply with the proposed regulations.

Although the FDA does not regulate the practice of pharmacy, other than
pharmacy compounding, which we do not currently engage in, FDA regulations
impact some of our product and service offerings because the FDA regulates
drug advertising and promotion, including direct-to-consumer advertising, done
by or on behalf of drug manufacturers and marketers. As we expand our product
and service offerings, more of our products and services will likely be
subject to FDA regulation.

The inclusion of prescription drugs as a Medicare benefit has been the
subject of numerous bills in the U.S. Congress. Should legislation on
prescription drug coverage for Medicare recipients be enacted into law, we
would be subject to compliance with any corresponding rules and regulations.

For a description of the risks we face with regard to these government
regulations, please see "Risk Factors--Governmental Regulation of the Health
Care and Pharmacy Industries Could Affect Our Business."

Intellectual Property

We regard the protection of our copyrights, service marks, trademarks,
trade dress and trade secrets as critical to our future success and rely on a
combination of copyright, trademark, service mark and trade secret laws and
contractual restrictions to establish and protect our proprietary rights in
products and services. We have entered into confidentiality and invention
assignment agreements with our employees and contractors, and nondisclosure
agreements with our vendors, fulfillment partners and strategic partners to
limit access to and disclosure of our proprietary information. We cannot be
certain that these contractual arrangements or the other steps taken by us to
protect our intellectual property will prevent misappropriation of our
technology. We have licensed in the past, and expect that we may license in
the future, certain of our proprietary rights, such as trademarks or
copyrighted material, to third parties. For example, as noted above, we have
licensed our technology to Amazon.com and we have also granted nonexclusive
rights to our trademarks in connection with advertising and affiliate
relationships. While we attempt to ensure that the quality of the
drugstore.com products brand is maintained by such licensees, we cannot assure
that such licensees will not take actions that might hurt the value of our
proprietary rights or reputation. We also rely on technologies that we license
from third parties, such as Oracle and Microsoft, the suppliers of key
database technology, the operating system and specific hardware components for
our service. We cannot be certain that these third-party technology licenses
will continue to be available to us on commercially reasonable terms. The loss
of such technology could require us to obtain substitute technology of lower
quality or performance standards or at greater cost, which could harm our
business.

We have filed applications for the registration of some of our trademarks
and service marks in the United States and in some other countries, including
for drugstore.com(TM), although we have not secured registration of any of our
marks to date. We may be unable to secure such registered marks. It is also
possible that our competitors or others will use marks similar to ours, which
could impede our ability to build brand identity and lead to customer
confusion. In addition, there could be potential trade name or trademark
infringement claims brought by owners of other registered trademarks or
trademarks that incorporate variations of the term drugstore.com(TM). Any
claims or customer confusion related to our trademark, or our failure to
obtain trademark registration, would negatively affect our business. In
addition, the laws of some foreign countries do not protect

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<PAGE>

our proprietary rights to the same extent as do the laws of the United States,
and effective copyright, trademark and trade secret protection may not be
available in such jurisdictions. Our efforts to protect our intellectual
property rights may not prevent misappropriation of our content. Our failure
or inability to protect our proprietary rights could substantially harm our
business.

Professional Advisory Board

We have a professional advisory board with whom we consult on our programs,
strategies and overall store development, as well as product selection and
product presentation. Certain members contribute periodic editorial features
as well. The advisory board will meet as a whole approximately once a year and
individual members are consulted as needed.

Our professional advisory board includes the following individuals:

. Martha Stewart, a media personality who specializes in applying creative
and practical principles in the home and garden;

. Kim Alexis, a well-known fashion model, actress and athlete;

. Barry Sears, Ph.D., a scientist and author of several popular books on
health and dieting, including the New York Times best-seller, The Zone;

. Loraine Stern, M.D., an associate clinical professor of pediatrics at
the University of California at Los Angeles and spokesperson for
children's health issues;

. Jennifer Jacobs, M.D., M.P.H., a clinical assistant professor of
epidemiology at the University of Washington School of Public Health and
Community Medicine and the President-elect of the American Institute of
Homeopathy.

Charitable Contributions

Prior to completion of this offering, we will donate approximately 200,000
shares of our common stock to a foundation to be established by us. The
foundation will make grants to charitable organizations. We intend to involve
our employees in determining the charitable purposes for this foundation.

Employees

As of July 4, 1999, we had 245 full-time employees. None of our employees
is represented by a labor union. We have not experienced any work stoppages
and consider our employee relations to be good.

Facilities

Our principal executive offices are located in Bellevue, Washington, where
we lease approximately 55,649 square feet under a lease that expires in July
2005. We also lease an approximately 18,750 square feet facility in Redmond,
Washington, which we vacated after moving to our new Bellevue facility, under
a lease that expires in September 2003. We have subleased the Redmond facility
for a period of 12 months and currently intend to sublease such space
thereafter, if possible. We anticipate that we will require additional space
as more personnel are hired and as we establish our own distribution center
and other facilities.

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<PAGE>

MANAGEMENT

Executive Officers and Directors

The following table sets forth information with respect to our executive
officers and directors as of July 4, 1999:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Peter M. Neupert(1)..... 43 Chairman of the Board of Directors, President and Chief Executive Officer
Suzan K. DelBene........ 37 Vice President, Marketing and Store Development
Kal Raman............... 31 Chief Information Officer and Senior Vice President, Operations
David E. Rostov......... 33 Vice President and Chief Financial Officer
Mark L. Silverman....... 34 Vice President, Health Services, General Counsel and Secretary
Jed A. Smith............ 33 Vice President, Strategic Partnerships and Director
Jeffrey P. Bezos........ 35 Director
Brook H. Byers(2)....... 53 Director
L. John Doerr........... 48 Director
William D. Savoy(2)(3).. 34 Director
Howard Schultz(1)....... 45 Director
</TABLE>
- --------
(1) Member of compensation committee
(2) Member of audit committee
(3) Pending appointment.

Peter M. Neupert has served as a director and the President and Chief
Executive Officer of drugstore.com since July 1998 and will be appointed
chairman of the board of directors prior to completion of this offering. From
March 1987 to July 1998, he worked for Microsoft Corporation in several
positions, most recently as Vice President of News and Publishing for
Microsoft's interactive media group. Mr. Neupert holds an M.B.A. from the Amos
Tuck School of Business at Dartmouth College and a B.A. from Colorado College.

Suzan K. DelBene has served as Vice President, Marketing and Store
Development of drugstore.com since September 1998. From June 1989 to August
1998, she worked at Microsoft Corporation in several positions, most recently
as Director of Marketing and Business Development in Microsoft's interactive
media group. Ms. DelBene holds an M.B.A. from the University of Washington and
a B.A. from Reed College.

Kal Raman (formerly known as Kalyanaraman Srinivasan) has served as Chief
Information Officer of drugstore.com since August 1998 and as Senior Vice
President, Operations since May 1999. He served as Vice President, Technology
of drugstore.com from August 1998 to May 1999 and as Vice President,
Technology and Operations from March 1999 to May 1999. From March 1998 to
August 1998, Mr. Raman served as the Chief Information Officer and Vice
President of Nations Rent and from February 1997 to March 1998, he served as
Senior Director, Information Systems of Blockbuster Inc. From May 1992 to
February 1997, Mr. Raman served as Director, International Division of Wal-
mart Stores Inc.

David E. Rostov has served as Vice President and Chief Financial Officer of
drugstore.com since January 1999. From January 1996 to January 1999, he worked
for Nextel International, Inc. as Chief Financial Officer. From 1992 to 1995,
he served in various capacities at McCaw Cellular Communications, Inc. Mr.
Rostov holds an M.B.A. and a Master's in Public Policy from the University of
Chicago Graduate School of Business and a B.A. from Oberlin College.

Mark L. Silverman has served as Secretary of drugstore.com since our
inception in April 1998, as Vice President, and General Counsel of
drugstore.com since January 1999 and as Vice President, Health Services and
General Counsel since March 1999. From December 1995 to January 1999, he was a
lawyer with the Venture Law Group, A Professional Corporation, becoming a
director in January 1998. Mr. Silverman was an attorney with Heller, Ehrman,
White & McAuliffe from December 1992 to November 1995. Mr. Silverman holds a
J.D. from the University of California, Los Angeles and a B.A. from the
University of California, Berkeley.

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<PAGE>

Jed A. Smith, a founder of drugstore.com, has served as a director and Vice
President of Strategic Partnerships since our inception in April 1998. In
1994, he founded Cybersmith and served as Vice President of Sales and
Marketing through 1998. Mr. Smith holds an M.B.A. from Harvard University
Graduate School of Business and a B.A. from Middlebury College.

Jeffrey P. Bezos has served as a director of drugstore.com since August
1998. Mr. Bezos, a founder of Amazon.com, has served as Chairman of the Board
of Directors of Amazon.com since its inception in 1994, Chief Executive
Officer of Amazon.com since May 1996, President of Amazon.com from inception
to June 1999 and Treasurer and Secretary of Amazon.com from May 1996 to March
1997. From December 1990 to June 1994, Mr. Bezos was employed by D.E. Shaw &
Co., a Wall Street investment firm, becoming Senior Vice President in 1992.
From April 1988 to December 1990, Mr. Bezos was employed by Bankers Trust
Company, becoming Vice President in February 1990. Mr. Bezos received his B.S.
in Electrical Engineering and Computer Science from Princeton University.

Brook H. Byers has served as a director of drugstore.com since May 1998.
Mr. Byers is a partner of Kleiner Perkins Caufield & Byers, a private venture
capital firm, and has been a technology venture capital investor since 1972.
He has served on the Board of Directors of over twenty companies, and he is
currently a director of Axys Pharmaceuticals, Nanogen, Chemdex.com and several
private companies. He also served as the founding President and Chairman of
Idec Pharmaceuticals, Ligand Pharmaceuticals, Athena Neurosciences and Insite
Vision Opthalmics. Mr. Byers serves on the boards of the California Healthcare
Institute and the Foundation of the University of California at San Francisco
Medical Center. Mr. Byers received a degree in Electrical Engineering from
Georgia Institute of Technology and an M.B.A. from the Stanford Graduate
School of Business.

L. John Doerr has served as a director of drugstore.com since November
1998. Mr. Doerr has been a general partner of Kleiner Perkins Caufield &
Byers, a private venture capital firm, since September 1980. In 1974, he
joined Intel Corporation and held various engineering, marketing and
management assignments. Mr. Doerr is also a director of Amazon.com, @Home
Networks, Healtheon Corporation, Intuit, Inc., Platinum Software, Inc., and
SunMicrosystems, as well as several private companies. Mr. Doerr received his
M.E.E. and B.S.E.E. from Rice University and his M.B.A. from Harvard
University Graduate School of Business.

Howard Schultz has served as a director of drugstore.com since November
1998. Mr. Schultz, the founder of Starbucks Corporation, has served as
Chairman of the Board and Chief Executive Officer of Starbucks since its
inception in 1985. From 1985 to June 1994, Mr. Schultz also served as
President of Starbucks. Mr. Schultz is one of two founding members of Maveron
LLC, a company providing advisory services to consumer-based businesses, and
is one of two members of a limited liability company that serves as a general
partner of its affiliated venture capital fund, Maveron Equity Partners, L.P.
Mr. Schultz is a governor on the National Association of Securities Dealers,
Inc. Board of Governors, and he is a director of Ebay, Inc. Mr. Schultz
received his B.S. degree from Northern Michigan University.

William D. Savoy will be appointed as a director of drugstore.com prior to
completion of this offering. Mr. Savoy is President of Vulcan Northwest Inc.,
managing the personal finances of Paul Allen, and Vice President of Vulcan
Ventures Inc., a venture capital fund wholly owned by Paul Allen. From 1987
until November 1990, Mr. Savoy was employed by Layered, Inc. and became its
President in 1988. Mr. Savoy serves on the Advisory Board of DreamWorks SKG
and also serves as director of CNET, Inc., Go2Net, Inc., Harbinger
Corporation, High Speed Access Corporation, Metricom, Inc., Telescan, Inc.,
Ticketmaster Online-CitySearch, USA Networks, Inc. and Value America, Inc. Mr.
Savoy holds a B.S. in Computer Science, Accounting, and Finance from Atlantic
Union College.

Our board of directors currently consists of nine members, including two
vacancies. Until the closing of this offering, Amazon.com has the right to
appoint one additional director to our board. In addition, under the terms of
a June 1999 voting agreement, if this offering is not completed by January 1,
2000 and Rite Aid is not represented on the board at such time, Rite Aid will
have the right to nominate one member to our board of directors. In addition
to the directors mentioned above, we intend to appoint the following two
individuals to our board of directors after completion of this offering:

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<PAGE>

Martin L. Grass is expected to be appointed as a director of drugstore.com
after completion of this offering. Mr. Grass has been chairman of the board and
chief executive officer of Rite Aid Corporation since March 1995. Previously,
Mr. Grass was president and chief operating officer of Rite Aid since April
1989, had been executive vice president for three years and prior thereto had
served as senior vice president. He has served Rite Aid in various capacities
since 1978. Mr. Grass has been a member of the Rite Aid board of directors
since 1982.

Melinda French Gates is expected to be appointed as a director of
drugstore.com after completion of this offering. Ms. Gates worked at Microsoft
Corporation from 1987 to May 1996 in a variety of positions, including serving
as both product manager and general manager for the development of several
multi-media products and other software programs. Since her retirement from
Microsoft in 1996, Ms. Gates has focused on philanthropic work in the Seattle
community. Ms. Gates holds a B.A. from Duke University and an M.B.A. from The
Fuqua School of Business at Duke University, and is a member of the Duke
University Board of Trustees.

At any stockholder meeting involving election of directors, Jed Smith,
Peter Neupert and several of our major prior investors have agreed to vote
their shares to elect one director designated by Amazon.com. The major prior
investors who are parties to this agreement are Kleiner Perkins Caufield and
Byers, Amazon.com, Vulcan Ventures, Rite Aid and GNC. The parties' obligations
to elect an Amazon.com designee terminate if Amazon.com owns less than 5% of
our voting stock.

Each director is elected for a period of one year at our annual meeting of
stockholders and serves until the next annual meeting or until his or her
successor is duly elected and qualified. The board of directors elects
executive officers on an annual basis. Executive officers serve until their
successor has been duly elected and qualified. There are no family
relationships among any of the directors, officers or key employees of
drugstore.com.

Board Committees

The board of directors has a compensation committee, a stock option
subcommittee and an audit committee.

Compensation Committee. The compensation committee of the board of
directors, which is effective upon this offering, will review and make
recommendations to the board regarding all forms of compensation and benefits
provided to our officers. In addition, the compensation committee establishes
and reviews general policies relating to the compensation and benefits of all
of our employees. The current members of the compensation committee are Peter
M. Neupert and Howard Schultz. Since the current members of the compensation
committee do not meet the definition of "non-employee directors" for purposes
of SEC Rule 16(b)(3), the full board of directors will continue to approve
stock option grants for our officers in order to qualify the option grants for
an exemption from short-swing trading rules.

Stock Option Subcommittee. The stock option subcommittee of the compensation
committee will be established prior to completion of this offering. The stock
option subcommittee will have authority to grant stock options to optionees who
are not executive officers or directors of drugstore.com. Peter M. Neupert will
be the sole member of the stock option subcommittee.

Audit Committee. The audit committee of the board of directors reviews and
monitors our internal accounting procedures, corporate financial reporting,
external and internal audits, the results and scope of the annual audit and
other services provided by our independent auditors, and our compliance with
legal matters that have a significant impact on our financial reports. Brook H.
Byers and William D. Savoy will be the members of the audit committee.

Compensation Committee Interlocks and Insider Participation

The board of directors established its compensation committee in May 1999.
Prior to establishing the compensation committee, the board of directors as a
whole performed the functions delegated to the

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<PAGE>

compensation committee. No interlocking relationship exists between our board
of directors or our compensation committee and the board of directors or
compensation committee of any other company, and no interlocking relationship
existed in the past.

Director Compensation

We currently do not provide any cash compensation to our directors for
their service as members of the board of directors, although we do reimburse
the directors for certain expenses in connection with attendance at board and
committee meetings. Under our 1998 stock plan, nonemployee directors are
eligible to receive stock option grants at the discretion of the board or any
other administrator of the plan. See "--Stock Plans" for a description of
option grants under the 1998 stock plan.

Executive Compensation

The following table sets forth the compensation received for services
rendered to drugstore.com for the fiscal year ended December 31, 1998 by our
Chief Executive Officer and our only other executive officer who earned more
than $100,000 in salary and bonus during the fiscal year ended December 31,
1998.

Summary Compensation Table

<TABLE>
<CAPTION>
Long-Term
Compensation
Annual Compensation Awards
-------------------- Securities
Underlying All Other
Name and Principal Position Salary ($) Bonus ($) Options (#) Compensation($)
- --------------------------- ---------- --------- ------------ ---------------
<S> <C> <C> <C> <C>
Peter M. Neupert.............. $107,692 -- -- $ 170(1)
President and Chief Executive
Officer
Kal Raman..................... $ 60,577 $120,000 150,000 $5,895(2)
Chief Information Officer and
Senior Vice President,
Operations
</TABLE>
- --------
(1) Represents premium paid for term life insurance for the benefit of Peter
M. Neupert.
(2) Represents reimbursement for relocation expenses and premium paid for term
life insurance for the benefit of Kal Raman.

Option Grants

The following table provides summary information regarding stock options
granted to our chief executive officer and our only other officer earning more
than $100,000 in salary and bonus during the fiscal year ended December 31,
1998.

Option Grants in Last Fiscal Year

<TABLE>
<CAPTION>
Individual Grants
---------------------
Potential Realizable
% of Total Value at Assumed
Number of Options Annual Rates of
Securities Granted to Stock Appreciation
Underlying Employees Exercise For Option Term ($)(2)
Options in Fiscal Price Expiration -----------------------
Name Granted(#) Year(1) ($/share) Date 5% ($) 10% ($)
- ---- ---------- ---------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Peter M. Neupert........ -- -- -- -- -- --
Kal Raman............... 150,000 8.91% $0.04 9/01/2008 $2,437,342 $3,884,614
</TABLE>
- --------
(1) Based on an aggregate of 1,683,584 shares underlying options granted by
drugstore.com during the fiscal year ended December 31, 1998 to our
employees and consultants.
(2) Based on assumed initial public offering price of $10.00 per share.

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<PAGE>

Option Exercises and Holdings

The following table provides summary information with respect to our chief
executive officer and our only other officer earning more than $100,000 in
salary and bonus during the 1998 fiscal year concerning exercisable and
unexercisable options held as of December 31, 1998. No options were exercised
by the individuals in the fiscal year ended December 31, 1998.

Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values

<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options at In-the-Money Options at
Fiscal Year-End (#) Fiscal Year-End ($)(1)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Peter M. Neupert............ -- -- -- --
Kal Raman................... -- 150,000 -- $1,494,000
</TABLE>
- --------

(1) Based on a value of $10.00 per share, the assumed initial public offering
price, minus the per share exercise price, multiplied by the number of
shares issued upon exercise of the option.

Stock Plans

1998 Stock Plan. Our 1998 stock plan provides for the grant of incentive
stock options to employees and nonstatutory stock options and stock purchase
rights to employees, directors and consultants to acquire shares of common
stock. The purposes of the 1998 stock plan are to attract and retain the best
available personnel, to provide additional incentives to our employees and
consultants and to promote the success of our business. Our board of directors
originally adopted the 1998 stock plan in July 1998 and our stockholders
approved the plan in July 1998. The plan was amended in January 1999 to
increase the total number of shares of common stock reserved for issuance. The
1998 stock plan was amended by the board a second time in April 1999 to
increase the total number of shares of common stock reserved for issuance to
7,827,000 shares and to incorporate certain other changes. We will submit the
amendment to the 1998 stock plan for approval by our stockholders prior to the
completion of this offering. Unless terminated earlier by the board of
directors, the 1998 stock plan will terminate in July 2008. As of July 4,
1999, options to purchase 3,032,809 shares of common stock were outstanding at
a weighted average exercise price of $1.77 per share, 8,000 shares had been
issued pursuant to restricted stock purchase agreements, no shares had been
issued upon exercise of outstanding options, and 4,786,191 shares remained
available for future grant.

The 1998 stock plan may be administered by the board of directors, a
committee appointed by the board of directors or a combination of the board of
directors and a committee, as determined by the board of directors. The
administrator determines the terms of options granted under the 1998 stock
plan, including the number of shares subject to the option, exercise price,
term and exercisability. In no event, however, may an individual receive
option grants for more than 2,500,000 shares of common stock under the 1998
stock plan in any fiscal year. Incentive stock options granted under the 1998
stock plan must have an exercise price of at least 100% of the fair market
value of the common stock on the date of grant and at least 110% of such fair
market value in the case of an optionee who holds more than 10% of the total
voting power of all classes of our stock. Nonstatutory stock options granted
under the 1998 stock plan will have an exercise price as determined by the
administrator. Payment of the exercise price may be made in cash or such other
consideration as determined by the administrator.

The administrator determines the term of options, which may not exceed 10
years or 5 years in the case of an incentive stock option granted to a holder
of more than 10% of the total voting power of all classes of our stock. No
option may be transferred by the optionee other than by will or the laws of
descent or distribution, provided, however, that the administrator may in its
discretion provide for the transferability of nonstatutory stock options
granted under the 1998 stock plan if the common stock is listed or approved
for listing on a national

54
<PAGE>

securities exchange or designated as a national market system security by the
National Association of Securities Dealers, Inc. Each option may be exercised
during the lifetime of the optionee only by such optionee or permitted
transferee. The administrator determines when options become exercisable.
Options granted under the 1998 stock plan generally must be exercised within 3
months after the termination of the optionee's status as an employee, director
or consultant of drugstore.com, or within 6 months if such termination is due
to the death or within 12 months if such termination is due to disability of
the optionee, but in no event later than the expiration of the option's term.
Options granted under the 1998 stock plan generally vest over a four-year or
five-year period at a rate of 1/4 of the total number of shares subject to the
option twelve months after the date of grant, with the remaining shares
vesting in equal installments at the end of each six month period thereafter.

In the event of our merger with or into another corporation, the successor
corporation may assume each option and outstanding stock purchase right or may
substitute an equivalent option or stock purchase right. However, if the
successor corporation does not agree to this assumption or substitution, the
option or stock purchase right will terminate. The board of directors has the
authority to amend or terminate the 1998 stock plan provided that no action
that impairs the rights of any holder of an outstanding option may be taken
without the holder's consent. In addition, we will obtain requisite
stockholder approval for any action requiring stockholder approval under the
applicable law.

In addition to stock options, the administrator may issue stock purchase
rights under the 1998 stock plan to employees, directors and consultants. The
administrator determines the number of shares, price, terms, conditions and
restrictions related to a grant of stock purchase rights and the purchase
price of a stock purchase right granted under the 1998 stock plan. The
administrator also determines the period during which the stock purchase right
is held open, but in no case shall such period exceed 30 days. Unless the
administrator determines otherwise, the recipient of a stock purchase right
must execute a restricted stock purchase agreement granting an option to
repurchase the unvested shares at cost upon termination of such recipient's
relationship with us.

1999 Employee Stock Purchase Plan. Our board of directors adopted the 1999
employee stock purchase plan in April 1999; we will submit the plan to our
stockholders for approval prior to the completion of this offering. A total of
500,000 shares of common stock has been reserved for issuance under the
purchase plan plus an annual increase on the first day of each of our fiscal
years beginning in 2000, 2001, 2002, 2003 and 2004 equal to the lesser of the
following:

. 500,000 shares;

. 3% of our shares outstanding on the last day of the immediate preceding
fiscal year; or

. such lesser number of shares as is determined by the board.

The purchase plan, which is intended to qualify under Section 423 of the
Internal Revenue Code, will be implemented by an offering period commencing on
the date of the closing of this offering and ending on January 31, 2000. Each
subsequent offering period will have a duration of six months. Each offering
period after the first offering period will commence on February 1 and August
1 of each year. The board of directors or a committee appointed by the board
will administer the purchase plan. Employees, including officers and employee
directors, of drugstore.com or of any majority-owned subsidiary designated by
the board, are eligible to participate in the purchase plan if they are
employed by drugstore.com or any such subsidiary for at least 20 hours per
week and more than 5 months per year. The purchase plan permits eligible
employees to purchase common stock through payroll deductions, which may not
exceed 20% of an employee's compensation, at a price equal to the lower of 85%
of the fair market value of our common stock at the beginning or end of the
offering period. Employees may end their participation in the offering at any
time during the offering period, and participation ends automatically on
termination of employment. If not terminated earlier, the purchase plan will
have a term of 10 years.

The purchase plan provides that in the event of our merger with or into
another corporation or a sale of all or substantially all of our assets, the
successor corporation will assume each right to purchase stock under the
purchase plan or will substitute an equivalent right. If the successor
corporation does not agree to an assumption

55
<PAGE>

or substitution, the offering period then in progress will be shortened so
that employees' rights to purchase stock under the purchase plan are exercised
prior to the merger or sale of assets. The board of directors has the power to
amend or terminate the purchase plan as long as that action does not adversely
affect any outstanding rights to purchase stock under the plan. We may,
however, terminate the purchase plan or an offering period if continuation of
the purchase plan or the offering period would cause us to incur adverse
accounting charges.

401(k) Plan

Effective April 1999, we adopted the drugstore.com, inc. 401(k) plan
covering our full-time employees. The 401(k) plan is intended to qualify under
Section 401(k) of the Internal Revenue Code of 1986, as amended, so that
contributions to the 401(k) plan by employees or by drugstore.com, and the
investment earnings thereon, are not taxable to employees until withdrawn from
the 401(k) plan, and so that contributions by drugstore.com, if any, will be
deductible by drugstore.com when made. Under the 401(k) plan, employees may
elect to reduce their current compensation by up to the statutorily prescribed
annual limit ($10,000 in 1999) and to have the amount of such reduction
contributed to the 401(k) plan. The 401(k) plan permits, but does not require,
additional matching contributions to the 401(k) plan by drugstore.com on
behalf of all participants in the 401(k) plan. To date, we have not made any
matching contributions to the 401(k) plan.

Employment Offer Letters

Peter M. Neupert's employment offer letter provides for an initial annual
salary of $250,000 and an initial annual bonus of up to $125,000. We also
granted Mr. Neupert a one-time right to purchase 1,260,000 shares of our
common stock at a purchase price of $.04 per share. We have a lapsing right to
repurchase Mr. Neupert's unvested shares. As of July 4, 1999, our right to
repurchase has lapsed with respect to 315,000 shares of stock and will lapse
with respect to 19,688 shares at the end of each month after the one-year
anniversary of his start date of June 27, 1998 while he remains employed, with
all of these shares becoming fully vested on the close of the month following
his fifth anniversary of employment. If we are acquired by another entity or
sell substantially all our assets, and Mr. Neupert is not offered a position
with the surviving corporation with responsibilities similar to those held at
drugstore.com, our right of repurchase will lapse with respect to all of these
shares. Mr. Neupert's employment is for no specified length of time, and
either party has the right to terminate Mr. Neupert's employment at any time
for any reason. If we terminate Mr. Neupert's employment other than for
"cause" (which is defined in his agreement to mean gross negligence or willful
misconduct in the performance of his duties, the failure to obey our board of
directors, defrauding or stealing from drugstore.com, or being convicted of a
crime that harms the business or reputation of drugstore.com), our right of
repurchase will lapse on an additional 236,250 shares of the then-unvested
portion. The offer letter also provides that in the event Mr. Neupert's
employment is terminated for any reason, he will continue to receive his then-
current base salary and benefits for a period of nine months.

Kal Raman's employment offer letter provides for an initial annual salary
of $175,000, a $100,000 signing bonus (which was grossed up to $120,000 to
negate the effect of applicable taxes), reimbursement of $5,000 for a lost
down payment on a house in Florida and an annual bonus of up to 15% of his
salary. We also offered Mr. Raman an option to purchase shares of common stock
under our 1998 stock plan. In the offer letter, we agreed to guarantee a loan
from a bank in the amount of $250,000. However, instead of guaranteeing a bank
loan, we and Mr. Raman agreed that we would loan $250,000 directly to Mr.
Raman. See "Certain Relationships and Related Transactions" for a description
of our loan arrangement with Mr. Raman. Mr. Raman's employment is for no
specified length of time, and either party has the right to terminate the
agreement at any time for any reason.

Jed A. Smith's employment offer letter provides for an initial annual base
salary of $125,000 and an initial bonus of $25,000 contingent on drugstore.com
reaching agreed milestones. Mr. Smith's employment is for no specified length
of time, and either party has the right to terminate Mr. Smith's employment at
any time for any reason. The offer letter also provides that, in the event Mr.
Smith's employment is terminated for other than "cause" (which is defined in
his agreement to mean gross negligence or willful misconduct in the
performance

56
<PAGE>

of his duties, the failure to obey our board of directors or chief executive
officer, defrauding or stealing from drugstore.com, or being convicted of a
crime that harms the business or reputation of drugstore.com), he will
continue to receive his then-current base salary and benefits for a period of
six months.

Mark L. Silverman's employment offer letter provides for an initial annual
base salary of $175,000, a $35,000 signing bonus and a bonus at the discretion
of the chief executive officer commensurate with other officers of
drugstore.com. We also offered Mr. Silverman an option to purchase shares of
our common stock under our 1998 stock plan. If we are acquired by another
entity or sell substantially all of our assets and Mr. Silverman is not
offered a position with the surviving corporation with responsibilities
similar to those held at drugstore.com or if his employment is terminated for
other than "cause" (which is defined in his agreement to mean gross negligence
or willful misconduct in the performance of his duties, the failure to obey
our board of directors or chief executive officer, defrauding or stealing from
drugstore.com, or being convicted of a crime that harms the business or
reputation of drugstore.com), the option with respect to all then-unvested
shares shall vest. Mr. Silverman's employment is for no specified length of
time, and either party has the right to terminate Mr. Silverman's employment
at any time for any reason. The offer letter also provides that, in the event
Mr. Silverman's employment is terminated without cause, he will continue to
receive his then-current base salary and benefits for a period of twelve
months.

Limitations on Directors' Liability and Indemnification

Our certificate of incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for:

. any breach of their duty of loyalty to the corporation or its
stockholders;

. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;

. unlawful payments of dividends or unlawful stock repurchases or
redemptions; or

. any transaction from which the director derived an improper personal
benefit.

This limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.

Our certificate of incorporation and bylaws provide that drugstore.com
shall indemnify our directors and executive officers and may indemnify our
other officers and employees and other agents to the fullest extent permitted
by law. We believe that indemnification under our bylaws covers at least
negligence and gross negligence on the part of indemnified parties. Our bylaws
also permit us to secure insurance on behalf of any officer, director,
employee or other agent for any liability arising out of his or her actions in
such capacity, regardless of whether the bylaws would permit indemnification.

We have entered into agreements to indemnify our directors and officers, in
addition to indemnification provided for in our bylaws. These agreements,
among other things, provide for indemnification of our directors and officers
for expenses specified in the agreements, including attorneys' fees,
judgments, fines and settlement amounts incurred by any such person in any
action or proceeding arising out of such person's services as a director or
officer of drugstore.com, any subsidiary of drugstore.com or any other company
or enterprise to which the person provides services at the request of
drugstore.com. We believe that these provisions and agreements are necessary
to attract and retain qualified persons as directors and officers.

57
<PAGE>

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Since our inception in April 1998, we have issued and sold shares of our
capital stock as follows: a total of 2,265,000 shares of common stock at a
price of $.04 per share in June, July and August 1998, a total of
10,000,000 shares of Series A preferred stock at a price of $.80 per share in
June and August 1998, a total of 5,446,268 shares of Series B preferred stock
at a price of $3.35 per share in October, November and December 1998, a total
of 4,472,844 shares of Series C preferred stock at a price of $7.825 per share
in January and March 1999, a total of 2,266,289 shares of Series D preferred
stock at a price of $17.65 per share in June 1999, and a total of 12,282,599
shares of Series E preferred stock in July 1999. All shares of our preferred
stock will convert into common stock on a 1-for-1 basis upon the closing of
this offering. The following table summarizes the shares of capital stock
purchased by executive officers, directors and five-percent stockholders and
their affiliates in these transactions:

<TABLE>
<CAPTION>
Series A Series B Series C Series D Series E
Common Preferred Preferred Preferred Preferred Preferred
Investor(1) Stock Stock Stock Stock Stock Stock
- ----------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Kleiner Perkins Caufield
& Byers(2)(3).......... -- 4,937,500 1,582,089 511,182 -- --
Amazon.com, Inc.(2)(4).. -- 5,000,000 3,177,612 2,555,911 -- --
Maveron Equity Partners,
L.P.(2)(5)............. -- -- 417,910 766,773 -- --
Peter M. Neupert(2)(6).. 1,260,000 -- 268,657 319,489 -- --
Vulcan Ventures Incorpo-
rated(2)............... -- -- -- -- 2,266,289 --
Rite Aid Corpora-
tion(2)(7)............. -- -- -- -- -- 9,334,746
General Nutrition
Investment Company
(2)(8)................. -- -- -- -- -- 2,947,853
</TABLE>
- --------
(1) Shares held by affiliated persons and entities have been added together
for the purposes of this chart. See "Principal Stockholders" for a chart
of beneficial owners.
(2) Holder of 5% or more of a class of our capital stock.
(3) Includes shares held by Kleiner Perkins Caufield & Byers VIII, L.P. (KPCB
VIII), KPCB VIII Founders Fund, L.P., and KPCB Life Sciences Zaibatsu Fund
II, L.P. KPCB VIII and KPCB VIII Founders Fund, L.P. are wholly controlled
by KPCV VIII Associates, L.P. KPCB Life Sciences Zaibatsu Fund II, L.P. is
wholly controlled by KPCB VII Associates, L.P., Brook H. Byers and L. John
Doerr, each a general partner of KPCB VIII Associates and KPCB VII
Associates, L.P., are both directors of drugstore.com. Mr. Byers and Mr.
Doerr each disclaim beneficial ownership of shares held by these entities
except to the extent of their pecuniary interest therein. In November
1998, drugstore.com and Kleiner Perkins Caufield & Byers agreed to rescind
the purchase of 89,552 of such shares and refund the $299,999.20 purchase
price. As a result, after November 1998, Kleiner Perkins Caufield & Byers
held 1,582,089 shares of Series B preferred stock.
(4) In consideration of Amazon.com's obligations under a technology license
and advertising agreement, we issued Amazon.com 5,000,000 shares of our
Series A preferred stock. We issued these shares primarily in exchange for
Amazon.com's early marketing and support efforts in connection with and
after our launch. Jeffrey P. Bezos, chairman of the board and chief
executive officer of Amazon.com, became a director of drugstore.com upon
completion of the issuance.
(5) Howard Schultz, a director of drugstore.com, is one of the two founding
members of Maveron LLC, and is one of two members of a limited liability
company that serves as a general partner of its affiliated venture capital
fund, Maveron Equity Partners, L.P.
(6) Mr. Neupert's shares of preferred stock are held jointly by Mr. Neupert
and Sheryl Neupert.

(7) In July 1999, we issued Rite Aid 9,334,746 shares of Series E preferred
stock in exchange for $7.6 million in cash and additional consideration
with an estimated fair value of $85.7 million. Martin L. Grass, whom we
expect to be appointed as a director of drugstore.com after completion of
this offering, is chairman of the board and chief executive officer of
Rite Aid.

58
<PAGE>

(8) In July 1999, we issued General Nutrition Investment Company, a wholly
owned subsidiary of GNC, 2,947,853 shares of Series E preferred stock for
$2.4 million in cash and additional consideration with an estimated fair
value of $27.1 million.

A provision of the investors' rights agreement dated May 19, 1999 between
drugstore.com and some of our stockholders precludes Kleiner Perkins Caufield
& Byers, Amazon.com and Maveron Equity Partners from purchasing additional
shares of our common stock without our prior approval if the purchase would
cause any of them to hold individually more than 40% of our outstanding common
stock (calculated on a fully diluted basis to include outstanding options and
shares reserved under our stock plans). This restriction lasts until August
2002. Pursuant to a June 17, 1999 addendum, Rite Aid and GNC were made parties
to this agreement and are subject to its provisions.

We are selling a number of shares of our common stock equal to $10,000,000
divided by the initial public offering price to Amazon.com concurrent with
this offering in a separate private placement transaction at a price per share
equal to the initial public offering price. Such offering is made in
connection with a letter agreement we entered into with Amazon.com.

In June 1999, we entered into a strategic relationship with Rite Aid
whereby Rite Aid customers will be able to refill prescriptions at our Web
site and either use our standard delivery options or pick up the prescriptions
at Rite Aid stores. In addition, Rite Aid and drugstore.com will promote each
others' services both online and offline, including a link from Rite Aid's Web
site to our Web site. In connection with this relationship, Rite Aid acquired
approximately 25.4% of our outstanding common stock prior to this offering. We
expect that Martin L. Grass, Rite Aid's chief executive officer and chairman
of its board of directors, will be appointed a member of our board of
directors after the completion of this offering. In addition, we will
participate in substantially all of the current and future retail pharmacy
networks managed by PCS Health Systems, Inc., a wholly-owned subsidiary of
Rite Aid, which claims to provide pharmacy benefit management services for
more than 50 million individuals in the United States. As part of the
relationship, both Rite Aid and drugstore.com agreed to certain exclusivity
provisions that will limit our ability to promote or affiliate with any other
physical retail drugstore and from operating a traditional physical drugstore,
and will preclude Rite Aid from offering or selling products or services on
the Internet other than through our Web site. In addition, the agreement
provides that if we establish our own distribution center, we will purchase
all of our pharmaceutical requirements from Rite Aid. The agreement contains
additional provisions providing for the licensing by Rite Aid to drugstore.com
of information technology systems and the integration of the information
technology and pharmacy systems of the two companies. This agreement extends
for ten years, but can be terminated for breach prior to such time.

In June 1999, we entered into a relationship with GNC whereby we will be
the exclusive online provider of GNC-branded products. We have the exclusive
right to sell GNC's nutrition products over the Internet, including the
PharmAssure brand of pharmacist recommended vitamins and nutritional
supplements, subject to our meeting performance parameters based on traffic to
our Web site and sales of GNC's products over the Internet in the third and
fifth year of the relationship. As long as we have the exclusive right to
distribute GNC's products over the Internet, we will not promote any other
retail health food store or operate a physical retail health food store. If
the exclusivity provisions of the agreement terminate, we have the non-
exclusive right to sell these products for the remaining term of the
agreement. As part of this relationship, we will create a separate part of our
Web site called the GNC LiveWell Store which is dedicated to selling on a
consignment basis GNC products. In connection with this relationship, GNC
acquired approximately 8.0% of our outstanding common stock prior to this
offering. As part of our relationship with GNC, GNC and drugstore.com agreed
to co-promote each other's products and services in both their traditional and
online marketing efforts, including GNC putting a link to our Web site on
their Web site. The agreement extends for ten years, but can be terminated for
breach prior to such time.

We have entered into offer letters with several of our executive officers.
See "Management--Employment Offer Letters" for a description of the offer
letters.

59
<PAGE>

On December 3, 1998, we loaned $250,000 to Kal Raman, our Senior Vice
President, Technology and Operations. In our offer letter to Mr. Raman, we
agreed to guarantee a loan for $250,000, and, in connection with this
obligation, chose to provide the loan directly to Mr. Raman. The loan bears
interest at 7% and is secured by the shares issuable upon exercise of Mr.
Raman's stock option. All principal and accrued interest under the loan
remains outstanding and is due and payable on the earlier of December 3, 1999,
or within 15 days after ceasing to provide substantial services to
drugstore.com. As of July 4, 1999, the outstanding balance of Mr. Raman's loan
was $260,212. See "Management--Employment Offer Letters" for a description of
our loan arrangement with Mr. Raman.

All future transactions, including any loans from us to our officers,
directors, principal stockholders or affiliates, will be approved by a
majority of our board of directors, including a majority of the independent
and disinterested members of the board, and if required by law, a majority of
disinterested stockholders.

In the event that drugstore.com merges or is acquired by another company
and Peter M. Neupert or Jed A. Smith is not offered a similar position with
similar responsibilities, respectively, by the surviving entity, or if the
surviving entity's principal office is located more than 50 miles from their
respective residences, all of Mr. Neupert's and Mr. Smith's unvested shares
will be released from our option to repurchase these shares.

60
<PAGE>

PRINCIPAL STOCKHOLDERS

The following table sets forth information regarding the beneficial
ownership of our common stock as of July 4, 1999, and as adjusted to reflect
the sale of common stock offered hereby, by:

. each stockholder known by us to own beneficially more than 5% of our
common stock;

. each director;

. our chief executive officer and our only other officer earning more
than $100,000 in salary and bonus during the 1998 fiscal year; and

. all directors and executive officers as a group.

As of July 4, 1999, there were 36,791,000 shares of common stock
outstanding and 31 stockholders of drugstore.com. Beneficial ownership is
determined in accordance with the rules of the SEC. In computing the number of
shares beneficially owned by a person and the percentage ownership of that
person, shares of common stock subject to options or warrants held by that
person that are currently exercisable or will become exercisable within 60
days after July 4, 1999 are deemed outstanding, while such shares are not
deemed outstanding for purposes of computing percentage ownership of any other
person. Unless otherwise indicated in the footnotes below, the persons and
entities named in the table have sole voting and investment power with respect
to all shares beneficially owned, subject to community property laws where
applicable.

<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially Owned
Owned Prior to this Offering After this Offering(1)(2)
----------------------------------------------------------------
Name and Address of Beneficial Owner Number Percentage Number Percentage
- ------------------------------------ ----------------- ------------------------------- --------------
<S> <C> <C> <C> <C>
Amazon.com, Inc.(1)....... 10,733,523 29.2% 11,733,523 27.4%
1516 2nd Avenue
Seattle, WA 98101
Rite Aid Corporation(2)... 9,334,746 25.4 9,334,746 21.8
30 Hunter Lane
Camp Hill, PA 17011
Kleiner Perkins Caufield &
Byers(3)................. 7,030,771 19.1 7,030,771 16.4
2750 Sand Hill Road
Menlo Park, CA 94025
General Nutrition
Investment Company(4).... 2,947,853 8.0 2,947,853 6.9
1002 South 63rd Avenue
At Buckeye
Phoenix, AZ 15222
Vulcan Ventures,
Incorporated(5).......... 2,266,289 6.2 2,266,289 5.3
110 110th Avenue NE,
Suite 550
Bellevue, WA 98004
Peter M. Neupert(6)....... 1,848,146 5.0 1,848,146 4.3
13920 Southeast Eastgate
Way Suite 300
Bellevue, WA 98005
Maveron Equity Partners,
L.P.(7).................. 1,184,683 3.2 1,184,683 2.8
Jeffrey P. Bezos(1)....... 10,733,523 29.2 11,733,523 27.4
Brook H. Byers(3)......... 7,030,771 19.1 7,030,771 16.4
L. John Doerr(3).......... 7,030,771 19.1 7,030,771 16.4
William Savoy(5).......... 2,266,289 6.2 2,266,289 5.3
Howard Schultz(7)......... 1,184,683 3.2 1,184,683 2.8
Jed A. Smith(8)........... 975,000 2.7 975,000 2.3
Kal Raman(9).............. 37,500 * 37,500 *
All directors and officers
as a group (11
persons)(10)........... 24,117,912 65.4 25,117,912 58.6
</TABLE>
- --------

* Less than 1%
(1) Jeffrey P. Bezos is a director of drugstore.com and is the chairman of the
board and chief executive officer of Amazon.com, Inc.

61
<PAGE>

(2) Under the terms of the Third Amended and Restated Voting Agreement dated
June 17, 1999, Rite Aid will have the right to nominate one member to our
board of directors.
(3) Consists of 6,313,633 shares held by Kleiner Perkins Caufield & Byers
VIII, L.P. (KPCB VIII), 365,600 shares held by KPCB VIII Founders Fund,
L.P., and 351,538 shares held by KPCB Life Sciences Zaibatsu Fund II, L.P.
KPCB VIII and KPCB VIII Founders Fund, L.P. are wholly controlled by KPCB
VIII Associates, L.P. KPCB Life Sciences Zaibatsu Fund II, L.P. is wholly
controlled by KPCB VII Associates, L.P. Brook H. Byers and L. John Doerr,
each a general partner of KPCB VIII Associates and KPCB VII Associates,
L.P., are both directors of drugstore.com. Mr. Byers and Mr. Doerr each
disclaim beneficial ownership of shares held by these entities except to
the extent of his pecuniary interest in those shares.

(4) On July 5, 1999, General Nutrition Companies, Inc., the parent company of
General Nutrition Investment Company, announced that it agreed to merge
with Royal Numico N.V., a European maker of nutrition products.
(5) William D. Savoy will be appointed a director of drugstore.com prior to
completion of this offering and is the vice president of Vulcan Ventures,
a venture capital firm wholly-owned by Paul Allen. Mr. Savoy disclaims
beneficial ownership of shares held by Vulcan Ventures except to the
extent of his pecuniary interest in those shares.

(6) As of July 4, 1999, 945,000 of such shares are subject to a right of
repurchase at cost in the event Peter M. Neupert ceases to be an employee
of drugstore.com. Mr. Neupert's shares of preferred stock are held jointly
by Mr. Neupert and Sheryl Neupert.
(7) Howard Schultz is a director of drugstore.com and one of two founding
members of Maveron LLC and is one of two members of a limited liability
company that serves as a general partner of its affiliated venture capital
fund, Maveron Equity Partners, L.P. Mr. Schultz disclaims beneficial
ownership of shares held by these entities except to the extent of his
pecuniary interest in those shares.

(8) As of July 4, 1999, 304,688 of such shares are subject to a right of
repurchase at cost in the event Jed A. Smith ceases to be an employee of
drugstore.com. Includes 40,000 shares held by The Jed Smith 1998
Irrevocable Trust and 15,000 shares held by family members of Mr. Smith.

(9) During 1998 and 1999, Kal Raman was granted options to purchase 225,000
shares of our common stock. As of 60 days after July 4, 1999, 37,500 of
these shares were vested.

(10) Does not include shares that will be beneficially owned by Rite Aid's
nominee to the board of directors since such nominee has not yet been
appointed to the board. 75,000 shares subject to options held by the
directors and officers are exercisable within 60 days of July 4, 1999.

<PAGE>

DESCRIPTION OF CAPITAL STOCK

As of July 4, 1999, there were 36,791,000 shares of common stock
outstanding. Upon completion of this offering, drugstore.com will be
authorized to issue 250,000,000 shares of common stock, $.0001 par value, and
10,000,000 shares of undesignated preferred stock, $.0001 par value.

The following description of drugstore.com's capital stock is not complete
and is qualified in its entirety by drugstore.com's certificate of
incorporation and bylaws, which are included as exhibits to the registration
statement of which this prospectus forms a part, and by the provisions of
applicable Delaware law.

Common Stock

The holders of common stock are entitled to one vote per share on all
matters to be voted on by the stockholders. Subject to preferences that may be
applicable to any outstanding preferred stock, the holders of common stock are
entitled to receive ratably such dividends, if any, as may be declared from
time to time by the board of directors out of funds legally available for that
purpose. See "Dividend Policy" for a description of drugstore.com's policy of
distribution of dividends. In the event of a liquidation, dissolution or
winding up of drugstore.com, the holders of common stock are entitled to share
ratably in all assets remaining after payment of liabilities, subject to prior
distribution rights of preferred stock, if any, then outstanding. The common
stock has no preemptive or conversion rights or other subscription rights.
There are no redemption or sinking fund provisions applicable to the common
stock. All outstanding shares of common stock are fully paid and
nonassessable, and the shares of common stock to be issued upon the closing of
this offering will be fully paid and nonassessable.

Preferred Stock

Upon the closing of this offering, the board of directors will have the
authority, without action by the stockholders, to designate and issue
preferred stock in one or more series and to designate the rights, preferences
and privileges of each series, any or all of which may be greater than the
rights of the common stock. It is not possible to state the actual effect of
the issuance of any shares of preferred stock upon the rights of holders of
the common stock until the board of directors determines the specific rights
of the holders of such preferred stock. However, the effects might include,
among other things, restricting dividends on the common stock, diluting the
voting power of the common stock, impairing the liquidation rights of the
common stock and delaying or preventing a change in control of drugstore.com
without further action by the stockholders. drugstore.com has no present plans
to issue any shares of preferred stock.

Warrants

At July 4, 1999, we had one warrant outstanding to purchase a total of
10,000 shares of common stock at $7.825 per share. The warrant expires on
February 1, 2002.

Registration Rights

The holders of 35,468,000 shares of common stock (the "registrable
securities") or their permitted transferees are entitled to certain rights
with respect to registration of such shares under the Securities Act. These
rights are provided under the terms of an agreement between drugstore.com and
the holders of registrable securities. Under these registration rights,
beginning on the earlier of June 22, 2003, or six months after the effective
date of the offering contemplated by this prospectus, holders of at least 33%
of the then-outstanding registrable securities may require on two occasions
that drugstore.com register their shares for public resale. We are obligated
to register these shares only if the shares to be registered would have an
anticipated public offering price of at least $5,000,000. In addition, holders
of then-outstanding registrable securities with an aggregate offering price of
at least $40 million may require that we register their shares for public
resale on Form S-3 or similar short-form registration, provided we are
eligible to use Form S-3 or similar short-form registration statement and
provided further that the value of the securities to be registered is at least
$500,000. Furthermore,

63
<PAGE>

in the event we elect to register any of our shares of common stock for
purposes of effecting any public offering, the holders of registrable
securities are entitled to include their shares of common stock in the
registration, subject however to our right to reduce the number of shares
proposed to be registered in view of market conditions. All expenses in
connection with any registration (other than underwriting discounts and
commissions) will be borne by us. All registration rights will terminate five
years after the date of this public offering or, with respect to each holder
of registrable securities, at such time as the holder is entitled to sell all
of its shares in any three month period under Rule 144 of the Securities Act.

A provision of the investors' rights agreement between drugstore.com and
some of our stockholders precludes Kleiner Perkins Caufield & Byers,
Amazon.com, Maveron Equity Partners, Rite Aid and GNC from purchasing
additional shares of our common stock without our prior approval if the
purchase would cause them to hold more than 40% of our outstanding common
stock (calculated on a fully-diluted basis to include outstanding options and
shares reserved under our stock plans). This restriction lasts until August
2002.

Delaware and Washington Antitakeover Law and Certain Charter and Bylaw
Provisions

Provisions of Delaware law and our certificate of incorporation and bylaws
could make more difficult the acquisition of drugstore.com by a third party
and the removal of incumbent officers and directors. These provisions,
summarized below, are expected to discourage certain types of coercive
takeover practices and inadequate takeover bids and to encourage persons
seeking to acquire control of drugstore.com to first negotiate with us. We
believe that the benefits of increased protection of our ability to negotiate
with the proponent of an unfriendly or unsolicited proposal to acquire or
restructure drugstore.com outweigh the disadvantages of discouraging such
proposals because, among other things, negotiation of such proposals could
result in an improvement of their terms.

We are subject to Section 203 of the Delaware General Corporation Law,
which regulates corporate acquisitions. In general, Section 203 prohibits a
publicly held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years following the
date the person became an interested stockholder, unless:

. the board of directors approved the transaction in which such
stockholder became an interested stockholder prior to the date the
interested stockholder attained such status;

. upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, he or she owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding shares owned by persons who are directors and also
officers and shares in employee stock plans in which the participants
have no right to determine confidentially whether shares held subject to
the plan will be tendered in a tender or exchange offer; or

. on or subsequent to such date the business combination is approved by
the board of directors and authorized by 66 2/3% vote at an annual or
special meeting of stockholders.

A business combination generally includes a merger, asset or stock sale, or
other transaction resulting in a financial benefit to the interested
stockholder. In general, an "interested stockholder" is a person who, together
with affiliates and associates, owns, or within three years prior to the
determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock.

The laws of the State of Washington, where our principal executive offices
are located, also impose restrictions on certain transactions between certain
foreign corporations and significant stockholders. Chapter 23B.19 of the
Washington Business Corporation Act (the WBCA) prohibits a "target
corporation," with certain exceptions, from engaging in certain "significant
business transactions" with a person or group of persons who beneficially own
10% or more of the voting securities of the target corporation (an "acquiring
person") for a period of five years after such acquisition, unless the
transaction or acquisition of such shares is approved by a majority of the
members of the target corporation's board of directors prior to the time of
acquisition. Such prohibited transactions include, among other things, a
merger or consolidation with, disposition of assets to, or issuance or
redemption of stock to or from, the acquiring person, termination of 5% or
more of the employees of

64
<PAGE>

the target corporation as a result of the acquiring person's acquisition of
10% or more of the shares or allowing the acquiring person to receive
disproportionate benefit as a stockholder. After the five-year period, a
significant business transaction may take place as long as it complies with
certain fair price provisions of the statute.

A "target corporation" includes a foreign corporation if (1) the
corporation has a class of voting stock registered pursuant to Section 12 or
15 of the Exchange Act, (2) the corporation's principal executive office is
located in Washington, (3) any of (a) more than 10% of the corporation's
stockholders of record are Washington residents, (b) more than 10% of its
shares are owned of record by Washington residents, or (c) 1,000 or more of
its stockholders of record are Washington residents, (4) a majority of the
corporation's employees are Washington residents or more than 1,000 Washington
residents are employees of the corporation, and (5) a majority of the
corporation's tangible assets are located in Washington or the corporation has
more than $50.0 million of tangible assets located in Washington. A
corporation may not "opt out" of this statute and, therefore, we anticipate
this statute will apply to us. Depending upon whether we meet the definition
of a target corporation, Chapter 23B.19 of the WBCA may have the effect of
delaying, deferring or preventing a change in control of us.

Our certificate of incorporation permits the board of directors to issue
preferred stock with voting or other rights without any stockholder action.
The authorization of undesignated preferred stock makes it possible for the
board of directors to issue preferred stock with voting or other rights or
preferences that could impede the success of any attempt to change control of
drugstore.com. These and other provisions may have the effect of deterring
hostile takeovers or delaying changes in control or management of
drugstore.com.

Transfer Agent and Registrar

The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services LLC.

65
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Prior to this offering, there has been no market for our common stock.
Future sales of substantial amounts of common stock in the public market could
adversely affect prevailing market prices. Furthermore, since only a limited
number of shares will be available for sale shortly after this offering
because of certain contractual and legal restrictions on resale, as described
below, sales of substantial amounts of our common stock in the public market
after the restrictions lapse could adversely affect the prevailing market
price and impair our ability to raise equity capital in the future.

Upon completion of the offering, we will have outstanding 42,791,000 shares
of common stock. Of these shares, the 5,000,000 shares sold in the offering,
plus any shares issued upon exercise of the underwriters' over-allotment
option, will be freely tradable without restriction under the Securities Act,
unless purchased by our "affiliates" as that term is defined in Rule 144 under
the Securities Act (generally, officers, directors or 10% stockholders).

The remaining 37,791,000 shares outstanding are "restricted securities"
within the meaning of Rule 144 under the Securities Act. Restricted shares may
be sold in the public market only if registered or if they qualify for an
exemption from registration under Rules 144, 144(k) or 701 promulgated under
the Securities Act, which are summarized below. Sales of the restricted shares
in the public market, or the availability of such shares for sale, could
adversely affect the market price of the common stock.

Our directors, officers and securityholders have entered into lock-up
agreements in connection with this offering generally providing that they will
not offer, sell, contract to sell or grant any option to purchase or otherwise
dispose of our common stock or any securities exercisable for or convertible
into our common stock owned by them for a period of 180 days after the date of
this prospectus without the prior written consent of Morgan Stanley & Co.
Incorporated, the representative of the underwriters. As a result of these
contractual restrictions, notwithstanding possible earlier eligibility for
sale under the provisions of Rules 144, 144(k) and 701, shares subject to
lock-up agreements will not be salable until such agreements expire or are
waived by the designated underwriters' representative. Morgan Stanley & Co.
Incorporated has notified us that it currently has no plans to release any
portion of the securities subject to lock-up agreements. Taking into account
the lock-up agreements, and assuming Morgan Stanley & Co. Incorporated does
not release stockholders from these agreements, the following shares will be
eligible for sale in the public market at the following times:

. Beginning on the effective date of this prospectus, only the shares sold
in the offering will be immediately available for sale in the public
market except for that portion of the shares sold in the offering
reserved for sale to directors, officers, employees, business associates
and related persons of drugstore.com that will be subject to lock-up
agreements.

. Beginning 180 days after the effective date, approximately 17,769,268
shares will be eligible for sale pursuant to Rule 701 and Rule 144,
assuming no exercise of options, of which all but 146,000 shares are
held by affiliates.

. An additional 4,472,844 shares will be eligible for sale pursuant to
Rule 144 after January 29, 2000. Further, an additional 2,266,289 shares
will be eligible for sale pursuant to Rule 144 after May 19, 2000.
12,282,599 shares will become eligible for sale pursuant to Rule 144 on
July 8, 2000. We intend to sell to Amazon.com, Inc. $10,000,000 of
shares of common stock at the initial public offering price concurrently
with the closing of this offering that will become eligible for sale
pursuant to Rule 144 one year from the date of the closing of this
offering. Shares eligible to be sold by affiliates pursuant to Rule 144
are subject to volume restrictions as described below. In addition, Jed
A. Smith and Peter M. Neupert, in aggregate, granted drugstore.com a
right to repurchase up to 1,676,250 shares of common stock held by them
at the original purchase price of $0.04 per share if their employment
terminates under certain circumstances. Our right of repurchase lapses
(a) 25% immediately and (b) the remaining 75% lapses beginning one year
after the vesting commencement date at a rate of 1/48th per month. At
July 4, 1999, 1,249,688 shares held by Mr. Smith and Mr. Neupert were
subject to repurchase under this agreement.

66
<PAGE>

In general, under Rule 144, and beginning after the expiration of the lock-
up agreements 180 days after the date of this prospectus, a person, or persons
whose shares are combined, who has beneficially owned restricted securities
for at least one year would be entitled to sell within any three-month period
a number of shares that does not exceed the greater of the following:

. one percent of the number of shares of common stock then outstanding
(which will equal approximately 427,910 shares immediately after this
offering); or

. the average weekly trading volume of the common stock during the four
calendar weeks preceding the sale.

Sales under Rule 144 are also subject to certain manner of sale provisions and
notice requirements and to the availability of current public information
about us. Under Rule 144(k), a person who is not deemed to have been our
affiliate at any time during the three months preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.

Rule 701, as currently in effect, permits resales of shares in reliance
upon Rule 144 but without compliance with certain restrictions, including the
holding period requirement, of Rule 144. Any of our employees, officers,
directors or consultants who purchased shares pursuant to a written
compensatory plan or contract may be entitled to rely on the resale provisions
of Rule 144. Rule 701 permits affiliates to sell their Rule 701 shares under
Rule 144 without complying with the holding period requirement of Rule 144.
Rule 701 further provides that non-affiliates may sell such shares in reliance
on Rule 144 without having to comply with the holding period, public
information, volume limitation or notice provisions of Rule 144. In addition,
we intend to file registration statements under the Securities Act as promptly
as possible after the effective date to register shares to be issued pursuant
to our employee benefit plans. As a result, any options exercised under the
1998 stock plan, the 1999 employee stock purchase plan or any other benefit
plan after the effectiveness of such registration statement will also be
freely tradable in the public market, except that shares held by affiliates
will still be subject to the volume limitation, manner of sale, notice and
public information requirements of Rule 144 unless otherwise resalable under
Rule 701. As of July 4, 1999, there were outstanding options for the purchase
of 3,032,809 shares of our common stock under the 1998 stock plan and
4,786,191 shares were available for future grant.

67
<PAGE>

UNDERWRITERS

Under the terms and subject to conditions contained in the underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated, Donaldson, Lufkin & Jenrette
Securities Corporation and Thomas Weisel Partners LLC are acting as
representatives, have severally agreed to purchase, and drugstore.com has
agreed to sell to them, severally, the respective number of shares of common
stock set forth opposite the names of such underwriters below:

<TABLE>
<CAPTION>
Number
Name of Shares
---- ---------
<S> <C>
Morgan Stanley & Co. Incorporated..................................
Donaldson, Lufkin & Jenrette Securities Corporation................
Thomas Weisel Partners LLC.........................................
---------
Total............................................................ 5,000,000
=========
</TABLE>

The underwriters are offering the shares subject to their acceptance of the
shares from drugstore.com and subject to prior sale. The underwriting
agreement provides that the obligations of the several underwriters to pay for
and accept delivery of the shares of common stock offered hereby are subject
to the approval of legal matters by their counsel and to certain other
conditions. The underwriters are obligated to take and pay for all of the
shares of common stock offered by this prospectus, other than those covered by
the over-allotment option described below, if any such shares are taken.

The underwriters initially propose to offer part of the shares of common
stock directly to the public at the public offering price set forth on the
cover page of the prospectus and part to certain dealers at a price that
represents a concession not in excess of $ a share under the public offering
price. Any underwriter may allow, and the dealers may reallow, a concession
not in excess of $ a share to other underwriters or to certain other
dealers. After the initial offering of the shares of common stock, the
offering price and other selling terms may from time to time be varied by the
representatives of the underwriters.

drugstore.com has granted to the underwriters an option, exercisable for 30
days from the date of this prospectus, to purchase up to an aggregate of
750,000 additional shares of common stock at the public offering price set
forth on the cover page hereof, less underwriting discounts and commissions.
The underwriters may exercise this option solely for the purpose of covering
over-allotments, if any, made in connection with this offering of common
stock. To the extent this over-allotment option is exercised, each underwriter
will become obligated, subject to certain conditions, to purchase
approximately the same percentage of additional shares of common stock as the
number set forth next to each underwriter's name in the preceding table bears
to the total number of shares of common stock set forth next to the names of
all underwriters in the preceding table.

At the request of drugstore.com, the underwriters have reserved up to 10%
of the shares of common stock to be issued by drugstore.com and offered hereby
for sale, at the initial public offering price, to directors, officers,
employees, business associates and related persons of drugstore.com. The
number of shares of common stock available for sale to the general public will
be reduced to the extent these individuals purchase such reserved shares. Any
reserved shares which are not so purchased will be offered by the underwriters
to the general public on the same basis as the other shares offered by this
prospectus.

68
<PAGE>

Each of drugstore.com and the officers, directors, and stockholders has
agreed that, without the prior written consent of Morgan Stanley & Co.
Incorporated on behalf of the underwriters, or otherwise during the period
ending 180 days after the date of this prospectus it will not: (1) offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend or otherwise transfer or dispose of, directly or indirectly,
any shares of common stock; or any securities convertible into or exercisable
or exchangeable for common stock; or (2) enter into any swap or similar
arrangement that transfers to another, in whole or in part, any of the
economic consequences of ownership of the common stocks; whether any such
transaction described above is to be settled by delivery of common stock or
such other securities after the date of this prospectus. Morgan Stanley & Co.
Incorporated informed drugstore.com that they do not presently intend to
release any person from these agreements.

The underwriters have informed drugstore.com that they do not intend sales
to discretionary accounts to exceed five percent of the total number of shares
of common stock offered by them.

Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol "DSCM."

In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the common stock
for their own account. In addition, to cover any over-allotments or to
stabilize the price of the common stock, the underwriters may bid for, and
purchase, shares of common stock in the open market. Finally, the underwriting
syndicate may reclaim selling concessions allowed to an underwriter or a
dealer for distributing the common stock in the offering if the syndicate
repurchases previously distributed common stock in transactions to cover
syndicate short positions, in stabilization transactions or otherwise. Any of
these activities may stabilize or maintain the market price of the common
stock above independent market levels. The underwriters are not required to
engage in these activities, and may end any of these activities at any time.

drugstore.com and the underwriters have agreed to indemnify each other
against certain liabilities, including liabilities under the Securities Act.

Thomas Weisel Partners LLC, one of the representatives of the underwriters,
was organized and registered as a broker-dealer in December 1998. Since
December 1998, Thomas Weisel Partners LLC has been named as a lead or co-
manager on 40 filed public offerings of equity securities, of which 22 have
been completed, and has acted as a syndicate member in an additional 17 public
offerings of equity securities. Thomas Weisel Partners LLC does not have any
material relationship with us or any of our officers, directors or controlling
persons, except with respect to its contractual relationship with us under the
underwriting agreement entered into in connection with this offering.

Pricing of the Offering

Prior to this offering, there has been no public market for the shares of
common stock. The initial public offering price will be determined by
negotiations between drugstore.com and the representatives. Among the factors
to be considered in determining the initial public offering price will be:

. the future prospects of drugstore.com and our industry in general;

. sales, earnings and certain other financial operating information of
drugstore.com in recent periods; and

. the price-earnings ratios, price-sales ratios, market prices of
securities and financial and operating information of companies engaged
in activities similar to those of drugstore.com.

The estimated public offering price range set forth on the cover page of
this prospectus is subject to change as a result of market conditions and
other factors.

69
<PAGE>

LEGAL MATTERS

The validity of the common stock offered hereby will be passed upon for
drugstore.com by Venture Law Group, A Professional Corporation, Menlo Park,
California. John H. Sellers, a senior attorney at Venture Law Group, is an
Assistant Secretary of drugstore.com. Certain legal matters will be passed
upon for the underwriters by Wilson Sonsini Goodrich & Rosati, Professional
Corporation, Palo Alto, California. As of the date of this prospectus, an
investment partnership associated with Venture Law Group owns an aggregate of
21,000 shares of our common stock, and one director of Venture Law Group
beneficially owns 4,500 shares of our common stock.

EXPERTS

Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements as of December 31, 1998 and for the period from April 2,
1998 (inception) to December 31, 1998, as set forth in their report. We have
included our financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on
their authority as experts in accounting and auditing.

WHERE YOU CAN FIND MORE INFORMATION

We have filed with the SEC, a registration statement on Form S-1 under the
Securities Act with respect to the shares of common stock offered hereby. This
prospectus does not contain all the information set forth in the registration
statement and the exhibits thereto. For further information with respect to
drugstore.com and such common stock, we refer you to the registration
statement and to the exhibits filed therewith. Statements contained in this
prospectus as to the contents of any contract or other document referred to
are not necessarily complete, and in each instance reference is made to the
copy of such contract or other document filed as an exhibit to the
registration statement, each such statement being qualified in all respects by
such reference. A copy of the registration statement may be inspected by
anyone without charge at the Public Reference Section of the SEC at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of all
or any portion of the registration statement may be obtained from the Public
Reference Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549,
upon payment of prescribed fees. The SEC maintains a web site at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the SEC.

70
<PAGE>

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................... F-2
Consolidated Balance Sheets................................................. F-3
Consolidated Statements of Operations....................................... F-4
Consolidated Statements of Stockholders' Equity............................. F-5
Consolidated Statements of Cash Flows....................................... F-6
Notes to Consolidated Financial Statements.................................. F-7
</TABLE>

F-1
<PAGE>

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
drugstore.com, inc.

We have audited the accompanying consolidated balance sheet of drugstore.com,
inc. as of December 31, 1998, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the period from April 2,
1998 (inception) to December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
from material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of drugstore.com,
inc. at December 31, 1998, and the consolidated results of its operations and
its cash flows for the period from April 2, 1998 (inception) to December 31,
1998, in conformity with generally accepted accounting principles.

Ernst & Young LLP

Seattle, Washington
January 29, 1999, except for Note 7
as to which the date is

July 7, 1999

F-2
<PAGE>

DRUGSTORE.COM, INC.

CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

<TABLE>
<CAPTION>
Pro Forma
Stockholders'
Equity
December 31, July 4, July 4,
1998 1999 1999
------------ ----------- -------------
(unaudited) (Note 7)
(unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents.............. $14,408 $ 68,087
Accounts receivable.................... -- 272
Inventories............................ -- 1,498
Prepaid marketing expenses............. 4,317 939
Other prepaid expenses and current
assets................................ 520 1,011
------- --------
Total current assets..................... 19,245 71,807
Fixed assets, net of accumulated
depreciation of $66 and $932............ 2,616 6,221
Intangible assets, net of accumulated
amortization of $33 and $71............. 230 5,246
Note receivable from officer............. 250 260
Deposits and other assets................ 176 1,202
------- --------
Total assets............................. $22,517 $ 84,736
======= ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable....................... $ 1,254 $ 6,727
Accrued compensation................... 327 1,320
Accrued marketing expenses............. -- 1,578
Other current liabilities.............. 142 141
Current portion of capital lease
obligations........................... 472 1,307
------- --------
Total current liabilities................ 2,195 11,073
Capital lease obligations, less current
portion................................. 975 1,099
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.001 par
value ($.0001 pro forma):
Authorized shares--60,000,000
(10,000,000 pro forma)
Series A preferred stock, designated
10,000,000 shares
Issued and outstanding shares--
10,000,000 (none pro forma)
(aggregate liquidation preference of
$8,000)............................. 7,986 7,986
Series B preferred stock, designated
5,500,000 shares
Issued and outstanding shares--
5,446,268 (none pro forma)
(aggregate liquidation preference of
$18,245)............................ 18,237 18,237
Series C preferred stock, designated
5,000,000 shares
Issued and outstanding shares--
4,472,844 (none pro forma)
(aggregate liquidation preference of
$35,000)............................ -- 34,981
Series D preferred stock, designated
2,300,000 shares
Issued and outstanding shares--
2,266,289 (none pro forma)
(aggregate liquidation preference of
$40,000)........................... -- 44,982
Common stock, $.001 par value ($.0001
pro forma):
Authorized shares--250,000,000
(250,000,000 pro forma)
Issued and outstanding shares--
2,323,000 (24,508,401 pro forma)...... 2 2 $ 2
Additional paid-in capital.............. 2,858 9,109 115,295
Deferred stock-based compensation....... (2,246) (6,197) (6,197)
Accumulated deficit..................... (7,490) (36,536) (36,536)
------- -------- -------
Total stockholders' equity............... 19,347 72,564 $72,564
------- -------- =======
Total liabilities and stockholders'
equity.................................. $22,517 $ 84,736
======= ========
</TABLE>

See accompanying notes.

F-3
<PAGE>

DRUGSTORE.COM, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

<TABLE>
<CAPTION>
Period from Period from Six Months
April 2, 1998 April 2, 1998 Ended
(Inception) to (Inception) to July 4,
December 31, 1998 June 30, 1998 1999
----------------- -------------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C>
Net sales........................ $ -- $ -- $ 4,202
Cost of sales.................... -- -- 5,551
--------- ------- ----------
Gross profit (loss)............ -- -- (1,349)
Operating expenses:
Marketing and sales............ 3,092 -- 16,517
Product development............ 2,178 104 5,942
General and administrative..... 1,894 79 3,955
Amortization of stock-based
compensation.................. 500 39 2,276
--------- ------- ----------
Total operating expenses..... 7,664 222 28,690
--------- ------- ----------
Operating loss................... (7,664) (222) (30,039)
Other income (expense):
Interest income................ 177 -- 1,033
Interest expense............... (3) -- (40)
--------- ------- ----------
Net loss......................... $ (7,490) $ (222) $ (29,046)
========= ======= ==========
Basic and diluted net loss per
share........................... $ (13.71) $ (4.42) $ (28.95)
========= ======= ==========
Pro forma basic and diluted net
loss per share.................. $ (.92) $ (.45) $ (1.40)
========= ======= ==========
Weighted average shares
outstanding used to compute
basic and diluted net loss per
share........................... 546,149 50,211 1,003,152
========= ======= ==========
Weighted average shares
outstanding used to compute
pro forma basic and diluted net
loss per share.................. 8,167,570 494,031 20,796,875
========= ======= ==========
</TABLE>

See accompanying notes.

F-4
<PAGE>

DRUGSTORE.COM, INC.

STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(in thousands, except share data)

<TABLE>
<CAPTION>
Convertible Preferred Stock
-----------------------------------------------------------------------
Series A Series B Series C Series D Common Stock Additional Deferred
----------------- ----------------- ----------------- ----------------- ---------------- Paid-in Stock-based
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Capital Compensation
---------- ------ --------- ------- --------- ------- --------- ------- --------- ------ ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Initial issuance
of common shares
to founders in
exchange for
cash and
intellectual
property........ -- $ -- -- $ -- -- $ -- -- $ -- 2,315,000 $ 2 $ 111 $ --
Issuance of
Series A
preferred stock
in June and
August, net of
offering costs
of $14.......... 5,000,000 3,986 -- -- -- -- -- -- -- -- -- --
Issuance of
Series A
preferred stock
in August in
exchange for
Technology
License and
Advertising
Agreement....... 5,000,000 4,000 -- -- -- -- -- -- -- -- -- --
Issuance of
Series B
preferred stock
in October,
November and
December, net of
offering costs
of $8........... -- -- 5,446,268 18,237 -- -- -- -- -- -- -- --
Exercise of
common stock
options......... -- -- -- -- -- -- -- -- 8,000 -- 1 --
Deferred stock-
based
compensation.... -- -- -- -- -- -- -- -- -- -- 2,746 (2,746)
Amortization of
stock-based
compensation ... -- -- -- -- -- -- -- -- -- -- -- 500
Net loss and
comprehensive
loss............ -- -- -- -- -- -- -- -- -- -- -- --
---------- ------ --------- ------- --------- ------- --------- ------- --------- --- ------ -------
Balance at
December 31,
1998............ 10,000,000 7,986 5,446,268 18,237 -- -- -- -- 2,323,000 2 2,858 (2,246)
Issuance of
Series C
preferred stock
in January and
March, net of
offering costs
of $19
(unaudited)..... -- -- -- -- 4,472,844 34,981 -- -- -- -- -- --
Issuance of
Series D
preferred stock
in June, net of
offering costs
of $18
(unaudited)..... -- -- -- -- -- -- 2,266,289 44,982 -- -- -- --
Issuance of
warrants to
purchase common
stock
(unaudited)..... -- -- -- -- -- -- -- -- -- -- 24 --
Deferred stock-
based
compensation
(unaudited)..... -- -- -- -- -- -- -- -- -- -- 6,227 (6,227)
Amortization of
stock-based
compensation
(unaudited)..... -- -- -- -- -- -- -- -- -- -- -- 2,276
Net loss and
comprehensive
loss
(unaudited)..... -- -- -- -- -- -- -- -- -- -- -- --
---------- ------ --------- ------- --------- ------- --------- ------- --------- --- ------ -------
Balance at July
4, 1999
(unaudited)..... 10,000,000 $7,986 5,446,268 $18,237 4,472,844 $34,981 2,266,289 $44,982 2,323,000 $ 2 $9,109 $(6,197)
========== ====== ========= ======= ========= ======= ========= ======= ========= === ====== =======
<CAPTION>
Accumulated
Deficit Total
----------- --------
<S> <C> <C>
Initial issuance
of common shares
to founders in
exchange for
cash and
intellectual
property........ $ -- $ 113
Issuance of
Series A
preferred stock
in June and
August, net of
offering costs
of $14.......... -- 3,986
Issuance of
Series A
preferred stock
in August in
exchange for
Technology
License and
Advertising
Agreement....... -- 4,000
Issuance of
Series B
preferred stock
in October,
November and
December, net of
offering costs
of $8........... -- 18,237
Exercise of
common stock
options......... -- 1
Deferred stock-
based
compensation.... -- --
Amortization of
stock-based
compensation ... -- 500
Net loss and
comprehensive
loss............ (7,490) (7,490)
----------- --------
Balance at
December 31,
1998............ (7,490) 19,347
Issuance of
Series C
preferred stock
in January and
March, net of
offering costs
of $19
(unaudited)..... -- 34,981
Issuance of
Series D
preferred stock
in June, net of
offering costs
of $18
(unaudited)..... -- 44,982
Issuance of
warrants to
purchase common
stock
(unaudited)..... -- 24
Deferred stock-
based
compensation
(unaudited)..... -- --
Amortization of
stock-based
compensation
(unaudited)..... -- 2,276
Net loss and
comprehensive
loss
(unaudited)..... (29,046) (29,046)
----------- --------
Balance at July
4, 1999
(unaudited)..... $(36,536) $72,564
=========== ========
</TABLE>

See accompanying notes.

F-5
<PAGE>

DRUGSTORE.COM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

<TABLE>
<CAPTION>
Period from Period from
April 2, 1998 April 2, 1998 Six Months
(Inception) to (Inception) to Ended
December 31, 1998 June 30, 1998 July 4, 1999
----------------- -------------- ------------
(unaudited) (unaudited)
<S> <C> <C> <C>
Operating Activities:
Net loss......................... $(7,490) $ (222) $(29,046)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization.. 90 -- 993
Amortization of stock-based
compensation.................. 500 39 2,276
Technology license and
advertising agreement-related
expenses...................... 58 -- 3,314
Changes in:
Accounts receivable........... -- -- (272)
Inventories................... -- -- (1,498)
Prepaid marketing expenses.... (552) (300) 122
Other prepaid expenses and
current assets............... (484) -- (535)
Deposits and other assets..... (176) (2) (1,026)
Accounts payable and accrued
expenses..................... 1,723 39 7,225
Other......................... -- -- (10)
------- ------ --------
Net cash used in operating
activities...................... (6,331) (446) (18,457)
Investing Activities:
Purchase of fixed assets......... (1,202) -- (3,176)
Addition of intangible assets.... (90) (90) (30)
Issuance of note receivable to
officer......................... (250) -- --
------- ------ --------
Net cash used in investing
activities...................... (1,542) (90) (3,206)
Financing Activities:
Proceeds from sales of common
stock........................... 90 39 --
Proceeds from exercise of stock
options......................... 1 -- --
Net proceeds from sales of Series
A preferred stock............... 3,986 3,936 --
Net proceeds from sales of Series
B preferred stock............... 18,237 -- --
Net proceeds from sales of Series
C preferred stock............... -- -- 34,981
Net proceeds from sales of Series
D preferred stock............... -- -- 39,982
Proceeds from capital lease
obligations..................... -- -- 538
Principal payments on capital
lease obligations............... (33) -- (159)
------- ------ --------
Net cash provided by financing
activities...................... 22,281 3,975 75,342
------- ------ --------
Net increase in cash and cash
equivalents..................... 14,408 3,439 53,679
Cash and equivalents at beginning
of period....................... -- -- 14,408
------- ------ --------
Cash and equivalents at end of
period.......................... $14,408 $3,439 $ 68,087
======= ====== ========
Supplemental Cash Flow
Information:
Cash paid for interest........... $ 48 $ -- $ 22
Equipment acquired through
capital lease agreements........ $ 1,480 $ -- $ 595
Issuance of common stock in
exchange for intellectual
property........................ $ 23 $ -- $ --
Issuance of Series A preferred
stock in exchange for technology
license and advertising
agreement....................... $ 4,000 $ -- $ --
Issuance of Series D preferred
stock in exchange for cable
television advertising.......... $ -- $ -- $ 5,000
Issuance of warrants to purchase
common stock in exchange for
intangible asset................ $ -- $ -- $ 24
</TABLE>

See accompanying notes.

F-6
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

1. Organization and Summary of Significant Accounting Policies

General

drugstore.com, inc. and its wholly-owned subsidiary, DS Pharmacy, Inc.,
(collectively, the Company) are engaged in the development of Internet-based
retailing opportunities focused on filling needs for health, wellness, beauty,
personal care and pharmacy products and related information. The Company was
incorporated on April 2, 1998 and launched its Web site and commenced
commercial operations on February 24, 1999. The Company was previously
considered a development stage company.

The Company has incurred significant operating losses since inception of
operations and has limited working capital. The Company has financed its
operations to date through the issuance of equity securities. Further
development and establishment of the Company's business will require
additional equity financing. The Company believes that equity financing can be
obtained from existing or new investors. However, there can be no assurance
that the Company will be able to obtain such equity financing on acceptable
terms, if at all.

Interim Financial Statements

The accompanying balance sheet as of July 4, 1999 and the statements of
operations and cash flows for the period from April 2, 1998 (inception) to
June 30, 1998 and the six months ended July 4, 1999 are unaudited. In the
opinion of management, the unaudited financial statements have been prepared
on the same basis as the audited financial statements and include all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the results of operations and cash flows for the interim
periods. Operating results for the six months ended July 4, 1999 are not
necessarily indicative of the results that may be expected for the year ending
January 2, 2000.

Principles of Consolidation and Basis of Presentation

The accompanying consolidated financial statements include those of
drugstore.com, inc. and its wholly-owned subsidiary, DS Pharmacy, Inc. All
material intercompany transactions and balances have been eliminated.

On January 1, 1999, the Company adopted a 52/53 week fiscal year ending on
the Sunday closest to December 31. The 1999 fiscal year ends on January 2,
2000, with each of the fiscal quarters representing a 13-week period. The
effect of the change on prior periods is insignificant.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements.
Actual results could differ from those estimates.

Cash Equivalents

The Company considers all highly liquid investments with a maturity of
three months or less at the date of purchase to be cash equivalents.

Concentration of Credit Risk

The Company is subject to concentrations of credit risk from its cash
investments. The Company's credit risk is managed through monitoring the
stability of the financial institutions utilized and diversification of its
financial resources.

F-7
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

Financial instruments consist of cash and cash equivalents and capital
lease obligations. The fair value of all financial instruments approximates
the carrying amount based on the current rate offered for similar instruments.

Inventories

Inventories are stated at the lower of cost (using the weighted average
cost method) or market. The Company has contracts with RxAmerica L.L.C. to
purchase and distribute all of its pharmaceutical products and Walsh
Distribution, Inc. to purchase a substantial majority and distribute all of
its non-pharmaceutical products. The agreement with RxAmerica is for a one-
year term ending February 2000, which will automatically extend for an
additional year unless either party gives written notice of termination. The
agreement with Walsh Distribution, Inc. is for a three-year term ending
January 2002, but may be terminated by the Company earlier upon accelerated
payment of minimum fees that would not exceed $2.5 million.

Fixed Assets

Fixed assets are stated at cost less accumulated depreciation and
amortization, which includes the amortization of assets recorded under capital
leases. Depreciation and amortization is provided using the straight-line
method over the estimated useful lives of the related assets, which range from
two to seven years. Fixed assets purchased under capital leases and leasehold
improvements are amortized over the shorter of the lease term or estimated
useful life.

Long-Lived Assets

Long-lived assets and intangible assets are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. Impairment is measured by comparing the carrying value
of the long-lived assets to the estimated undiscounted future cash flows
expected to result from use of the assets and their ultimate disposition. In
circumstances where impairment is determined to exist, the Company will write
down the asset to its fair value based on the present value of estimated
expected future cash flows. To date, no such impairment has been indicated.

Revenue Recognition

The Company recognizes revenue from product sales, net of discounts, when
the products are shipped to customers. Outbound shipping and handling fees are
also included in net sales upon shipment. The Company generally refunds all or
a portion of the net sales in the event a customer is not satisfied with the
product or service provided. The Company provides an estimated allowance for
such sales returns in the period of sale. Sales returns to date have been
insignificant.

Product Development

Product development expenses consist primarily of payroll and related
expenses for Web site development and systems personnel and consultants,
system infrastructure and costs of Web site content. Expenditures relating to
product development have been expensed as incurred.

Income Taxes

The Company accounts for income taxes under the liability method. Under the
liability method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to be recovered. Valuation
allowances are established, when necessary, to reduce deferred tax assets to
the amounts expected to be realized.

F-8
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

Advertising

Advertising production costs are expensed as incurred. Costs of
communicating advertising associated with television, radio, print and other
media are expensed when such services are used. Costs associated with Web
portal advertising contracts are amortized on a straight-line basis over the
period such advertising is expected to be used. Advertising expense for the
period ended December 31, 1998 and the six months ended July 4, 1999 was
$1,638,000 and $9,248,000, respectively.

Stock-Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB No. 25), and related
interpretations, in accounting for employee stock options rather than the
alternative fair value accounting allowed by Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). APB
No. 25 provides that the compensation expense relative to the Company's
employee stock options is measured based on the intrinsic value of the stock
option. SFAS No. 123 requires companies that continue to follow APB No. 25 to
provide a pro forma disclosure of the impact of applying the fair value method
of SFAS No. 123 (see Note 5). The Company accounts for stock issued to non-
employees in accordance with the provisions of SFAS No. 123 and the Emerging
Issues Task Force consensus in Issue No. 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services.

Net Loss Per Share

Net loss per share is computed using the weighted average number of shares
of common stock outstanding less the number of shares subject to repurchase.
Shares associated with stock options, warrants and the convertible preferred
stock are not included in the calculation of diluted net loss per share
because they are antidilutive.

Pro Forma Net Loss Per Share (Unaudited)

Pro forma net loss per share is computed using the weighted average number
of common shares outstanding, including the pro forma effects of the automatic
conversion of all outstanding convertible preferred stock into shares of
common stock effective upon the closing of the Company's initial public
offering as if such conversion occurred at the date of original issuance.

F-9
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

The following table sets forth the computation of basic and diluted net
loss per share and pro forma basic and diluted net loss per share for the
periods indicated:

At December 31, 1998, there were 1,515,334 stock options that were excluded
from the computation of actual and pro forma diluted net loss per share as
their effect was antidilutive. If the Company had reported net income, the
calculation of these per share amounts would have included the dilutive effect
of these common stock equivalents using the treasury stock method.

Segment Information

In January 1999, the Company adopted SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information. This standard established
interim and annual reporting standards for an enterprise's operating segments
and related disclosures about its products, services, geographic areas and
major customers. Since commencement of operations in February 1999, the
Company's business consists of a single retail drug segment that sells health,
beauty, wellness, personal care and pharmacy products on-line and provides
related product information on the Company's Web site.

New Accounting Pronouncements

In March 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. SOP 98-1 requires all costs related to
the development of internal use software other than those incurred during the
application development stage to be expensed as incurred. Costs incurred
during the application development stage are required to be capitalized and
amortized over the estimated useful life of the software. The Company adopted
SOP 98-1 in the quarter ended April 4, 1999 and there was no significant
impact upon adoption.

F-10
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 is effective for fiscal years
beginning after June 15, 2000. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in
the fair value of derivatives are recorded each period in current earnings or
other comprehensive income, depending on whether a derivative is designed as
part of a hedge transaction and, if it is, the type of hedge transaction. The
Company does not expect that the adoption of SFAS No. 133 will have a material
impact on its financial statements because it does not currently hold any
derivative instruments.

2. Fixed Assets

Fixed assets consists of the following:

<TABLE>
<CAPTION>
December 31,
1998
--------------
(In thousands)
<S> <C>
Computers and equipment....................................... $1,862
Purchased software............................................ 711
Furniture and fixtures........................................ 20
Leasehold improvements........................................ 89
------
2,682
Less accumulated depreciation................................. (66)
------
$2,616
======
</TABLE>

Included in computers and equipment and purchased software are assets
acquired under capital leases with an original cost of approximately
$1,115,000 and $365,000, respectively, as of December 31, 1998. Accumulated
amortization on the leased assets was approximately $10,000 as of December 31,
1998. Approximately $1,370,000 of computers and equipment as of December 31,
1998 were not placed into service until the launch of the Company's Web store
in February 1999.

3. Leases and Marketing Agreements

The Company leases office space under an operating lease, which calls for
fixed rental payments through 2003. In addition, the Company leases various
office equipment under operating leases. Total rent expense under operating
leases for the periods ended December 31, 1998 and July 4, 1999 approximated
$127,000 and $972,000, respectively.

Capital lease obligations bear interest at rates ranging from 4% to 7% and
mature 24 to 36 months from the date of funding. At December 31, 1998, the
Company had no additional financing available under the agreements.

The Company has also entered into certain non-cancelable advertising
agreements with various Web portals, including Yahoo!, America On-Line and
Excite, which require the Company to make fixed payments to such portals over
the term of the agreements. In exchange, the portals have committed to display
the agreed-upon advertisement a minimum number of times on such portal's Web
site over the term of the contract. The costs associated with Web portal
advertising contracts are amortized on a straight-line basis over the period
such advertising is expected to be used.

F-11
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

Future minimum commitments at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Capital Operating Marketing
Leases Leases Agreements
------- --------- ----------
(In thousands)
<S> <C> <C> <C>
1999......................................... $ 534 $ 1,539 $ 4,402
2000......................................... 620 1,541 3,230
2001......................................... 398 1,574 2,970
2002......................................... -- 1,600 3,710
2003......................................... -- 1,603 --
Thereafter................................... -- 2,238 --
------ ------- -------
Total minimum lease payments................. 1,552 $10,095 $14,312
======= =======
Less amounts representing interest........... (105)
------
Present value of minimum payments............ 1,447
Less current portion of capital lease
obligations................................. (472)
------
Noncurrent portion of capital lease
obligations................................. $ 975
======
</TABLE>

On January 28, 1999, the Company signed a seven-year lease for a new
corporate headquarters in Bellevue, Washington, which is expected to commence
no later than March 12, 1999. The minimum lease payments associated with this
lease are included in the commitments above. The Company has the option to
extend the lease for two additional three-year terms. The Company provided a
letter of credit totaling $640,000 as security for the lease. The letter of
credit may be reduced annually by specified amounts in the lease agreement
upon our achievement of certain economic goals. At December 31, 1998, there
were no letters of credit outstanding.

The Company has an agreement with Walsh Distribution, Inc. that provides
inventory and certain order fulfillment services for three years ending
January 2002. This agreement may be terminated earlier by the Company upon an
accelerated payment of minimum fees that would not exceed $2.5 million.

4. Income Taxes

The Company did not provide any current or deferred United States federal
income tax provision or benefit for any of the periods presented because it
has experienced operating losses since inception. The Company provided a full
valuation allowance on the net deferred tax asset, consisting primarily of net
operating loss carryforwards and research and development credit
carryforwards, because of uncertainty regarding their realizability.

At December 31, 1998, the Company had net operating loss carryforwards and
research and development credit carryforwards of approximately $6,737,000 and
$32,000, respectively. These carryforwards will expire in 2018. In 1999, due
to the issuance and sale of preferred stock, the Company incurred ownership
changes pursuant to applicable regulations in effect under the Internal
Revenue Code of 1986, as amended. Therefore, the Company's use of losses
incurred through the date of these ownership changes will be limited during
the carryforward period. The Company estimates that the use of the
approximately $6.7 million of net operating losses incurred through December
31, 1998 as well as losses incurred subsequent thereto until the date of the
ownership change would be limited to approximately $4.1 million per year in
order to offset future taxable income. To the extent that any single-year loss
is not utilized to the full amount of the limitation, such unused loss is
carried over to subsequent years until the earlier of its utilization or the
expiration of the relevant carryforward period.

F-12
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

Deferred tax assets reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Since the Company's
utilization of these deferred tax assets is dependent on future profits which
are not assured, a valuation allowance equal to the deferred tax assets has
been provided. Significant components of the Company's deferred tax assets as
of December 31, 1998 are as follows (in thousands):

<TABLE>
<S> <C>
Deferred tax assets:
Net operating loss carryforward................................... $ 2,291
Research and development credit carryforward...................... 32
Other temporary differences....................................... 79
-------
Total gross deferred tax assets..................................... 2,402
Less valuation allowance............................................ (2,402)
-------
Net deferred tax assets............................................. $ --
=======

A reconciliation of income taxes computed at the statutory rate to the
income tax amount recorded for the period ended December 31, 1998 is as
follows (in thousands):

Income tax benefit at statutory rate................................ $ 2,547
Stock-based compensation............................................ (169)
Other permanent differences......................................... (8)
Research and development credit..................................... 32
Increase in valuation allowance..................................... (2,402)
-------
Income tax benefit.................................................. $ --
=======
</TABLE>

5. Stockholders' Equity

Convertible Preferred Stock

In June and August 1998, the Company issued 10,000,000 shares of Series A
preferred stock in a private placement offering in exchange for gross cash
proceeds of $4,000,000, and a Technology License and Advertising Agreement
with Amazon.com that provides for the right to license certain technology and
receive certain technological and advertising support from Amazon.com. In
addition, the Company agreed to license its technology to Amazon.com and
participate in mutually agreed upon advertising activities. No cash payments
are required under the Technology License and Advertising Agreement with
Amazon.com. The Company valued the right to license certain technology and
receive such technological and advertising support at $4,000,000 based on the
value of Series A preferred stock issued concurrently for cash. Such value was
allocated to prepaid marketing expense, license rights and prepaid technical
consulting services in the amount of $3,765,000, $150,000 and $85,000,
respectively, based on their estimated fair value and will be amortized to
expense over the period the services are provided or the life of the license.
During the period ended December 31, 1998 and the six months ended July 4,
1999, the Company recognized expenses under such agreement totaling $58,000
and $3,314,000, respectively.

In October, November and December 1998, the Company issued 5,446,268 shares
of Series B preferred stock in a private placement offering in exchange for
gross cash proceeds of $18,245,000.

F-13
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

In January and March 1999, the Company issued 4,472,844 shares of Series C
preferred stock in a private placement offering in exchange for gross cash
proceeds of $35,000,000.

Each share of Series A, Series B and Series C preferred stock is
convertible into one share of common stock at the option of the holder,
subject to certain antidilution adjustments, in accordance with the conversion
formula provided in the Company's certificate of incorporation (currently on a
1:1 ratio). Outstanding preferred shares automatically convert into common
stock, at the Company's option, upon the closing of an initial public offering
of the Company's common stock in which gross proceeds exceed $15.0 million and
a per share price of not less than $10.00 per share. Holders of each share of
preferred stock are entitled to the number of votes per share that would be
equivalent to the number of shares of common stock into which a share of
preferred stock is convertible and are entitled to dividends if and when
declared by the board of directors. No dividends have been declared. In the
event of any consolidation, merger, or liquidation, the holders of the Series
A, Series B and Series C preferred stock shall be entitled to receive $0.80,
$3.35 and $7.825 per share of preferred stock, respectively, plus cumulative
dividends, if and when declared, at the annual rate of 10%. The Company
granted the preferred stockholders certain registration rights and also agreed
not to carry out certain actions without prior approval of the holders of not
less than two-thirds of the outstanding preferred shares, voting together as a
single class.

Common Stock

The Company and its common and Series A, Series B and Series C stockholders
entered into an agreement, which, among other issues, addresses election of
directors, restrictions on transfer of equity securities by stockholders,
sales of new securities by drugstore.com, and covenants related to transfer of
shares. All provisions of the agreement, with the exception of covenants
related to transfer of shares, expire upon the closing of an initial public
offering.

In conjunction with the sale of Series A preferred stock, the Company's
founder and Chief Executive Officer each granted drugstore.com a right to
repurchase 2,235,000 shares of common stock held by them at the original
purchase price of $0.04 per share if their employment terminates under certain
circumstances. The Company's right of repurchase lapses (1) 25% immediately
and (2) the remaining 75% lapses beginning after one year from the vesting
commencement date at a rate of 1/48th per month. At December 31, 1998,
1,391,875 shares held by the founder and the CEO were subject to repurchase
under these agreements. The restricted stock agreements also provide that in
the event of a change of control whereby the individual was not offered a
position with similar responsibilities or termination of employment for other
than cause, additional shares would vest to the individual.

1998 Stock Plan

Under the terms of the 1998 stock plan, the board of directors may grant
incentive and nonqualified stock options to employees, officers, directors,
agents, consultants, and independent contractors of the Company. In connection
with the introduction of the 1998 stock plan, 2,735,000 shares of common stock
were reserved for future issuance. In January 1999 and April 1999, the Company
increased the number of shares reserved for future issuance under such plan by
1,500,000 and 3,592,000 shares, respectively (see Note 7). Generally, the
Company grants stock options with exercise prices equal to the fair market
value of the common stock on the date of grant, as determined by the board of
directors. Options generally vest over a four to five year period and expire
ten years from the date of grant.

F-14
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

A summary of stock option activity follows:

<TABLE>
<CAPTION>
Outstanding Options
---------------------------
Shares Available Number of Weighted-Average
for Grant Shares Exercise Price
---------------- --------- ----------------
<S> <C> <C> <C>
1998 Stock Plan
introduction............... 2,735,000 --
Options granted............. (1,683,584) 1,683,584 $ 0.17
Options exercised........... -- (8,000) 0.12
Options canceled............ 160,250 (160,250) 0.04
---------- ---------
Outstanding at December 31,
1998......................... 1,211,666 1,515,334 0.18
1998 Stock Plan amendments.. 5,092,000 -- --
Options granted ............ (1,683,600) 1,683,600 3.12
Options canceled............ 166,125 (166,125) 0.91
---------- ---------
Outstanding at April 4, 1999.. 4,786,191 3,032,809 $ 1.77
========== =========
</TABLE>

The following table summarizes information regarding stock options
outstanding and exercisable as of December 31, 1998:

<TABLE>
<CAPTION>
Outstanding Options
-----------------------------------------
Weighted-Average Exercisable
Exercise Number Remaining Number of
Price of Shares Contractual Life Shares
-------- --------- ---------------- -----------
<S> <C> <C> <C>
$0.04 505,834 9.7 years 19,167
$0.12 618,500 9.8 years --
$0.45 391,000 9.9 years --
--------- ------
1,515,334 19,167
========= ======
</TABLE>

Under APB No. 25, no compensation expense is recognized when the exercise
price of the Company's employee stock options equals the fair value of the
underlying stock on the date of grant. Deferred stock-based compensation is
recorded for those situations where the exercise price of an option or the
purchase price of restricted stock was lower than the deemed fair value for
financial reporting purposes of the underlying common stock. The Company
recorded aggregate deferred stock-based compensation of $2,746,000 during 1998
and $6,227,000 in the six months ended July 4, 1999. The deferred stock-based
compensation is being amortized over the vesting period of the underlying
options and restricted stock. Total amortization of stock-based compensation
recognized was $500,000 during 1998 and $2,276,000 in the six months ended
July 4, 1999. Amortization of stock-based compensation is allocable to
employees in the following expense categories:

<TABLE>
<CAPTION>
Period from
April 2, 1998 Six Months
(Inception) to Ended
December 31, 1998 July 4, 1999
----------------- ------------
<S> <C> <C>
Marketing and sales......................... 24% 41%
Product development......................... 24 32
General and administrative.................. 52 27
--- ---
100% 100%
=== ===
</TABLE>

F-15
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

Had the stock-based compensation for the Company's stock option plan and
restricted stock agreements been determined based on the Black-Scholes model
using the multiple-option approach, the Company's net loss would have been
adjusted to the following pro forma amount for the period ended December 31,
1998 (in thousands):

<TABLE>
<S> <C>
Net loss--as reported........................................... $ (7,490)
Incremental pro forma compensation expense under SFAS No. 123... (11)
--------
Net loss--pro forma............................................. $ (7,501)
========
Basic and diluted net loss per share--as reported............... $ (13.71)
========
Basic and diluted net loss per share--pro forma................. $ (13.73)
========
Pro forma basic and diluted net loss per share--as reported..... $ (.92)
========
Pro forma basic and diluted net loss per share--pro forma....... $ (.92)
========
</TABLE>

The fair value at each option grant is estimated on the date of grant using
the Black-Scholes option pricing model, assuming no expected dividends and
assuming a measure of a volatility based on a review of a peer group of
Internet companies at a comparable developmental stage utilizing the following
weighted average assumptions at December 31, 1998:

<TABLE>
<S> <C>
Average risk-free interest rate.................................. 4.5%
Average expected life............................................ 3.0 years
Volatility....................................................... 50%
</TABLE>

For purposes of the pro forma disclosures, the estimated weighted average
fair value of the options granted, estimated to be $0.78 per share at December
31, 1998, is amortized to expense over the options' vesting period. This
amount has been reduced by the amount of amortization of deferred stock-based
compensation already recorded in the accompanying statements of operations
that has a weighted average value of $0.77 per share. Compensation expense
recognized in providing pro forma disclosures may not be representative of the
effects on pro forma earnings for future years because the amounts above
include only the amortization for the fair value of 1998 grants.

Common Stock Reserved for Future Issuance

The following shares of common stock were reserved at December 31, 1998:

<TABLE>
<S> <C>
1998 Stock Plan................................................. 2,727,000
Conversion of Series A preferred stock.......................... 10,000,000
Conversion of Series B preferred stock.......................... 5,446,268
----------
18,173,268
==========
</TABLE>

6. Note Receivable from Officer

On December 3, 1998, the Company loaned an officer $250,000 evidenced by a
note receivable bearing 7% interest, secured by the officer's stock options to
purchase an aggregate of 150,000 shares of common stock at $0.04 per share,
none of which are vested at December 31, 1998.

F-16
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

7. Subsequent Events

Issuance of Warrant

In February 1999, the Company issued a warrant to purchase 10,000 shares of
its common stock at $7.83 per share in exchange for the right to use the 1-
800-DRUGSTORE and related iterations of telephone numbers. Such warrant is
exercisable immediately and expires in February 2002. The fair value of such
warrant was estimated at $24,000 and was recorded as an intangible asset.

Proposed Initial Public Offering of Common Stock

In April 1999, the board of directors authorized the Company to proceed
with an initial public offering of its common stock. The board of directors
also approved a change in the par value of the common and preferred stock to
$.0001 per share and change in the total number of authorized shares to
260,000,000 shares, of which 250,000,000 will be common stock and 10,000,000
will be undesignated preferred stock. This increase in the number of
authorized shares and change in par value is expected to become effective upon
the completion of the offering. If the offering is consummated as presently
anticipated, all of the outstanding preferred stock will automatically convert
into common stock. The unaudited pro forma stockholders' equity at July 4,
1999 gives effect to the conversion of all outstanding shares of convertible
preferred stock at July 4, 1999 into 22,185,401 shares of common stock upon
completion of the offering and the change in the capital structure of the
Company.

1998 Stock Plan

In April 1999, the board of directors increased the number of shares
reserved under the 1998 stock plan by 3,592,000 shares to 7,827,000 shares. As
of July 4, 1999 the Company has reserved a total of 7,819,000 shares of common
stock for future issuance of stock options to employees, officers, directors,
or consultants under the 1998 stock plan.

1999 Employee Stock Purchase Plan

The Company's 1999 employee stock purchase plan was adopted by the board of
directors in April 1999, subject to stockholder approval, to be effective upon
the completion of the Company's initial public offering of its common stock. A
total of 500,000 shares of common stock has been reserved for issuance under
the employee stock purchase plan plus an annual increase on the first day of
each of the fiscal years beginning in 2000, 2001, 2002, 2003 and 2004 equal to
the lesser of (1) 500,000 shares, (2) three percent (3%) of our shares
outstanding on the last day of the immediate preceding fiscal year, or (3)
such lesser number of shares as is determined by the board of directors.
Eligible employees may purchase common stock at 85% of the lesser of the fair
market value of the Company's common stock on the first or the last day of the
applicable six month purchase period.

Defined Contribution Plan

Effective April 1999, the Company adopted a defined contribution retirement
plan under Section 401(k) of the Internal Revenue Code which covers
substantially all employees. Eligible employees may contribute amounts to the
plan, via payroll withholding, subject to certain limitations. Under the
401(k) plan, employees may elect to reduce their current compensation by up to
the statutorily prescribed annual limit ($10,000 in 1999) and to have the
amount of such reduction contributed to the 401(k) plan. The 401(k) plan
permits, but does not require, additional matching contributions to the 401(k)
plan by the Company on behalf of all participants in the 401(k) plan. To date,
the Company has not made any matching contributions to the 401(k) plan.

Issuance of Series D Convertible Preferred Stock

In June 1999, the Company issued 2,266,289 shares of Series D preferred
stock to a new investor in exchange for $40 million in cash and an obligation
to provide cable television advertising valued at $5 million

F-17
<PAGE>

DRUGSTORE.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(Information as of July 4, 1999 and for the six months ended July 4, 1999 is
unaudited)

based on comparable transactions with unaffiliated third parties. The
advertising is expected to be aired over a three year period and will be
expensed in the period in which the airtime is used. The Series D preferred
stock carries substantially the same terms and conditions as the Series A, B
and C preferred stock and is convertible into common stock at a one-to-one
ratio upon an initial public offering subject to certain conditions.

Issuance of Series E Convertible Preferred Stock

In July 1999, the Company consummated an agreement with two investors to
issue 12,282,599 shares of Series E preferred stock in exchange for an
aggregate of $10 million in cash and other consideration, including exclusive
advertising commitments and other obligations with an estimated fair value of
$112.8 million. The aggregate purchase price of $122.8 million will be
allocated based on the relative fair value of the assets and services to be
received and amortized over the related service periods. The Series E
preferred stock carries substantially the same terms as the Series A, B, C and
D preferred stock and is convertible into common stock at a one-to one ratio
upon an initial public offering subject to certain conditions. In connection
with the issuance of the Series E preferred stock, the certificate of
incorporation was amended on July 7, 1999 to increase the total authorized
number of preferred and common stock to 310,000,000 shares and the
accompanying financial statements reflect the increase in the capitalization.

F-18
<PAGE>

The inside back cover includes:

drugstore.com
Makes Shopping Easy

The following text is placed at the top left of the page:
HELP ON A PERSONAL LEVEL

The advantage of the Internet allows drugstore.com to offer customers help on a
personal level. Customers can shop from their home or office any time of the
day or night. They can get useful information to make informed product
decisions. They can ask a pharmacist questions in privacy. drugstore.com
provides the information and interaction that makes shopping easy.

[PICTURE OF SKIN CARE ADVISOR PAGE]
[PICTURE OF RESOURCE CENTER PAGE]
[PICTURE OF PREGNANCY AND INFANT CENTER PAGE]
[PICTURE OF QUICK LISTS PAGE]

The following text appears to the left of the picture of the Skin Care Advisor
page:
SHOPPING ADVISOR
drugstore.com helps customers who are not sure about what product to buy. The
customer provides information about what he or she needs and the Shopping
Advisors help identify the right products.

The following text appears to the right of the picture of the Resource Center
page:

SOLUTIONS
An easy way for customers to find the information they need in order to make
informed product decisions, the Solutions area includes Ask Your Pharmacist,
Health and Wellness Guides, Shopping Advisors and more.

The following text appears to the left of the picture of the Quick Lists page:
QUICK LISTS

An easy way to find what you need and assist you in stocking up on frequently
used items.

The following underneath the picture of the Pregnancy Center page:
PREGNANCY
Whether it's the first child or the fifth, the Pregnancy and Infant Center helps
families prepare for childbirth and child rearing.

Until ____________, 1999, 25 days after commencement of the offering, all
dealers effecting transactions in our common stock, whether or not participating
in this offering, may be required to deliver a prospectus. This delivery
requirement is in addition to the dealers' obligation to deliver a prospectus
when acting as underwriters and with respect to their unsold allotments or
subscriptions.

The back cover of the prospecuts contains the company's logo.

-4-
<PAGE>

[drugstore.com logo]
<PAGE>

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

Item 13. Other Expenses of Issuance and Distribution

The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by registrant in connection
with the sale of common stock being registered. All amounts are estimates
except the SEC registration fee and the NASD filing fee and the Nasdaq
National Market entry and listing fee.

<TABLE>
<CAPTION>
Amount
to be Paid
----------
<S> <C>
SEC registration fee.......................................... $ 18,765
NASD filing fee............................................... 6,250
Nasdaq National Market entry and listing fee.................. 95,000
Printing and engraving expenses............................... 300,000
Legal fees and expenses....................................... 350,000
Accounting fees and expenses.................................. 200,000
Blue Sky qualification fees and expenses...................... 5,000
Transfer Agent and Registrar fees............................. 15,000
Miscellaneous fees and expenses............................... 59,985
----------
Total..................................................... $1,050,000
==========
</TABLE>

Item 14. Indemnification of Directors and Officers

Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's board of directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit such indemnification under
certain circumstances for liabilities (including reimbursement for expenses
incurred) arising under the Securities Act of 1933, as amended (the Act).
Article XIII of registrant's certificate of incorporation and sections 6.1 and
6.2 of Article VI of registrant's bylaws provide for indemnification of its
directors, officers, employees and other agents to the maximum extent
permitted by the Delaware General Corporation Law. In addition, registrant has
entered into indemnification agreements with its directors and officers. The
indemnification agreements may require registrant, among other things, to
indemnify its directors against certain liabilities that may arise by reason
of their status or service as directors (other than liabilities arising from
willful misconduct of culpable nature), to advance their expenses incurred as
a result of any proceeding against them as to which they could be indemnified,
and to obtain directors' insurance if available on reasonable terms. The
underwriting agreement (Exhibit 1.1 hereto) also provides for cross
indemnification among drugstore.com and the underwriters with respect to
certain matters, including matters arising under the Act.

Item 15. Recent Sales of Unregistered Securities

(a) Since inception in April 1998, registrant has issued and sold (without
payment of any selling commission to any person) the following unregistered
securities:

(1) In June, July and August 1998, registrant issued and sold 2,265,000
shares of common stock to a total of 5 investors for an aggregate purchase
price of $90,600.

(2) In June 1998 and August 1998, registrant issued and sold shares of
Series A preferred stock convertible into an aggregate of 10,000,000 shares
of common stock to a total of 5 investors for an aggregate purchase price
of $8,000,000.

(3) In October, November and December 1998, registrant issued and sold
shares of Series B preferred stock convertible into an aggregate of
5,446,268 shares of common stock to a total of 6 investors for an aggregate
purchase price of $18,244,997.80.

(4) In January 1999, registrant issued and sold shares of Series C
preferred stock convertible into an aggregate of 1,457,891 shares of common
stock to a total of 5 investors for an aggregate purchase price of
$11,407,997.07.

II-1
<PAGE>

(5) In January 1999, registrant issued and sold two convertible
promissory notes convertible into shares of Series C preferred stock and
further convertible into an aggregate of 3,014,953 shares of common stock
to a total of 2 investors for an aggregate purchase price of
$23,592,007.22. These notes were converted into shares of Series C
preferred stock in March 1999.

(6) In February 1999, registrant issued a warrant to purchase 10,000
shares of common stock in connection with a corporate partnership
agreement.

(7) In May 1999, registrant issued and sold a convertible promissory
note convertible into shares of Series D preferred stock and further
convertible into 2,266,289 shares of common stock to one investor for an
aggregate purchase price of $40,000,000.85. These notes were converted to
shares of Series D preferred stock in June 1999.

(8) In June 1999, registrant entered into an agreement with Rite Aid and
GNC, pursuant to which Rite Aid and a wholly owned subsidiary of GNC were
issued shares of Series E preferred stock. Under the agreement, registrant
issued Rite Aid 9,334,746 shares of Series E preferred stock in exchange
for $7.6 million in cash and additional consideration with an estimated
fair value of $85.7 million, and registrant issued GNC 2,947,853 shares of
Series E preferred stock for $2.4 million in cash and additional
consideration with an estimated fair value of $27.1 million.

(9) As of July 4, 1999, 8,000 shares of fully vested common stock had
been issued pursuant to restricted stock purchase agreements and no shares
of common stock had been issued upon exercise of options; 3,032,809 shares
of common stock were issuable upon exercise of outstanding options under
registrant's 1998 stock plan.

(b) There were no underwritten offerings employed in connection with any of
the transactions set forth in Item 15(a).

The issuances described in Items 15(a)(1)-(8) were deemed to be exempt from
registration under the Securities Act in reliance upon Section 4(2) thereof as
transactions by an issuer not involving any public offering. The issuances
described in Item 15(a)(9) were deemed to be exempt from registration under
the Act in reliance upon Rule 701 promulgated thereunder in that they were
offered and sold either pursuant to written compensatory benefit plans or
pursuant to a written contract relating to compensation, as provided by Rule
701. In addition, such issuances were deemed to be exempt from registration
under Section 4(2) of the Act as transactions by an issuer not involving any
public offering. The recipients of securities in each such transaction
represented their intentions to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution thereof and
appropriate legends where affixed to the securities issued in such
transactions. All recipients had adequate access, through their relationships
with the registrant, to information about the registrant.

Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits

<TABLE>
<C> <S>
1.1* Form of Underwriting Agreement.

3.2 Sixth Amended and Restated Certificate of Incorporation.

3.3* Form of Amended and Restated Certificate of Incorporation of
drugstore.com, to be filed and effective upon completion of this
offering.

3.4* Bylaws of drugstore.com, as amended.

5.1* Opinion of Venture Law Group, A Professional Corporation.

10.1* Form of Indemnification Agreement between drugstore.com and each of its
officers and directors.

10.2* 1998 Stock Plan, as amended.

</TABLE>

II-2
<PAGE>

<TABLE>
<S> <C>
10.3* 1999 Employee Stock Purchase Plan.

10.4* Restricted Stock Purchase Agreement with Jed A. Smith dated June 19, 1998.

10.5* Restricted Stock Purchase Agreement with Peter M. Neupert dated July 23, 1998.
10.6* Form of Warrant To Purchase Common Stock.

10.7* Series A Preferred Stock Purchase Agreement dated June 22, 1998.

10.8* Series B Preferred Stock Purchase Agreement dated October 9, 1998.

10.9* Series B Preferred Stock Rescission Agreement dated November 23, 1998 between drugstore.com
and entities affiliated with Kleiner Perkins Caufield & Byers.

10.10* Series C Preferred Stock and Convertible Note Purchase Agreement dated January 29, 1999.

10.11* Series D Preferred Stock and Convertible Note Purchase Agreement dated May 19, 1999.

10.12 Fourth Amended and Restated Investors' Rights Agreement dated May 19, 1999.

10.13* Sublease Agreement dated January 29, 1999 between drugstore.com and The Boeing Company for
offices at 13920 Southeast Eastgate Way, Suite 300, Bellevue, Washington.

10.14*+ Amended and Restated Technology License and Advertising Agreement between drugstore.com,
Amazon.com and Amazon.com Drugstore, Inc.

10.15*+ Pharmacy Service Agreement dated February 8, 1999 with RxAmerica.

10.16*+ Service & Supply Agreement dated January 29, 1999 with Walsh Distribution, Inc.

10.17* Offer Letter dated June 29, 1998 with Peter M. Neupert.

10.18* Offer Letter dated July 28, 1998 with Kal Raman.

10.19* Offer Letter dated December 4, 1998 with Mark L. Silverman.

10.20* Offer Letter dated June 18, 1998 with Jed A. Smith.

10.21* Amended and Restated Voting Agreement dated May 19, 1999.

10.22* Letter Agreement dated May 19, 1999 with Amazon.com.

10.23* Cable Advertising Agreement dated May 19, 1999 with Vulcan Ventures Incorporated.

10.24* Series E Preferred Stock Purchase Agreement dated June 17, 1999.

10.25* Addendum to Fourth Amended and Restated Investors' Rights Agreement dated June 17, 1999.

10.26** Third Amended and Restated Voting Agreement dated June 17, 1999.

10.27* Main Agreement dated June 17, 1999 with Rite Aid Corporation.

10.28* Main Agreement dated June 17, 1999 with General Nutrition Companies, Inc.

10.29* Governance Agreement dated June 17, 1999 with Rite Aid Corporation.

10.30* Governance Agreement dated June 17, 1999 with General Nutrition Companies, Inc. and
General Nutrition Investment Company.

10.31* Pharmacy Supply and Services Agreement dated June 17, 1999 with Rite Aid Corporation.

21.1* Subsidiaries.

23.1 Consent of Ernst & Young LLP, Independent Auditors.

23.2 Consent of Counsel (see Exhibit 5.1).

24.1* Power of Attorney.

27.1 Financial Data Schedule (EDGAR-filed version only).
</TABLE>
- --------
* Previously filed.
** To be supplied by amendment.
+ Confidential treatment has been requested as to certain portions of this
Exhibit. Such confidential portions have been provided separately to the SEC.

II- 3
<PAGE>

(b) Financial Statement Schedules

All financial statement schedules are omitted because they are inapplicable
or the requested information is shown in the financial statements of the
registrant or the related notes to the financial statements.

Item 17. Undertakings

The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (Act) may be permitted to directors, officers and controlling persons
of the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.

The undersigned registrant hereby undertakes that:

(1) For purposes of determining any liability under the Act, the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the registrant pursuant to Rule 424(b)(1), or (4),
or 497(h) under the Act shall be deemed to be a part of this Registration
Statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the Act, each
posteffective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered
therein, and this offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.

II-4
<PAGE>

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the undersigned
Registrant has duly caused this Amendment No. 3 to Registration Statement on
Form S-1 to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Bellevue, State of Washington, on July 8, 1999.

drugstore.com, inc.

/s/ David E. Rostov
By: _________________________________
David E. Rostov
Vice President and Chief Financial
Officer

Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to Registration Statement on Form S-1 has been signed by the following
persons in the capacities and on the dates indicated:

<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
*Peter M. Neupert President, Chief Executive July 8, 1999
______________________________________ Officer and Director
(Peter M. Neupert) (Principal Executive
Officer)

/s/ David E. Rostov Vice President and Chief July 8, 1999
______________________________________ Financial Officer
(David E. Rostov) (Principal Financial and
Accounting Officer)

*Jeffrey P. Bezos Director July 8, 1999
______________________________________
(Jeffrey P. Bezos)

*Brook H. Byers Director July 8, 1999
______________________________________
(Brook H. Byers)

*L. John Doerr Director July 8, 1999
______________________________________
(L. John Doerr)

*Howard Schultz Director July 8, 1999
______________________________________
(Howard Schultz)

*Jed A. Smith Director July 8, 1999
______________________________________
(Jed A. Smith)

/s/ David E. Rostov July 8, 1999
*By: _______________________________
David E. Rostov
Attorney-in-Fact
</TABLE>

II-5
<PAGE>

EXHIBIT INDEX

<TABLE>
<C> <S>
1.1* Form of Underwriting Agreement.

3.2 Sixth Amended and Restated Certificate of Incorporation.

3.3* Form of Amended and Restated Certificate of Incorporation of
drugstore.com, to be filed and effective upon completion of this
offering.

3.4* Bylaws of drugstore.com, as amended.

5.1* Opinion of Venture Law Group, A Professional Corporation.

10.1* Form of Indemnification Agreement between drugstore.com and each of
its officers and directors.

10.2* 1998 Stock Plan, as amended.

10.3* 1999 Employee Stock Purchase Plan.

10.4* Restricted Stock Purchase Agreement with Jed A. Smith dated June 19,
1998.

10.5* Restricted Stock Purchase Agreement with Peter M. Neupert dated July
23, 1998.

10.6* Form of Warrant To Purchase Common Stock.

10.7* Series A Preferred Stock Purchase Agreement dated June 22, 1998.

10.8* Series B Preferred Stock Purchase Agreement dated October 9, 1998.

10.9* Series B Preferred Stock Rescission Agreement dated November 23, 1998
between drugstore.com and entities affiliated with Kleiner Perkins
Caufield & Byers.

10.10* Series C Preferred Stock and Convertible Note Purchase Agreement dated
January 29, 1999.

10.11* Series D Preferred Stock and Convertible Note Purchase Agreement dated
May 19, 1999.

10.12 Fourth Amended and Restated Investors' Rights Agreement dated May 19,
1999.

10.13* Sublease Agreement dated January 29, 1999 between drugstore.com and
The Boeing Company for offices at 13920 Southeast Eastgate Way, Suite
300, Bellevue, Washington.

10.14*+ Amended and Restated Technology License and Advertising Agreement
between drugstore.com, Amazon.com and Amazon.com Drugstore, Inc.

10.15*+ Pharmacy Service Agreement dated February 8, 1999 with RxAmerica.

10.16*+ Service & Supply Agreement dated January 29, 1999 with Walsh
Distribution, Inc.

10.17* Offer Letter dated June 29, 1998 with Peter M. Neupert.

10.18* Offer Letter dated July 28, 1998 with Kal Raman.

10.19* Offer Letter dated December 4, 1998 with Mark L. Silverman.

10.20* Offer Letter dated June 18, 1998 with Jed A. Smith.

10.21* Amended and Restated Voting Agreement dated May 19, 1999.

10.22* Letter Agreement with Amazon.com.

10.23* Cable Advertising Agreement dated May 19, 1999 with Vulcan Ventures
Incorporated.

10.24* Series E Preferred Stock Purchase Agreement dated June 17, 1999.

10.25* Addendum to Fourth Amended and Restated Investors' Rights Agreement
dated June 17, 1999.

10.26** Third Amended and Restated Voting Agreement dated June 17, 1999.
</TABLE>
<PAGE>

<TABLE>
<S> <C>
10.27* Main Agreement dated June 17, 1999 with Rite Aid Corporation.

10.28* Main Agreement dated June 17, 1999 with General Nutrition Companies, Inc.

10.29* Governance Agreement dated June 17, 1999 with Rite Aid Corporation.

10.30* Governance Agreement dated June 17, 1999 with General Nutrition Companies, Inc. and General
Nutrition Investment Company.

10.31* Pharmacy Supply and Services Agreement dated June 17, 1999 with Rite Aid Corporation.

21.1* Subsidiaries.

23.1 Consent of Ernst & Young LLP, Independent Auditors.

23.2 Consent of Counsel (see Exhibit 5.1).

24.1* Power of Attorney.

<PAGE>

EXHIBIT 3.2

EXHIBIT A

SIXTH AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION

DRUGSTORE.COM, INC.

The undersigned, Peter M. Neupert and Mark L. Silverman, hereby certify
that:

1. They are the duly elected and acting President and Secretary,
respectively, of drugstore.com, inc., a Delaware corporation.

2. The Certificate of Incorporation of this corporation was originally
filed with the Secretary of State of Delaware on April 2, 1998.

3. The Certificate of Incorporation of this corporation shall be amended
and restated to read in full as follows:

ARTICLE I

"The name of this corporation is drugstore.com, inc. (the "Corporation").

ARTICLE II

The address of the Corporation's registered office in the State of Delaware
is 1013 Centre Road, Wilmington, Delaware 19805, County of New Castle. The name
of its registered agent at such address is Corporation Service Company.

ARTICLE III

The purpose of the Corporation is to engage in any lawful act or activity
for which corporations may be organized under the General Corporation Law of the
State of Delaware.

ARTICLE IV

(A) Classes of Stock. The Corporation is authorized to issue three classes
of stock to be designated, respectively, "Common Stock," "Serial Preferred
Stock" and "Preferred Stock" The total number of shares which the
<PAGE>

Corporation is authorized to issue is Three Hundred Ten Million (310,000,000)
shares, each with a par value of $0.001 per share. Two Hundred Fifty Million
(250,000,000) shares shall be Common Stock, Ten Million (10,000,000) shares
shall be Serial Preferred Stock and Fifty Million (50,000,000) shares shall be
Preferred Stock.

(B) Rights, Preferences and Restrictions of Serial Preferred Stock. The
Serial Preferred Stock may be issued from time to time in one or more series.
The Board of Directors is hereby authorized to provide for the issuance of
shares of Serial Preferred Stock in one or more series and, by filing a
certificate pursuant to the applicable law of the State of Delaware (hereinafter
referred to as "Preferred Stock Designation"), to establish from time to time
the number of shares to be included in each such series, and to fix the
designation, powers, preferences and rights of the shares of each such series
and the qualifications, limitations and restrictions thereof. The authority of
the Board of Directors with respect to each series shall include, but not be
limited to, determination of the following:

(i) The designation of the series, which may be by distinguishing
number, letter or title.

(ii) The number of shares of the series, which number the Board of
Directors may thereafter (except where otherwise provided in the Preferred Stock
Designation) increase or decrease (but not below the number of shares thereof
then outstanding).

(iii) The amounts payable on, and the preferences, if any, of shares
of the series in respect of dividends, and whether such dividends, if any, shall
be cumulative or noncumulative.

(iv) Dates at which dividends, if any, shall be payable.

(v) The redemption rights and price or prices, if any, for shares of
the series.

(vi) The terms and amount of any sinking fund provided for the
purchase or redemption of shares of the series.

(vii) The amounts payable on, and the preferences, if any, of shares
of the series in the event of any voluntary or involuntary liquidation,
dissolution or winding up of the affairs of the Corporation.
<PAGE>

(viii) Whether the shares of the series shall be convertible into or
exchangeable for shares of any other class or series, or any other security, of
the Corporation or any other corporation, and, if so, the specification of such
other class or series or such other security, the conversion or exchange price
or prices or rate or rates, any adjustments thereof, the date or dates at which
such shares shall be convertible or exchangeable and all other terms and
conditions upon which such conversion or exchange may be made.

(ix) Restrictions on the issuance of shares of the same series or of
any other class or series.

(x) The voting rights, if any, of the holders of shares of the
series.

(C) Rights, Preferences and Restrictions of Preferred Stock. The Preferred
Stock authorized by this Sixth Amended and Restated Certificate of Incorporation
shall consist of the series of Preferred Stock set forth below. The first
series of Preferred Stock shall be designated "Series A Preferred Stock" and
shall consist of Ten Million (10,000,000) shares. The second series of
Preferred Stock shall be designated "Series B Preferred Stock" and shall consist
of Five Million Five Hundred Thousand (5,500,000) shares. The third series of
Preferred Stock shall be designated "Series C Preferred Stock" and shall consist
of Five Million (5,000,000) shares. The fourth series of Preferred Stock shall
be designated "Series D Preferred Stock" and shall consist of Two Million Three
Hundred Thousand (2,300,000) shares. The fifth series of Preferred Stock shall
be designated "Series E Preferred Stock" and shall consist of Twelve Million
Three Hundred Thousand (12,300,000) shares. The rights, preferences,
privileges, and restrictions granted to and imposed on the Series A Preferred
Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D
Preferred Stock and the Series E Preferred Stock are as set forth below in this
Article IV(C).

1. Dividend Provisions. The holders of shares of Series A, Series
B, Series C, Series D and Series E Preferred Stock shall be entitled to receive
dividends, out of any assets legally available therefor, prior and in preference
to any declaration or payment of any dividend (payable other than in Common
Stock or other securities and rights convertible into or entitling the holder
thereof to receive, directly or indirectly, additional shares of Common Stock of
the Corporation) on the Common Stock of the Corporation, at the rate of $0.08
per share per annum on each outstanding share of Series A Preferred Stock, the
rate
<PAGE>

of $0.335 per share per annum on each outstanding share of Series B Preferred
Stock, the rate of $0.7825 per share per annum on each outstanding share of
Series C Preferred Stock, the rate of $1.765 per share per annum on each
outstanding share of Series D Preferred Stock, and the rate of $0.081416 per
share per annum on each outstanding share of Series E Preferred Stock (in each
case as adjusted for any stock dividends, combinations, splits,
recapitalizations and the like with respect to such shares after June 17, 1999)
payable quarterly when, as and if declared by the Board of Directors. Such
dividends shall not be cumulative. In addition, in the event dividends are paid
on any share of Common Stock, an additional dividend shall be paid with respect
to all outstanding shares of Preferred Stock in an amount equal per share (on an
as-if-converted basis) to the amount paid or set-aside for each share of Common
Stock of the Corporation whenever funds are legally available therefor, when, as
and if declared by the Board of Directors.

2. Liquidation.

(a) Preference. In the event of any liquidation, dissolution or
winding up of the Corporation, either voluntary or involuntary, the holders of
the Series A, Series B, Series C, Series D and Series E Preferred Stock shall be
entitled to receive, prior and in preference to any distribution of any of the
assets of the Corporation to the holders of Common Stock by reason of their
ownership thereof, an amount per share equal to (i) $0.80 per share for each
share of Series A Preferred Stock then held by them, (ii) $3.35 per share for
each share of Series B Preferred Stock then held by them, (iii) $7.825 per share
for each share of Series C Preferred Stock then held by them, (iv) $17.65 per
share for each share of Series D Preferred Stock then held by them and (v)
$0.81416 per share for each share of Series E Preferred Stock then held by them,
plus declared but unpaid dividends (in each case as adjusted for any stock
dividends, combinations, splits, recapitalizations and the like with respect to
such shares after June 17, 1999). If, upon the occurrence of such event, the
assets and funds thus distributed among the holders of the Series A, Series B,
Series C, Series D and Series E Preferred Stock shall be insufficient to permit
the payment to such holders of the full aforesaid preferential amounts, then,
subject to the rights of holders of any outstanding series of Serial Preferred
Stock, the entire assets and funds of the Corporation legally available for
distribution shall be distributed ratably among the holders of the Series A,
Series B, Series C, Series D and Series E Preferred Stock in proportion to the
preferential amount
<PAGE>

each such holder is otherwise entitled to receive.

(b) Remaining Assets. Upon the completion of the distribution
required by Section 2(a) above, if assets remain in the Corporation, subject to
the rights of holders of any outstanding series of Serial Preferred Stock, the
holders of the Common Stock of the Corporation shall receive all of the
remaining assets of the Corporation available for distribution to stockholders.

(i) Deemed Liquidation. For purposes of this Section 2, a
liquidation, dissolution or winding up of the Corporation shall be deemed to
occur if the Corporation shall (A) sell, convey, or otherwise dispose of all or
substantially all of its property or business or merge or consolidate with any
other corporation (other than a wholly-owned subsidiary corporation) where the
stockholders of the Corporation own less than fifty percent (50%) of the voting
power of the surviving entity after such merger or consolidation or (B) effect
any other transaction or series of related transactions in which more than fifty
percent (50%) of the voting power of the Corporation is disposed of, provided
that this Section 2(c)(i) shall not apply to a merger effected solely for the
purpose of changing the domicile of the Corporation.

(ii) Valuation of Consideration. In the event of a deemed liquidation
as described in Section 2(c)(i) above, if the consideration received by the
Corporation is other than cash, its value will be deemed its fair market value.
Any securities shall be valued as follows:

(A) Securities not subject to investment letter or other similar
restrictions on free marketability:

(1) If traded on a securities exchange or The Nasdaq Stock Market, the
value shall be deemed to be the average of the closing prices of the securities
on such exchange over the thirty-day period ending three (3) days prior to the
closing;

(2) If actively traded over-the-counter, the value shall be deemed to
be the average of the closing bid or sale prices (whichever is applicable) over
the thirty-day period ending three (3) days prior to the closing; and

(3) If there is no active
<PAGE>

public market, the value shall be the fair market value thereof, as mutually
determined by the Corporation and the holders of at least a majority of the
voting power of all then outstanding shares of Preferred Stock.

(B) The method of valuation of securities subject to investment letter
or other restrictions on free marketability (other than restrictions arising
solely by virtue of a stockholder's status as an affiliate or former affiliate)
shall be to make an appropriate discount from the market value determined as
above in Section 2(c)(ii)(A) to reflect the approximate fair market value
thereof, as mutually determined by the Corporation and the holders of a majority
of the voting power of all then outstanding shares of Preferred Stock.

(iii) Notice of Transaction. The Corporation shall give each holder
of record of Preferred Stock written notice of such impending transaction not
later than ten (10) days prior to the stockholders' meeting called to approve
such transaction, or ten (10) days prior to the closing of such transaction,
whichever is earlier, and shall also notify such holders in writing of the final
approval of such transaction. The first of such notices shall describe the
material terms and conditions of the impending transaction and the provisions of
this Section 2, and the Corporation shall thereafter give such holders prompt
notice of any material changes. The transaction shall in no event take place
sooner than ten (10) days after the Corporation has given the first notice
provided for herein or sooner than five (5) days after the Corporation has given
notice of any material changes provided for herein.

(iv) Effect of Noncompliance. In the event the requirements of
Section 2(c)(iii) are not complied with, the Corporation shall forthwith either
cause the closing of the transaction to be postponed until such requirements
have been complied with, or cancel such transaction, in which event the rights,
preferences and privileges of the holders of the Preferred Stock shall revert to
and be the same as such rights, preferences and privileges existing immediately
prior to the date of the first notice referred to in Section 2(c)(iii) hereof.

3. Redemption. The Preferred Stock is not redeemable.

4. Conversion. The holders of the Series A, Series B, Series C,
Series D and Series E Preferred Stock shall have conversion rights as follows
(the "Conversion Rights"):
<PAGE>

(a) Right to Convert. Subject to Section 4(c), each share of Series
A, Series B, Series C, Series D and Series E Preferred Stock shall be
convertible, at the option of the holder thereof, at any time after the date of
issuance of such share, at the office of the Corporation or any transfer agent
for such stock, into such number of fully paid and nonassessable shares of
Common Stock as is determined by dividing (i) $0.80 in the case of the Series A
Preferred Stock, (ii) $3.35 in the case of the Series B Preferred Stock, (iii)
$7.825 in the case of the Series C Preferred Stock, (iv) $17.65 in the case of
the Series D Preferred Stock and (v) $0.81416 in the case of the Series E
Preferred Stock by the Conversion Price applicable to such share, determined as
hereafter provided, in effect on the date the certificate is surrendered for
conversion. The initial Conversion Price per share shall be $0.80 for shares of
Series A Preferred Stock, $3.35 for shares of Series B Preferred Stock, $7.825
for shares of Series C Preferred Stock, $17.65 for shares of Series D Preferred
Stock and $0.81416 for shares of Series E Preferred Stock. Such initial
Conversion Price shall be subject to adjustment as set forth in Section 4(d)
below.

(b) Automatic Conversion. Each share of Series A, Series B, Series C,
Series D and Series E Preferred Stock shall automatically be converted into
shares of Common Stock at the applicable Conversion Price at the time in effect
for such share immediately upon the earlier of (i) except as provided below in
Section 4(c), the Corporation's sale of its Common Stock in an underwritten
public offering pursuant to a registration statement under the Securities Act of
1933, as amended (the "Securities Act"), the public offering price of which is
not less than $10.00 per share (appropriately adjusted for any stock split,
dividend, combination or other recapitalization) and which results in gross cash
proceeds in excess of $15,000,000 and (ii) the date specified by written consent
or agreement of the holders of at least two-thirds (2/3) of the then outstanding
shares of Preferred Stock, voting together as a class.

(c) Mechanics of Conversion. Before any holder of Series A, Series B,
Series C, Series D or Series E Preferred Stock shall be entitled to convert the
same into shares of Common Stock, he shall surrender the certificate or
certificates therefor, duly endorsed, at the office of the Corporation or of any
transfer agent for such series of Preferred Stock, and shall give written notice
to the Corporation at its principal corporate office, of the election to convert
the same and shall state therein the name or names in which the certificate or
certificates for
<PAGE>

shares of Common Stock are to be issued. The Corporation shall, as soon as
practicable thereafter, issue and deliver at such office to such holder of
Preferred Stock, or to the nominee or nominees of such holder, a certificate or
certificates for the number of shares of Common Stock to which such holder shall
be entitled as aforesaid. Such conversion shall be deemed to have been made
immediately prior to the close of business on the date of such surrender of the
shares of such series of Preferred Stock to be converted, and the person or
persons entitled to receive the shares of Common Stock issuable upon such
conversion shall be treated for all purposes as the record holder or holders of
such shares of Common Stock as of such date. If the conversion is in connection
with an underwritten offering of securities registered pursuant to the
Securities Act the conversion may, at the option of any holder tendering such
Preferred Stock for conversion, be conditioned upon the closing with the
underwriters of the sale of securities pursuant to such offering, in which event
the person(s) entitled to receive Common Stock upon conversion of such Preferred
Stock shall not be deemed to have converted such Preferred Stock until
immediately prior to the closing of such sale of securities.

(d) Conversion Price Adjustments of Preferred Stock for Certain Splits
and Combinations. The Conversion Price of the Series A, Series B, Series C,
Series D and Series E Preferred Stock shall be subject to adjustment from time
to time as follows:

(i) Stock Splits and Dividends. In the event the Corporation should
at any time or from time to time after the date upon which any shares of Series
A, Series B or Series C Preferred Stock were first issued (the "Purchase Date"
with respect to each such series), or after May 19, 1999 with respect to the
Series D Preferred Stock (the "Purchase Date" with respect to the Series D
Preferred Stock), or after June 17, 1999 with respect to the Series E Preferred
Stock ( the "Purchase Date" with respect to the Series E Preferred Stock) fix a
record date for the effectuation of a split or subdivision of the outstanding
shares of Common Stock or the determination of holders of Common Stock entitled
to receive a dividend or other distribution payable in additional shares of
Common Stock or other securities or rights convertible into, or entitling the
holder thereof to receive directly or indirectly, additional shares of Common
Stock (hereinafter referred to as "Common Stock Equivalents") without a
corresponding split or subdivision of the Preferred Stock or a corresponding
dividend or other distribution to the Preferred Stock, then,
<PAGE>

as of such record date (or the date of such dividend distribution, split or
subdivision if no record date is fixed), the Conversion Price of each of the
Series A, Series B, Series C, Series D and Series E Preferred Stock shall be
appropriately decreased so that the number of shares of Common Stock issuable on
conversion of each share of such series shall be increased in proportion to such
increase of the aggregate of shares of Common Stock outstanding and those
issuable with respect to such Common Stock Equivalents with the number of shares
issuable with respect to Common Stock Equivalents determined from time to time
as provided in Section 4(d)(iii) below.

(ii) Reverse Stock Splits. If the number of shares of Common Stock
outstanding at any time after the Purchase Date is decreased by a combination of
the outstanding shares of Common Stock without a corresponding decrease of the
Preferred Stock, then, following the record date of such combination, the
Conversion Price for each of the Series A, Series B, Series C, Series D and
Series E Preferred Stock shall be appropriately increased so that the number of
shares of Common Stock issuable on conversion of each share of such series shall
be decreased in proportion to such decrease in outstanding shares.

(iii) The following provisions shall apply for purposes of this
Section 4(d):

(A) The aggregate maximum number of shares of Common Stock deliverable
upon conversion or exercise of Common Stock Equivalents (assuming the
satisfaction of any conditions to convertibility or exercisability, including,
without limitation, the passage of time, but without taking into account
potential antidilution adjustments) shall be deemed to have been issued at the
time such Common Stock Equivalents were issued.

(B) In the event of any change in the number of shares of Common Stock
deliverable or in the consideration payable to the Corporation upon conversion
or exercise of such Common Stock Equivalents including, but not limited to, a
change resulting from the antidilution provisions thereof, the Conversion Price
of each of the Series A, Series B, Series C, Series D and Series E Preferred
Stock, to the extent in any way affected by or computed using such Common Stock
Equivalents, shall be recomputed to reflect such change, but no further
adjustment shall be made for the actual issuance of Common Stock or any payment
of such consideration upon the exercise of any such options or rights or the
conversion or exchange of such securities.
<PAGE>

(C) Upon the termination or expiration of the convertibility or
exercisability of any such Common Stock Equivalents, the Conversion Price of
each of the Series A, Series B, Series C, Series D and Series E Preferred Stock,
to the extent in any way affected by or computed using such Common Stock
Equivalents, shall be recomputed to reflect the issuance of only the number of
shares of Common Stock (and Common Stock Equivalents which remain convertible or
exercisable) actually issued upon the conversion or exercise of such Common
Stock Equivalents.

(e) Other Distributions. In the event the Corporation shall declare a
distribution payable in securities of other persons, evidences of indebtedness
issued by the Corporation or other persons, assets (excluding cash dividends) or
options or rights not referred to in Section 4(d)(i), then, in each such case
for the purpose of this Section 4(e), the holders of Series A, Series B, Series
C, Series D and Series E Preferred Stock shall be entitled to a proportionate
share of any such distribution as though they were the holders of the number of
shares of Common Stock of the Corporation into which their shares of Preferred
Stock are convertible as of the record date fixed for the determination of the
holders of Common Stock of the Corporation entitled to receive such
distribution.

(f) Recapitalizations. If at any time or from time to time there shall
be a recapitalization of the Common Stock (other than a subdivision, combination
or merger or sale of assets transaction provided for elsewhere in this Section 4
or Section 2) provision shall be made so that the holders of the Series A,
Series B, Series C, Series D and Series E Preferred Stock shall thereafter be
entitled to receive upon conversion of such Preferred Stock the number of shares
of stock or other securities or property of the Corporation or otherwise, to
which a holder of Common Stock deliverable upon conversion would have been
entitled on such recapitalization. In any such case, appropriate adjustment
shall be made in the application of the provisions of this Section 4 with
respect to the rights of the holders of such Preferred Stock after the
recapitalization to the end that the provisions of this Section 4 (including
adjustment of the Conversion Price then in effect and the number of shares
purchasable upon conversion of such Preferred Stock) shall be applicable after
that event and be as nearly equivalent as practicable.

(g) No Impairment. The Corporation will not, by amendment of its
Certificate of Incorporation or through any reorganization, recapitalization,
transfer of
<PAGE>

assets, consolidation, merger, dissolution, issue or sale of securities or any
other voluntary action, avoid or seek to avoid the observance or performance of
any of the terms to be observed or performed hereunder by the Corporation, but
will at all times in good faith assist in the carrying out of all the provisions
of this Section 4 and in the taking of all such action as may be necessary or
appropriate in order to protect the Conversion Rights of the holders of
Preferred Stock against impairment.

(h) No Fractional Shares and Certificate as to Adjustments.

(i) No fractional shares shall be issued upon the conversion of any
share or shares of the Series A, Series B, Series C, Series D or Series E
Preferred Stock, and the number of shares of Common Stock to be issued shall be
rounded to the nearest whole share. The number of shares issuable upon such
conversion shall be determined on the basis of the total number of shares of
Series A, Series B, Series C, Series D or Series E Preferred Stock the holder is
at the time converting into Common Stock and the number of shares of Common
Stock issuable upon such aggregate conversion.

(ii) Upon the occurrence of each adjustment or readjustment of the
Conversion Price of Series A, Series B, Series C, Series D or Series E Preferred
Stock pursuant to this Section 4, the Corporation, at its expense, shall
promptly compute such adjustment or readjustment in accordance with the terms
hereof and prepare and furnish to each holder of such Preferred Stock a
certificate setting forth such adjustment or readjustment and showing in detail
the facts upon which such adjustment or readjustment is based. The Corporation
shall, upon the written request at any time of any holder of Series A, Series B,
Series C, Series D or Series E Preferred Stock, furnish or cause to be furnished
to such holder a like certificate setting forth (A) such adjustment or
readjustment, (B) the Conversion Price for such series of Preferred Stock at the
time in effect and (C) the number of shares of Common Stock and the amount, if
any, of other property which at the time would be received upon the conversion
of a share of such series of Preferred Stock.

(i) Notices of Record Date. In the event of any taking by the
Corporation of a record of the holders of any class of securities for the
purpose of determining the holders thereof who are entitled to receive any
dividend (other than a cash dividend) or other distribution, the Corporation
shall mail to each holder of Series A, Series B, Series C, Series D or Series E
Preferred Stock, at least ten
<PAGE>

(10) days prior to the date specified therein, a notice specifying the date on
which any such record is to be taken for the purpose of such dividend,
distribution or right, and the amount and character of such dividend,
distribution or right.

(j) Reservation of Stock Issuable Upon Conversion. The Corporation
shall at all times reserve and keep available out of its authorized but unissued
shares of Common Stock, solely for the purpose of effecting the conversion of
the shares of the Series A, Series B, Series C, Series D and Series E Preferred
Stock, such number of its shares of Common Stock as shall from time to time be
sufficient to effect the conversion of all outstanding shares of such series of
Preferred Stock; and if at any time the number of authorized but unissued shares
of Common Stock shall not be sufficient to effect the conversion of all then
outstanding shares of such series of Preferred Stock, in addition to such other
remedies as shall be available to the holder of such Preferred Stock, the
Corporation will take such corporate action as may, in the opinion of its
counsel, be necessary to increase its authorized but unissued shares of Common
Stock to such number of shares as shall be sufficient for such purposes,
including, without limitation, engaging in best efforts to obtain the requisite
stockholder approval of any necessary amendment to this Certificate of
Incorporation.

(k) Notices. Any notice required by the provisions of this Section 4
to be given to the holders of shares of Series A, Series B, Series C, Series D
or Series E Preferred Stock shall be deemed given: (i) upon personal delivery to
the party to be notified; (ii) when sent by confirmed telex or facsimile if sent
during normal business hours of the recipient; if not, then on the next business
day; (iii) one (1) day after deposit with a nationally recognized overnight
courier, specifying next day delivery, with written verification of receipt; or
(iv) five (5) days after having been deposited in the United States mail,
postage prepaid. All notices shall be addressed to each holder of record at his
address appearing on the books of the Corporation.

5. Voting Rights. The holder of each share of Series A, Series B,
Series C, Series D or Series E Preferred Stock shall have the right to one vote
for each share of Common Stock into which such Preferred Stock could then be
converted, and with respect to such vote, such holder shall have full voting
rights and powers equal to the voting rights and powers of the holders of Common
Stock, and shall be entitled, notwithstanding any provision hereof, to notice
<PAGE>

of any stockholders' meeting in accordance with the bylaws of the Corporation,
and shall be entitled to vote, together with holders of Common Stock, with
respect to any question upon which holders of Common Stock have the right to
vote. Fractional votes shall not, however, be permitted and any fractional
voting rights available on an as-converted basis (after aggregating all shares
into which shares of Series A, Series B, Series C, Series D or Series E
Preferred Stock held by each holder could be converted) shall be rounded to the
nearest whole number (with one-half being rounded upward).

6. Protective Provisions. So long as at least 1,000,000 shares of
Preferred Stock are outstanding (as adjusted for stock splits, stock dividends,
combinations or recapitalizations and the like), the Corporation shall not
without first obtaining the approval (by vote or written consent, as provided by
law) of the holders of at least two thirds (2/3) of the then outstanding shares
of Preferred Stock, voting together as a class:

(a) authorize or issue, or obligate itself to issue, any other equity
security, including any other security convertible into or exercisable for any
equity security, having a preference over, or being on a parity with, the Series
A, Series B, Series C, Series D or Series E Preferred Stock with respect to
voting, dividends, conversion or upon liquidation;

(b) effect a liquidation, dissolution or winding up of the Corporation
or a transaction described in Section 2(c)(i) above;

(d) amend, alter or repeal the Corporation's Certificate of
Incorporation or Bylaws or take any other action, whether by merger,
consolidation or otherwise, in a manner that would alter or change the rights,
preferences or privileges of the shares of Preferred Stock so as to affect
adversely the shares of such class.

7. Status of Converted Stock. In the event any shares of Preferred
Stock shall be converted pursuant to Section 4 hereof, the shares so converted
shall be retired and canceled and shall not be reissued by the Corporation. The
Certificate of Incorporation of the Corporation shall be appropriately amended
to effect the corresponding reduction in the Corporation's authorized capital
stock. No share or shares of Preferred Stock acquired by the Corporation by
reason of redemption, purchase or otherwise shall be
<PAGE>

reissued.

(D) Common Stock.

1. The holders of shares of Common Stock shall be entitled to one
vote for each such share upon all questions presented to the common stockholders
of the Corporation.

2. The Corporation shall be entitled to treat the person in whose
name any share of its stock is registered as the owner thereof for all purposes
and shall not be bound to recognize any equitable or other claim to, or interest
in, such share on the part of any other person, whether or not the Corporation
shall have notice thereof, except as expressly provided by applicable law.

3. Subject to the prior rights of holders of all classes or series of
stock at the time outstanding having prior rights as to dividends, the holders
of the Common Stock shall be entitled to receive, when and as declared by the
Board of Directors, out of any assets of the Corporation legally available
therefor, such dividends as may be declared from time to time by the Board of
Directors.

4. Upon the liquidation, dissolution or winding up of the
Corporation, the assets of the Corporation shall be distributed as provided in
Section 2 of Article IV(C).

5. The Common Stock is not redeemable.

ARTICLE V

In furtherance of, and not in limitation of, the powers conferred by law,
the Board of Directors is expressly authorized and empowered to adopt, amend or
repeal the bylaws of the Corporation.

ARTICLE VI

Elections of directors need not be by written ballot unless otherwise
provided in the Bylaws of the Corporation.

ARTICLE VII

(A) To the fullest extent permitted by the Delaware General Corporation
Law, as the same exists or as may hereafter be amended, a director of the
Corporation shall not be personally liable to the Corporation or its
<PAGE>

stockholders for monetary damages for breach of fiduciary duty as a director.

(B) The Corporation shall indemnify to the fullest extent permitted by law
any person made or threatened to be made a party to an action or proceeding,
whether criminal, civil, administrative or investigative, by reason of the fact
that he, his testator or intestate is or was a director or officer of the
Corporation or any predecessor of the Corporation, or serves or served at any
other enterprise as a director or officer at the request of the Corporation or
any predecessor to the Corporation.

(C) Neither any amendment nor repeal of this Article VII, nor the adoption
of any provision of the Corporation's Certificate of Incorporation inconsistent
with this Article VII, shall eliminate or reduce the effect of this Article VII
in respect of any matter occurring, or any action or proceeding accruing or
arising or that, but for this Article VII, would accrue or arise, prior to such
amendment, repeal or adoption of an inconsistent provision.

* * *
<PAGE>

The foregoing Sixth Amended and Restated Certificate of Incorporation,
which both amends and restates the Certificate of Incorporation of the
Corporation, as heretofore amended and restated, has been duly adopted by the
corporation's Board of Directors and stockholders in accordance with the
applicable provisions of Sections 242 and 245, and by written consent of
stockholders pursuant to Section 228, of the General Corporation Law of the
State of Delaware.

Executed at Bellevue, Washington on July 6, 1999.

/s/ Peter M. Neupert
______________________________
Peter M. Neupert, President

/s/ Mark L. Silverman
______________________________
Mark L. Silverman, Secretary

<PAGE>

EXHIBIT 10.12

DRUGSTORE.COM, INC.

FOURTH AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT

May 19, 1999
<PAGE>

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
1. Registration Rights.......................................................... 1
1.1 Definitions........................................................... 1
1.2 Request for Registration.............................................. 3
1.3 Company Registration.................................................. 4
1.4 Form S-3 Registration................................................. 4
1.5 Obligations of the Company............................................ 5
1.6 Furnish Information................................................... 7
1.7 Expenses of Registration.............................................. 7
1.8 Underwriting Requirements............................................. 8
1.9 Delay of Registration................................................. 9
1.10 Indemnification....................................................... 9
1.11 Reports Under Securities Exchange Act of 1934......................... 11
1.12 Assignment of Registration Rights..................................... 12
1.13 Limitations on Subsequent Registration Rights......................... 12
1.14 Market Stand-Off Agreement............................................ 12
1.15 Termination of Registration Rights.................................... 13
2. Covenants of the Company..................................................... 13
2.1 Delivery of Financial Statements...................................... 13
2.2 Inspection............................................................ 14
2.3 Right of First Offer.................................................. 14
2.4 Employee Confidential Information and Invention Assignment Agreements. 15
2.5 Termination of Covenants.............................................. 15
3. Standstill Agreement......................................................... 15
3.1 No Increase of Ownership Interest..................................... 16
3.1 Notice of Voting Securities Purchases................................. 16
3.3 Acts in Concert with Others........................................... 16
3.4 Termination of Standstill Agreement................................... 16
3.5 Permitted Transaction................................................. 17
4. Sales by Amazon.com and Kleiner Perkins Caufield & Byers..................... 17
4.1 Right of First Refusal................................................ 17
4.2 Assignment of Right of First Refusal.................................. 18
4.3 Permitted Transactions................................................ 19
4.4 Prohibited Transfers.................................................. 19
4.5 Legended Certificates................................................. 19
4.6 Termination of Right of First Refusal................................. 19
5. Miscellaneous................................................................ 20
5.1 Successors and Assigns................................................ 20
5.2 Amendments and Waivers................................................ 20
5.3 Notices............................................................... 20
5.4 Severability.......................................................... 20
</TABLE>
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<PAGE>

<TABLE>
<S> <C>
5.5 Governing Law......................................................... 20
5.6 Counterparts.......................................................... 20
5.7 Titles and Subtitles.................................................. 21
5.8 Aggregation of Stock.................................................. 21
</TABLE>
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<PAGE>

DRUGSTORE.COM, INC.

FOURTH AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT

This Fourth Amended and Restated Investors' Rights Agreement (the
"Agreement") is made as of the 19th day of May, 1999 by and among drugstore.com,
inc., a Delaware corporation (the "Company") and the investors listed on Exhibit
A hereto (the "Investors") and terminates and supersedes in all respects that
certain Third Amended and Restated Investors' Rights Agreement dated January 29,
1999, by and among the Company and certain of the Investors (the "Prior
Agreement").

RECITALS

A. The Company and certain of the Investors have entered into a Series D
Preferred Stock and Convertible Note Purchase Agreement (the "Purchase
Agreement") of even date herewith pursuant to which the Company will sell to
such Investors and such Investors will purchase from the Company shares of the
Company's Series D Preferred Stock. In connection with entering into the
Purchase Agreement, the Company and the Investors wish to enter into this
Agreement in order to provide the Investors with (i) certain rights to register
shares of the Company's Common Stock issuable upon conversion of the Series A,
Series B, Series C, and Series D Preferred Stock held by the Investors, (ii)
certain rights to receive and inspect information pertaining to the Company,
(iii) a right of first offer with respect to certain issuances by the Company of
its securities, and (iv) certain other covenants by the Company. The Company
and the Investors who were parties to the prior Agreement desire to induce the
Investors to purchase shares of Series D Preferred Stock pursuant to the
Purchase Agreement by agreeing to the terms and conditions set forth herein.

B. Pursuant to Section 5.2 of the Prior Agreement, this Agreement is being
executed by the Company and the holders of at least two-thirds (2/3) of the
Registrable Securities (as defined in the Prior Agreement) then outstanding,
thereby agreeing that the Prior Agreement be terminated and superseded and
replaced in its entirety by this Agreement.

AGREEMENT

The parties hereby agree as follows:

1. Registration Rights. The Company and the Investors covenant and
agree as follows:

1.1 Definitions. For purposes of this Section 1:

(a) The terms "register," "registered," and "registration"
refer to a registration effected by preparing and filing a registration
statement or similar document in compliance with the Securities Act of 1933, as
amended (the "Securities Act"), and the declaration or ordering of effectiveness
of such registration statement or document;
<PAGE>

(b) The term "Registrable Securities" means (i) the shares
of Common Stock issuable or issued upon conversion of the Series A Preferred
Stock, the Series B Preferred Stock, the Series C Preferred Stock and the Series
D Preferred Stock, (ii) shares of Common Stock issued or issuable upon
conversion of Series A, Series B, Series C or Series D Preferred Stock issued or
issuable upon exercise of warrants to purchase Series A, Series B, Series C or
Series D Preferred Stock issued to financial institutions or lessors in
connection with commercial credit arrangements, equipment financings or similar
transactions approved in each case by the Board of Directors of the Company,
which entities execute a counterpart signature page hereto and agree to be bound
by the terms hereof, (iii) shares of Common Stock issued or issuable upon
conversion of Series A, Series B, Series C or Series D Preferred Stock issued or
issuable upon exercise of warrants to purchase Series A, Series B, Series C or
Series D Preferred Stock issued to providers of products or technologies (or
rights thereto) to the Company, if such issuance is approved by the Board of
Directors of the Company, which entities execute a counterpart signature page
hereto and agree to be bound by the terms hereof; (iv) shares of Series D
Preferred Stock issued or issuable upon conversion of the Convertible Promissory
Notes issued pursuant to the Purchase Agreement, and (v) any other shares of
Common Stock of the Company issued as (or issuable upon the conversion or
exercise of any warrant, right or other security which is issued as) a dividend
or other distribution with respect to, or in exchange for or in replacement of,
the shares listed in (i), (ii), (iii) and (iv); provided, however, that the
foregoing definition shall exclude in all cases any Registrable Securities sold
by a person in a transaction in which his or her rights under this Agreement are
not assigned. Notwithstanding the foregoing, Common Stock or other securities
shall only be treated as Registrable Securities if and so long as they have not
been (A) sold to or through a broker or dealer or underwriter in a public
distribution or a public securities transaction, or (B) sold in a transaction
exempt from the registration and prospectus delivery requirements of the
Securities Act under Section 4(1) thereof so that all transfer restrictions, and
restrictive legends with respect thereto, if any, are removed upon the
consummation of such sale;

(c) The number of shares of "Registrable Securities then
outstanding" shall be determined by the number of shares of Common Stock
outstanding which are, and the number of shares of Common Stock issuable
pursuant to then exercisable or convertible securities which are, Registrable
Securities;

(d) The term "Holder" means any person owning or having the
right to acquire Registrable Securities or any assignee thereof in accordance
with Section 1.12 of this Agreement;

(e) The term "Form S-3" means such form under the
Securities Act as in effect on the date hereof or any successor form under the
Securities Act;

(f) The term "SEC" means the Securities and Exchange
Commission; and

(g) The term "Qualified IPO" means an underwritten public
offering by the Company of shares of its Common Stock pursuant to a registration
statement under the

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<PAGE>

Securities Act, which results in gross proceeds in excess of $15,000,000 and the
public offering price of which is at least $10.00 per share (appropriately
adjusted for any stock split, dividend, combination or other recapitalization).

1.2 Request for Registration.

(a) If the Company shall receive at any time after the earlier
of (i) June 22, 2003, or (ii) six (6) months after the effective date of the
first registration statement for a public offering of securities of the Company
(other than a registration statement on Form S-4, S-8 or any successor thereto),
a written request from the Holders of at least thirty-three percent (33%) of the
Registrable Securities then outstanding that the Company file a registration
statement under the Securities Act covering the registration of Registrable
Securities, then the Company shall, within fifteen (15) days of the receipt
thereof, give written notice of such request to all Holders and shall, subject
to the limitations of subsection 1.2(b), use its best efforts to effect as soon
as practicable, and in any event within 90 days of the receipt of such request,
the registration under the Securities Act of all Registrable Securities which
the Holders request to be registered within ten (10) days of the mailing of such
notice by the Company in accordance with Section 5.3.

(b) If the Holders initiating the registration request hereunder
("Initiating Holders") intend to distribute the Registrable Securities covered
by their request by means of an underwriting, they shall so advise the Company
as a part of their request made pursuant to this Section 1.2 and the Company
shall include such information in the written notice referred to in subsection
1.2(a). The underwriter will be selected by a majority in interest of the
Initiating Holders and shall be reasonably acceptable to the Company. In such
event, the right of any Holder to include his Registrable Securities in such
registration shall be conditioned upon such Holder's participation in such
underwriting and the inclusion of such Holder's Registrable Securities in the
underwriting (unless otherwise mutually agreed by a majority in interest of the
Initiating Holders and such Holder) to the extent provided herein. All Holders
proposing to distribute their securities through such underwriting shall
(together with the Company as provided in subsection 1.5(e)) enter into an
underwriting agreement in customary form with the underwriter or underwriters
selected for such underwriting. Notwithstanding any other provision of this
Section 1.2, if the underwriter advises the Initiating Holders in writing that
marketing factors require a limitation of the number of shares to be
underwritten, then the Initiating Holders shall so advise all Holders of
Registrable Securities which would otherwise be underwritten pursuant hereto,
and the number of shares of Registrable Securities that may be included in the
underwriting shall be allocated among all Holders thereof, including the
Initiating Holders, in proportion (as nearly as practicable) to the amount of
Registrable Securities of the Company owned by each Holder; provided, however,
that the number of shares of Registrable Securities to be included in such
underwriting shall not be reduced unless all other securities are first entirely
excluded from the underwriting.

(c) Notwithstanding the foregoing, if the Company shall furnish
to Holders requesting a registration statement pursuant to this Section 1.2, a
certificate signed by the President of the Company stating that in the good
faith judgment of the Board of Directors of

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<PAGE>

the Company, it would be seriously detrimental to the Company and its
stockholders for such registration statement to be filed and it is therefore
essential to defer the filing of such registration statement, the Company shall
have the right to defer such filing for a period of not more than 120 days after
receipt of the request of the Initiating Holders; provided, however, that the
Company may not utilize this right more than once in any twelve-month period.

(d) In addition, the Company shall not be obligated to effect,
or to take any action to effect, any registration pursuant to this Section 1.2:

(i) After the Company has effected two (2) registrations
pursuant to this Section 1.2 and such registrations have been declared or
ordered effective;

(ii) During the period starting with the date sixty (60)
days prior to the Company's good faith estimate of the date of filing of, and
ending on a date one hundred eighty (180) days after the effective date of, a
registration subject to Section 1.3 hereof; provided that the Company is
actively employing in good faith all reasonable efforts to cause such
registration statement to become effective;

(iii) If the anticipated aggregate offering price to the
public would not be in excess of $5,000,000; or

(iv) If the Initiating Holders propose to dispose of shares
of Registrable Securities that may be immediately registered on Form S-3
pursuant to a request made pursuant to Section 1.4 below.

1.3 Company Registration. If (but without any obligation to do so)
the Company proposes to register (including for this purpose a registration
effected by the Company for stockholders other than the Holders) any of its
stock under the Securities Act in connection with the public offering of such
securities solely for cash (other than a registration on Form S-4, Form S-8 or
any successors thereto, a registration in which the only stock being registered
is Common Stock issuable upon conversion of debt securities which are also being
registered, or any registration on any form which does not include substantially
the same information as would be required to be included in a registration
statement covering the sale of the Registrable Securities), the Company shall,
at such time, promptly give each Holder written notice of such registration.
Upon the written request of each Holder given within fifteen (15) days after
mailing of such notice by the Company in accordance with Section 5.3, the
Company shall, subject to the provisions of Section 1.8, cause to be registered
under the Securities Act all of the Registrable Securities that each such Holder
has requested to be registered.

1.4 Form S-3 Registration. In case the Company shall receive a
written request or requests (i) from any Holder or Holders of at least twenty
percent (20%) of the Registrable Securities then outstanding (other than Vulcan
Ventures Incorporated ("Vulcan")) or (ii) from Vulcan, provided Vulcan then
holds Registrable Securities with an aggregate offering price of at least $40
million, that, in each case, the Company effect a registration on Form S-3 and
any related qualification or compliance with respect to all or a part of the
Registrable Securities owned by such Holder or Holders, the Company will:

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<PAGE>

(a) promptly give written notice of the proposed registration,
and any related qualification or compliance, to all other Holders; and

(b) as soon as practicable, effect such registration and all
such qualifications and compliances as may be so requested and as would permit
or facilitate the sale and distribution of all or such portion of such Holder's
or Holders' Registrable Securities as are specified in such request, together
with all or such portion of the Registrable Securities of any other Holder or
Holders joining in such request as are specified in a written request given
within fifteen (15) days after receipt of such written notice from the Company;
provided, however, that the Company shall not be obligated to effect any such
registration, qualification or compliance, pursuant to this Section 1.4: (i) if
Form S-3 is not available for such offering by the Holders; (ii) if the Holders
propose to sell Registrable Securities at an aggregate price to the public of
less than $500,000; (iii) if the Company shall furnish to the Holders a
certificate signed by the President of the Company stating that in the good
faith judgment of the Board of Directors of the Company, it would be seriously
detrimental to the Company and its stockholders for such Form S-3 Registration
to be effected at such time, in which event the Company shall have the right to
defer the filing of the Form S-3 registration statement for a period of not more
than 120 days after receipt of the request of the Holder or Holders under this
Section 1.4; provided, however, that the Company shall not utilize this right
more than once in any twelve month period; (iv) if the Company has, within the
twelve (12) month period preceding the date of such request, already effected
two registrations on Form S-3 for the Holders pursuant to this Section 1.4; (v)
in any particular jurisdiction in which the Company would be required to qualify
to do business or to execute a general consent to service of process in
effecting such registration, qualification or compliance; or (vi) during the
period ending one hundred eighty (180) days after the effective date of a
registration statement subject to Section 1.3.

(c) Subject to the foregoing, the Company shall file a
registration statement covering the Registrable Securities and other securities
so requested to be registered as soon as practicable after receipt of the
request or requests of the Holders. Registrations effected pursuant to this
Section 1.4 shall not be counted as demands for registration or registrations
effected pursuant to Sections 1.2 or 1.3, respectively.

1.5 Obligations of the Company. Whenever required under this Section
1 to effect the registration of any Registrable Securities, the Company shall,
as expeditiously as reasonably possible:

(a) Prepare and file with the SEC a registration statement with
respect to such Registrable Securities and use all reasonable efforts to cause
such registration statement to become effective, and, upon the request of the
Holders of a majority of the Registrable Securities registered thereunder, keep
such registration statement effective for up to one hundred twenty (120) days.
The Company shall not be required to file, cause to become effective or maintain
the effectiveness of any registration statement (other than a registration
statement on Form S-3 pursuant to Section 1.4) that contemplates a distribution
of securities on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act.

-5-
<PAGE>

(b) Prepare and file with the SEC such amendments and
supplements to such registration statement and the prospectus used in connection
with such registration statement as may be necessary to comply with the
provisions of the Securities Act with respect to the disposition of all
securities covered by such registration statement for up to one hundred twenty
(120) days.

(c) Furnish to the Holders such numbers of copies of a
prospectus, including a preliminary prospectus, in conformity with the
requirements of the Securities Act, and such other documents as they may
reasonably request in order to facilitate the disposition of Registrable
Securities owned by them.

(d) Use its best efforts to register and qualify the securities
covered by such registration statement under such other securities or Blue Sky
laws of such jurisdictions as shall be reasonably requested by the Holders,
provided that the Company shall not be required in connection therewith or as a
condition thereto to qualify to do business or to file a general consent to
service of process in any such states or jurisdictions.

(e) In the event of any underwritten public offering, enter into
and perform its obligations under an underwriting agreement, in usual and
customary form, with the managing underwriter of such offering. Each Holder
participating in such underwriting shall also enter into and perform its
obligations under such an agreement.

(f) Notify each Holder of Registrable Securities covered by such
registration statement at any time when a prospectus relating thereto is
required to be delivered under the Securities Act of the happening of any event
as a result of which the prospectus included in such registration statement, as
then in effect, includes an untrue statement of a material fact or omits to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading in the light of the circumstances then
existing, such obligation to continue for one hundred twenty (120) days.

(g) Cause all such Registrable Securities registered pursuant
hereunder to be listed on each securities exchange or market on which similar
securities issued by the Company are then listed.

(h) Provide a transfer agent and registrar for all Registrable
Securities registered pursuant hereunder and a CUSIP number for all such
Registrable Securities, in each case not later than the effective date of such
registration.

(i) Use its best efforts to furnish, at the request of any
Holder requesting registration of Registrable Securities pursuant to this
Section 1, on the date that such Registrable Securities are delivered to the
underwriters for sale in connection with a registration pursuant to this Section
1, if such securities are being sold through underwriters, or, if such
securities are not being sold through underwriters, on the date that the
registration statement with respect to such securities becomes effective, (i) an
opinion, dated such date, of the counsel representing the Company for the
purposes of such registration, in form and substance as is customarily given to
underwriters in an underwritten public offering, addressed to the

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<PAGE>

underwriters, if any, and to the Holders requesting registration of Registrable
Securities and (ii) a letter dated such date, from the independent certified
public accountants of the Company, in form and substance as is customarily given
by independent certified public accountants to underwriters in an underwritten
public offering, addressed to the underwriters, if any, and to the Holders
requesting registration of Registrable Securities.

1.6 Furnish Information. It shall be a condition precedent to the
obligations of the Company to take any action pursuant to this Section 1 with
respect to the Registrable Securities of any selling Holder that such Holder
shall furnish to the Company such information regarding itself, the Registrable
Securities held by it, and the intended method of disposition of such securities
as shall be required to effect the registration of such Holder's Registrable
Securities. The Company shall have no obligation with respect to any
registration requested pursuant to Section 1.2 or Section 1.4 of this Agreement
if, as a result of the application of the preceding sentence, the number of
shares or the anticipated aggregate offering price of the Registrable Securities
to be included in the registration does not equal or exceed the number of shares
or the anticipated aggregate offering price required to originally trigger the
Company's obligation to initiate such registration as specified in subsection
1.2(a) or subsection 1.4(b)(2), whichever is applicable.

1.7 Expenses of Registration.

(a) Demand Registration. All expenses (other than underwriting
discounts and commissions, stock transfer taxes and fees of counsel to the
selling Holders in addition to that provided below) incurred in connection with
registrations, filings or qualifications pursuant to Section 1.2, including
(without limitation) all registration, filing and qualification fees, printers'
and accounting fees, fees and disbursements of counsel for the Company, and the
reasonable fees and disbursements of one counsel for the selling Holders
selected by them with the approval of the Company, which approval shall not be
unreasonably withheld, shall be borne by the Company; provided, however, that
the Company shall not be required to pay for any expenses of any registration
proceeding begun pursuant to Section 1.2 if the registration request is
subsequently withdrawn at the request of the Holders of a majority of the
Registrable Securities to be registered (in which case all participating Holders
shall bear such expenses), unless the Holders of a majority of the Registrable
Securities agree to forfeit their right to one demand registration pursuant to
Section 1.2; provided further, however, that if at the time of such withdrawal,
the Holders have learned of a material adverse change in the condition,
business, or prospects of the Company from that known or reasonably foreseeable
to the Holders at the time of their request and have withdrawn the request with
reasonable promptness following disclosure by the Company of such material
adverse change, then the Holders shall not be required to pay any of such
expenses and shall retain their rights pursuant to Section 1.2.

(b) Company Registration. All expenses (other than underwriting
discounts and commissions, stock transfer taxes and fees of counsel to the
selling Holders in addition to that provided below) incurred in connection with
registrations, filings or qualifications of Registrable Securities pursuant to
Section 1.3 for each Holder, including (without limitation) all registration,
filing, and qualification fees, printers' and accounting fees,

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<PAGE>

fees and disbursements of counsel for the Company, and the reasonable fees and
disbursements of one counsel for the selling Holders selected by them with the
approval of the Company, which approval shall not be unreasonably withheld,
shall be borne by the Company.

(c) Registration on Form S-3. All expenses (other than
underwriting discounts and commissions, stock transfer taxes and fees of counsel
to the selling Holders in addition to that provided below) incurred in
connection with a registration requested pursuant to Section 1.4, including
(without limitation) all registration, filing, qualification, printers' and
accounting fees and the reasonable fees and disbursements of one counsel for the
selling Holder or Holders selected by them with the approval of the Company,
which approval shall not be unreasonably withheld, and counsel for the Company
shall be borne by the Company.

(d) Underwriting Discounts and Commissions. All underwriting
discounts and commissions incurred in connection with registrations in
connection with each registration statement under Section 1 shall be borne by
the participating sellers (and the Company, if the Company is a seller) in
proportion to the number of shares sold by each, or as they otherwise may agree.

1.8 Underwriting Requirements. In connection with any offering
involving an underwriting of shares of the Company's capital stock, the Company
shall not be required under Section 1.3 to include any of the Holders'
securities in such underwriting unless they accept the terms of the underwriting
as agreed upon between the Company and the underwriters selected by it (or by
other persons entitled to select the underwriters), and then only in such
quantity as the underwriters determine in their sole discretion will not
jeopardize the success of the offering by the Company. If the total amount of
securities, including Registrable Securities, requested by Holders to be
included in such offering exceeds the amount of securities sold other than by
the Company that the underwriters determine in their sole discretion is
compatible with the success of the offering, then the Company shall be required
to include in the offering only that number of such securities, including
Registrable Securities, which the underwriters determine in their sole
discretion will not jeopardize the success of the offering (the securities so
included to be apportioned pro rata among the selling stockholders according to
the total amount of securities entitled to be included therein owned by each
selling stockholder or in such other proportions as shall mutually be agreed to
by such selling stockholders) but in no event shall the amount of securities of
the selling Holders included in the offering be reduced below thirty percent
(30%) of the total amount of securities included in such offering, unless such
offering is the initial public offering of the Company's securities, in which
case, the selling stockholders may be excluded if the underwriters make the
determination described above and no other stockholder's securities are
included. For purposes of the preceding parenthetical concerning apportionment,
for any selling stockholder which is a holder of Registrable Securities and
which is a partnership or corporation, the partners, retired partners and
stockholders of such holder, or the estates and family members of any such
partners and retired partners and any trusts for the benefit of any of the
foregoing persons shall be deemed to be a single "selling stockholder," and any
pro-rata reduction with respect to such "selling stockholder" shall be based
upon the aggregate amount of shares carrying registration rights owned by all
entities and individuals included in such "selling stockholder," as defined in
this sentence.

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<PAGE>

1.9 Delay of Registration. No Holder shall have any right to obtain
or seek an injunction restraining or otherwise delaying any such registration as
the result of any controversy that might arise with respect to the
interpretation or implementation of this Section 1.

1.10 Indemnification. In the event any Registrable Securities are
included in a registration statement under this Section 1:

(a) To the extent permitted by law, the Company will indemnify
and hold harmless each Holder, any underwriter (as defined in the Securities
Act) for such Holder each person, if any, who controls such Holder or
underwriter within the meaning of the Securities Act or the Securities Exchange
Act of 1934, as amended (the "Exchange Act") and the partners, officers and
directors of any such Holder, against any losses, claims, damages, or
liabilities (joint or several) to which they may become subject under the
Securities Act, the Exchange Act or other federal or state law, insofar as such
losses, claims, damages, or liabilities (or actions in respect thereof) arise
out of or are based upon any of the following statements, omissions or
violations (collectively a "Violation"): (i) any untrue statement or alleged
untrue statement of a material fact contained in such registration statement,
including any preliminary prospectus or final prospectus contained therein or
any amendments or supplements thereto, (ii) the omission or alleged omission to
state therein a material fact required to be stated therein, or necessary to
make the statements therein not misleading, or (iii) any violation or alleged
violation by the Company of the Securities Act, the Exchange Act, any state
securities law or any rule or regulation promulgated under the Securities Act,
the Exchange Act or any state securities law; and the Company will pay to each
such Holder, underwriter or controlling person, as incurred, any legal or other
expenses reasonably incurred by them in connection with investigating or
defending any such loss, claim, damage, liability, or action; provided, however,
that the indemnity agreement contained in this subsection 1.10(a) shall not
apply to amounts paid in settlement of any such loss, claim, damage, liability,
or action if such settlement is effected without the consent of the Company
(which consent shall not be unreasonably withheld), nor shall the Company be
liable to any Holder, underwriter or controlling person for any such loss,
claim, damage, liability, or action to the extent that it arises out of or is
based upon a Violation which occurs in reliance upon and in conformity with
written information furnished expressly for use in connection with such
registration by any such Holder, underwriter or controlling person.

(b) To the extent permitted by law, each selling Holder will
indemnify and hold harmless the Company, each of its directors, each of its
officers who has signed the registration statement, each person, if any, who
controls the Company within the meaning of the Securities Act, any underwriter,
any other Holder selling securities in such registration statement and any
controlling person of any such underwriter or other Holder, against any losses,
claims, damages, or liabilities (joint or several) to which any of the foregoing
persons may become subject, under the Securities Act, the Exchange Act or other
federal or state law, insofar as such losses, claims, damages, or liabilities
(or actions in respect thereto) arise out of or are based upon any Violation, in
each case to the extent (and only to the extent) that such Violation occurs in
reliance upon and in conformity with written information furnished by such
Holder expressly for use in connection with such registration; and each such
Holder will pay, as incurred, any legal or

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other expenses reasonably incurred by any person intended to be indemnified
pursuant to this subsection 1.10(b), in connection with investigating or
defending any such loss, claim, damage, liability, or action; provided, however,
that the indemnity agreement contained in this subsection 1.10(b) shall not
apply to amounts paid in settlement of any such loss, claim, damage, liability
or action if such settlement is effected without the consent of the Holder,
which consent shall not be unreasonably withheld; provided, that in no event
shall any indemnity under this subsection 1.10(b) exceed the net proceeds from
the offering received by such Holder, except in the case of willful fraud by
such Holder.

(c) Promptly after receipt by an indemnified party under this
Section 1.10 of notice of the commencement of any action (including any
governmental action), such indemnified party will, if a claim in respect thereof
is to be made against any indemnifying party under this Section 1.10, deliver to
the indemnifying party a written notice of the commencement thereof and the
indemnifying party shall have the right to participate in, and, to the extent
the indemnifying party so desires, jointly with any other indemnifying party
similarly noticed, to assume the defense thereof with counsel mutually
satisfactory to the parties; provided, however, that an indemnified party
(together with all other indemnified parties which may be represented without
conflict by one counsel) shall have the right to retain one separate counsel,
with the reasonable fees and expenses to be paid by the indemnifying party, if
representation of such indemnified party by the counsel retained by the
indemnifying party would be inappropriate due to actual or potential differing
interests between such indemnified party and any other party represented by such
counsel in such proceeding. The failure to deliver written notice to the
indemnifying party within a reasonable time of the commencement of any such
action, if prejudicial to its ability to defend such action, shall relieve such
indemnifying party of any liability to the indemnified party under this Section
1.10, but the omission so to deliver written notice to the indemnifying party
will not relieve it of any liability that it may have to any indemnified party
otherwise than under this Section 1.10.

(d) If the indemnification provided for in this Section 1.10 is
held by a court of competent jurisdiction to be unavailable to an indemnified
party with respect to any loss, liability, claim, damage or expense referred to
therein, then the indemnifying party, in lieu of indemnifying such indemnified
party hereunder, shall contribute to the amount paid or payable by such
indemnified party as a result of such loss, liability, claim, damage, or expense
in such proportion as is appropriate to reflect the relative fault of the
indemnifying party on the one hand and of the indemnified party on the other in
connection with the statements or omissions that resulted in such loss,
liability, claim, damage or expense as well as any other relevant equitable
considerations; provided, that in no event shall any contribution by a Holder
under this Subsection 1.10(d) exceed the net proceeds from the offering received
by such Holder, except in the case of willful fraud by such Holder. The relative
fault of the indemnifying party and of the indemnified party shall be determined
by reference to, among other things, whether the untrue or alleged untrue
statement of a material fact or the omission to state a material fact relates to
information supplied by the indemnifying party or by the indemnified party and
the parties' relative intent, knowledge, access to information, and opportunity
to correct or prevent such statement or omission.

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<PAGE>

(e) Notwithstanding the foregoing, to the extent that the
provisions on indemnification and contribution contained in the underwriting
agreement entered into in connection with the underwritten public offering are
in conflict with the foregoing provisions, the provisions in the underwriting
agreement shall control.

(f) The obligations of the Company and Holders under this
Section 1.10 shall survive the completion of any offering of Registrable
Securities in a registration statement under this Section 1, and otherwise.

1.11 Reports Under Securities Exchange Act of 1934. With a view to
making available to the Holders the benefits of Rule 144 promulgated under the
Securities Act and any other rule or regulation of the SEC that may at any time
permit a Holder to sell securities of the Company to the public without
registration or pursuant to a registration on Form S-3, the Company agrees to:

(a) make and keep public information available, as those terms
are understood and defined in SEC Rule 144, at all times after ninety (90) days
after the effective date of the first registration statement filed by the
Company for the offering of its securities to the general public so long as the
Company remains subject to the periodic reporting requirements under Sections 13
or 15(d) of the Exchange Act;

(b) take such action, including the voluntary registration of
its Common Stock under Section 12 of the Exchange Act, as is necessary to enable
the Holders to utilize Form S-3 for the sale of their Registrable Securities,
such action to be taken as soon as practicable after the end of the fiscal year
in which the first registration statement filed by the Company for the offering
of its securities to the general public is declared effective;

(c) file with the SEC in a timely manner all reports and other
documents required of the Company under the Securities Act and the Exchange Act;
and

(d) furnish to any Holder, so long as the Holder owns any
Registrable Securities, forthwith upon request (i) a written statement by the
Company that it has complied with the reporting requirements of SEC Rule 144 (at
any time after ninety (90) days after the effective date of the first
registration statement filed by the Company), the Securities Act and the
Exchange Act (at any time after it has become subject to such reporting
requirements), or that it qualifies as a registrant whose securities may be
resold pursuant to Form S-3 (at any time after it so qualifies), (ii) a copy of
the most recent annual or quarterly report of the Company and such other reports
and documents so filed by the Company, and (iii) such other information as may
be reasonably requested in availing any Holder of any rule or regulation of the
SEC which permits the selling of any such securities without registration or
pursuant to such form.

1.12 Assignment of Registration Rights. The rights to cause the
Company to register Registrable Securities pursuant to this Section 1 may be
assigned (but only with all related obligations) by a Holder to a transferee or
assignee of at least 1,000,000 shares of such securities (appropriately adjusted
for any stock split, stock dividend, or other recapitalization) or to a partner
or affiliate (within the meaning of Rule 12b-2 of the Exchange Act) of the
Holder,

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provided that (i) the Company is, promptly after such transfer, furnished with
written notice of the name and address of such transferee or assignee and the
securities with respect to which such registration rights are being assigned;
(ii) the transferee or assignee agrees to be bound by the terms and conditions
of this Agreement; and (iii) such assignment shall be effective only if
immediately following such transfer the further disposition of such securities
by the transferee or assignee is restricted under the Securities Act.
Notwithstanding the limitations set forth in the foregoing sentence regarding
the minimum number of shares that must be transferred, any Holder that is a
corporation may transfer such Holder's registration rights to its wholly-owned
subsidiaries without restriction as to the number of shares transferred.

1.13 Limitations on Subsequent Registration Rights. Except as
provided in Section 1.1(b) and Section 5.9, from and after the date of this
Agreement, the Company shall not, without the prior written consent of the
Holders of a majority of the outstanding Registrable Securities, enter into any
agreement with any holder or prospective holder of any securities of the Company
which would allow such holder or prospective holder (a) to include such
securities in any registration filed under Section 1.2 hereof, unless under the
terms of such agreement, such holder or prospective holder may include such
securities in any such registration only to the extent that the inclusion of his
securities will not reduce the amount of the Registrable Securities of the
Holders which is included or (b) to make a demand registration which could
result in such registration statement being declared effective prior to the
earlier of either of the dates set forth in subsection 1.2(a) or within one
hundred twenty (120) days of the effective date of any registration effected
pursuant to Section 1.2.

1.14 "Market Stand-Off" Agreement. Each Holder hereby agrees that,
during the period of duration (up to, but not exceeding, 180 days) specified by
the Company and an underwriter of Common Stock or other securities of the
Company, following the effective date of a registration statement of the Company
filed under the Securities Act, it shall not, to the extent requested by the
Company and such underwriter, directly or indirectly sell, offer to sell,
contract to sell (including, without limitation, any short sale), grant any
option to purchase or otherwise transfer or dispose of (other than to donees who
agree to be similarly bound) any securities of the Company held by it at any
time during such period except Common Stock included in such registration;
provided, however, that:

(a) such agreement shall be applicable to the first such
registration statement of the Company which covers Common Stock (or other
securities) to be sold on its behalf to the public in an underwritten offering;
and

(b) all officers and directors of the Company, and all holders
of one percent or more of the Company's outstanding Common Stock (including
shares issuable upon conversion of Preferred Stock) enter into similar
agreements.

In order to enforce the foregoing covenant, the Company may impose
stop-transfer instructions with respect to the Registrable Securities of each
Holder (and the shares or securities of every other person subject to the
foregoing restriction) until the end of such period, and each Holder agrees
that, if so requested, such Holder will execute an agreement in the form

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provided by the underwriter containing terms which are essentially consistent
with the provisions of this Section 1.14.

Notwithstanding the foregoing, the obligations described in this
Section 1.14 shall not apply to a registration relating solely to employee
benefit plans on Form S-1 or Form S-8 or similar forms which may be promulgated
in the future, or a registration relating solely to a transaction on Form S-4 or
similar forms which may be promulgated in the future.

1.15 Termination of Registration Rights. No Holder shall be entitled
to exercise any right provided for in this Section 1 after the earlier of (i)
five (5) years following the consummation of a Qualified IPO, or (ii) such time
as Rule 144 or another similar exemption under the Securities Act is available
for the sale of all of such Holder's shares during a three-month period without
registration.

2. Covenants of the Company.

2.1 Delivery of Financial Statements. The Company shall deliver to
each Holder of at least 1,500,000 shares of Registrable Securities:

(a) as soon as practicable, but in any event within one hundred
twenty (120) days after the end of each fiscal year of the Company, an income
statement for such fiscal year, a balance sheet of the Company and statement of
stockholder's equity as of the end of such year, and a statement of cash flows
for such year, such year-end financial reports to be in reasonable detail,
prepared in accordance with generally accepted accounting principles ("GAAP"),
and audited and certified by an independent public accounting firm of nationally
recognized standing selected by the Company or otherwise reasonably acceptable
to Holders of a majority of the Registrable Securities then outstanding;

(b) within forty-five (45) days of the end of each quarter, an
unaudited income statement and a statement of cash flows and balance sheet for
and as of the end of such quarter, in reasonable detail; and

(c) as soon as practicable, but in any event at least fifteen
(15) days prior to the end of each fiscal year, an operating budget and business
plan for the next fiscal year.

2.2 Inspection. The Company shall permit each Holder of at least
1,000,000 shares of Registrable Securities, at such Holder's expense, to visit
and inspect the Company's properties, to examine its books of account and
records and to discuss the Company's affairs, finances and accounts with its
officers, all at such reasonable times as may be requested by the Investor;
provided, however, that the Company shall not be obligated pursuant to this
Section 2.2 to provide access to any information which the Board of Directors
reasonably determines in good faith to be a trade secret or similar confidential
information.

2.3 Right of First Offer. Subject to the terms and conditions
specified in this Section 2.3, the Company hereby grants to each Major Investor
(as hereinafter defined) a right of first offer with respect to future sales by
the Company of its Shares (as hereinafter defined). For

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purposes of this Section 2.3, a "Major Investor" shall mean any person who holds
at least 1,000,000 shares of the Preferred Stock (or the Common Stock issued
upon conversion thereof). For purposes of this Section 2.3, Major Investor
includes any general partners and affiliates of a Major Investor. A Major
Investor who chooses to exercise the right of first offer may designate as
purchasers under such right itself or its partners or affiliates in such
proportions as it deems appropriate.

Each time the Company proposes to offer any shares of, or securities
convertible into or exercisable for any shares of, any class of its capital
stock ("Shares"), the Company shall first make an offering of such Shares to
each Major Investor in accordance with the following provisions:

(a) The Company shall deliver a notice by certified mail or
overnight courier ("Notice") to the Major Investors stating (i) its bona fide
intention to offer such Shares, (ii) the number of such Shares to be offered,
and (iii) the price and terms, if any, upon which it proposes to offer such
Shares.

(b) Within 15 calendar days after delivery of the Notice, each
Major Investor may elect to purchase or obtain, at the price and on the terms
specified in the Notice, up to that portion of such Shares which equals the
proportion that the number of shares of Common Stock issued and held, or
issuable upon conversion and exercise of all convertible or exercisable
securities then held, by such Major Investor bears to the total number of shares
of Common Stock then outstanding (assuming full conversion and exercise of all
convertible or exercisable securities).

(c) The Company may, during the 60-day period following the
expiration of the period provided in subsection 2.3(b) hereof, offer the
remaining unsubscribed portion of the Shares to any person or persons at a price
not less than, and upon terms no more favorable to the offeree than those
specified in the Notice. If the Company does not enter into an agreement for the
sale of the Shares within such period, or if such agreement is not consummated
within 60 days of the execution thereof, the right provided hereunder shall be
deemed to be revived and such Shares shall not be offered unless first reoffered
to the Major Investors in accordance herewith.

(d) The right of first offer in this paragraph 2.3 shall not be
applicable (i) to the issuance or sale of capital stock (or options therefor) to
employees, consultants, officers or directors of the Company pursuant to stock
purchase or stock option plans or agreements approved by the Board of Directors
of the Company (including options granted prior to the date hereof), (ii) to the
issuance of securities in connection with bona fide acquisitions, mergers or
similar transactions, (iii) to the issuance of securities to financial
institutions or lessors in connection with commercial credit arrangements,
equipment financings or similar transactions, (iv) to the issuance and sale of
the Series D Preferred Stock under the Purchase Agreement and the Common Stock
issued upon conversion of the Series A, Series B, Series C or Series D Preferred
Stock, (v) to the issuance of securities in a public offering of securities
pursuant to a registration statement filed under the Securities Act, (vi) to the
issuance of securities pursuant to

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the conversion or exercise of options, warrants, notes, or other rights to
acquire securities of the Company, or (vii) to the issuance of securities
pursuant to stock splits, stock dividends or like transactions.

2.4 Employee Confidential Information and Invention Assignment
Agreements. The Company will require that all future employees, consultants and
officers having access to proprietary information execute Confidential
Information and Invention Assignment Agreements substantially in the form
currently used by the Company and that such form may not be altered in a manner
adverse to the Company without the approval of the Company's President.

2.5 Termination of Covenants.

(a) The covenants set forth in Sections 2.1 through Section 2.3
shall terminate as to each Investor and be of no further force or effect (i)
upon the consummation of a Qualified IPO, or (ii) when the Company shall (A)
sell, convey, or otherwise dispose of all or substantially all of its property
or business or merge or consolidate with any other corporation (other than a
wholly-owned subsidiary corporation) where the stockholders of the Company own
less than fifty percent (50%) of the voting power of the surviving entity after
such merger or consolidation or (B) effect any other transaction or series of
related transactions in which more than fifty percent (50%) of the voting power
of the Company is disposed of, provided that this subsection (ii) shall not
apply to a merger effected exclusively for the purpose of changing the domicile
of the Company.

(b) The covenants set forth in Sections 2.1 and 2.2 shall
terminate as to each Holder and be of no further force or effect when the
Company first becomes subject to the periodic reporting requirements of Sections
13 or 15(d) of the Exchange Act, if this occurs earlier than the events
described in Section 2.5(a) above.

3. Standstill Agreement.

3.1 No Increase of Ownership Interest. At any time following the
date of this Agreement, except with the prior written consent of a majority of
the Company's Board of Directors (excluding the vote of any director(s)
appointed by the respective Investor or otherwise affiliated with such
Investor), no Major Investor, together with any persons or entities affiliated
with such Major Investor (collectively, the "Standstill Investor"), shall
acquire beneficial ownership (as defined in Rule 13d-3 of the Exchange Act) of
any securities of the Company entitled to vote with respect to the election of
any directors of the Company ("Voting Securities"), any security convertible
into, exchangeable for, or exercisable for, or that may become any Voting
Securities or any other right to acquire Voting Securities (such Voting
Securities and rights to acquire Voting Securities are collectively referred to
herein as "Securities"), if after such acquisition, the Voting Securities then
beneficially owned by the Standstill Investor represent more than the Standstill
Investor's Threshold Percentage (defined below) of the Company's then
outstanding Voting Securities (assuming the conversion, exchange and/or exercise
of all convertible, exchangeable and exercisable securities, including all

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securities reserved for issuance under the Company's stock plans); provided
however, that if at any time the Voting Securities beneficially owned by a
Standstill Investor shall represent less than or the same as the Standstill
Investor's Threshold Percentage, and, subsequently and solely as a result of the
Company's repurchases of Voting Securities or a recapitalization of all the
Company's capital stock, the Voting Securities beneficially owned by a
Standstill Investor shall then represent more than the Standstill Investor's
Threshold Percentage, then such Standstill Investor shall not be deemed in
violation of this Section 3.1 for so long as such Standstill Investor does not
purchase or acquire additional Voting Securities. For purposes of this
Agreement, the "Standstill Investor's Threshold Percentage" shall be equal to
40.0% for each Standstill Investor. Notwithstanding the foregoing, for purposes
of this Section 3.1 and for purposes of Sections 3.2, 3.3, 3.4 and 3.5 only,
Vulcan Ventures Incorporated shall not be considered a "Major Investor" and
shall not be deemed a "Standstill Investor".

3.2 Notice of Voting Securities Purchases. Each Standstill Investor
shall notify the Company as to any future acquisition of beneficial ownership of
Voting Securities, or rights thereto, within ten (10) business days after such
action in order for the Company to monitor compliance with the terms of this
Agreement.

3.3 Acts in Concert with Others. The Standstill Investor shall not
join a partnership, limited partnership, syndicate or other group, or otherwise
act in concert with any third person, for the purpose of acquiring any
Securities that would exceed such Standstill Investor's Threshold Percentage.

3.4 Termination of Standstill Agreement. The covenants set forth in
this Section 3 shall terminate as to each Standstill Investor on the earlier of
(i) August 10, 2002, or (ii) when the Company shall (A) sell, convey, or
otherwise dispose of all or substantially all of its property or business or
merge or consolidate with any other corporation (other than a wholly-owned
subsidiary corporation) where the stockholders of the Company own less than
fifty percent (50%) of the voting power of the surviving entity after such
merger or consolidation or (B) effect any other transaction or series of related
transactions in which more than fifty percent (50%) of the voting power of the
Company is disposed of, except in each case a merger effected exclusively for
the purpose of changing the domicile of the Company.

3.5 Permitted Transaction. Notwithstanding the provisions of this
Section 3, on and after the eleventh business day after the commencement of a
proxy contest, tender offer or exchange offer which could result in a "Change of
Control Transaction" (as defined below) for outstanding Securities or on or
after the public announcement that the Company has entered into an agreement
with a third party not affiliated with the Company that would result in a Change
of Control Transaction, the Standstill Investor shall be permitted to make a
proposal to the Company's Board of Directors or shareholders or to tender or
exchange any Securities beneficially owned by it pursuant to such transaction.
As used herein, "Change of Control Transaction" shall mean (A) any tender or
exchange offer, merger, consolidation, recapitalization or other business
combination or transaction pursuant to which either (i) the holders of the
outstanding voting power immediately prior to the transaction would hold less
than 50% of the outstanding voting power outstanding immediately after the
transaction or (ii)

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50% of the assets of the Company would be transferred to or controlled by a
third party not affiliated with the Company, except in each case a merger
effected exclusively for the purpose of changing the domicile of the Company, or
(B) any action by the shareholders of the Company that results in the directors,
who as of the date of Closing constitute the Company's Board of Directors (the
"Incumbent Board"), ceasing to constitute at least a majority of the Company's
Board of Directors; provided, however, that any individual becoming a director
subsequent to the date of Closing whose nomination for election by the
shareholders of the Company was approved by the vote of the Incumbent Board
shall be considered as though such individual were a member of the Incumbent
Board.

4. Sales by Amazon.com and Kleiner Perkins Caufield & Byers.

4.1 Right of First Refusal. Before any shares of the Company's
capital stock ("Stock") held by Amazon.com, Inc. ("Amazon.com") or Kleiner
Perkins Caufield & Byers VIII (including its affiliated funds) ("KPCB") (each a
"ROFR Investor") may be sold or otherwise transferred, the Company or its
permitted assignee under Section 4.2 shall have a right of first refusal to
purchase such Stock on the terms and conditions set forth in this Section 4 (the
"Right of First Refusal").

(a) Notice of Proposed Transfer. The ROFR Investor proposing to
make a sale or transfer (the "Seller") shall deliver to the Company and the
other ROFR Investor a written notice (the "Seller Notice") stating: (i) the
Seller's bona fide intention to sell or otherwise transfer such Stock; (ii) the
name of each proposed purchaser or other transferee (the "Proposed Transferee");
(iii) the number of Shares of Stock proposed to be transferred to each Proposed
Transferee; and (iv) the terms and conditions of each proposed sale or transfer.
The Seller shall offer Stock at the same price (the "Offered Price") and upon
the same terms (or terms as similar as reasonably possible) to the Company or
its assignee.

(b) Exercise of Right of First Refusal. At any time within
fifteen (15) business days after receipt of the Seller Notice, the Company or
its assignee may, by giving written notice to the Seller, elect to purchase all
of the Stock proposed to be transferred to any one or more of the Proposed
Transferees, at the purchase price determined in accordance with subsection (c)
below.

(c) Purchase. The purchase price ("Purchase Price") for the
Stock purchased by the Company or its assignee under this Section 4 shall be the
Offered Price. If the Offered Price includes consideration other than cash, the
cash equivalent value of the non-cash consideration shall be determined by the
Board of Directors of the Company in good faith. Payment of the Purchase Price
shall be made, at the option of the Company or its assignee(s), in cash (by
check), by cancellation of all or a portion of any outstanding indebtedness of
the Seller to the Company (or, in the case of purchase by an assignee, to the
assignee), or by any combination thereof within 30 days after the Company or its
assignee provides the written notice to the Seller as provided in subsection (b)
above.

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<PAGE>

(d) Seller's Right to Transfer. If the Stock proposed in the
Seller Notice to be transferred is not purchased by the Company or its assignee
as provided in this Section 4, then the Seller may sell or otherwise transfer
such Stock to that Proposed Transferee at the Offered Price or at a higher
price, provided that such sale or other transfer is consummated within 90 days
after the date of the Seller Notice and provided further that any such sale or
other transfer is effected in accordance with any applicable securities laws. If
any Stock described in the Seller Notice is not transferred to the Proposed
Transferee within such period, or if the Seller proposes to change the price or
other terms to make them more favorable to the Proposed Transferee, a new Seller
Notice shall be given to the Company and the other ROFR Investor, and the
Company and/or its assignee shall again be offered the Right of First Refusal
before any Stock held by the Seller may be sold or otherwise transferred.

(e) Reissuance of Repurchased Shares. Any Stock purchased by
the Company under this Section 4 from a ROFR Investor may be retired by the
Company or held by the Company as treasury stock, but such Stock may not be
reissued by the Company without the prior written consent of the non-selling
ROFR Investor (the "Non-Selling Investor").

4.2 Assignment of Right of First Refusal. In the case of proposed
sales or transfers of Stock by a ROFR Investor, the Company agrees that in the
event that the Company declines to exercise the Right of First Refusal, the
Company will provide the Non-Selling Investor with notice of such determination
at least five (5) business days prior to the end of the period in which the
Right of First Refusal expires under Section 4.1(b). The Non-Selling Investor
shall then have the right, exercisable by notice prior to the end of such
period, to exercise such Right of First Refusal as the Company's assignee. Any
Stock purchased by a ROFR Investor under this Section 4.2 shall not be deemed
Voting Securities under Section 3.1 for purposes of calculating the Standstill
Investor's Threshold Percentage. The Right of First Refusal is not otherwise
assignable by the Company.

4.3 Permitted Transactions. The provisions of this Section 4 shall
not pertain or apply to:

(i) Stock sold pursuant to a registration statement filed under
the Securities Act;

(ii) Distributions of Stock by KPCB to its limited partners and
subsequent resales of such Stock;

(iii) Transfers of Stock by KPCB to any affiliated investment
fund or transfers of Stock by Amazon.com to any wholly-owned subsidiary,
provided in each case that the transferee of such Stock agrees to be bound by
the provisions of this paragraph;

(iv) Stock sold in connection with a transaction or series of
related transactions in which more than 80% of the voting power of the Company
is disposed of; or

(v) Sales or other transfers of Stock to any individual third
party (including all affiliates of such third party), if such transferred Stock
represents less than ten

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percent (10%) of the total number of shares of Stock held by the ROFR Investor
at the time of transfer.

4.4 Prohibited Transfers. Any attempt by a ROFR Investor to transfer
Stock of the Company in violation of this Section 4 hereof shall be void and the
Company agrees it will not effect such a transfer nor will it treat any alleged
transferee as the holder of such Stock.

4.5 Legended Certificates. Each certificate representing shares of
Stock of the Company now or hereafter owned by the ROFR Investors or issued to
any Permitted Transferee pursuant to Section 4.3(iii) shall be endorsed with the
following legend:

"THE SALE, PLEDGE, HYPOTHECATION OR TRANSFER OF THE SECURITIES
REPRESENTED BY THIS CERTIFICATE IS SUBJECT TO THE TERMS AND CONDITIONS
OF A CERTAIN RIGHT OF FIRST REFUSAL BY AND BETWEEN THE STOCKHOLDER,
THE CORPORATION AND CERTAIN HOLDERS OF PREFERRED STOCK OF THE
CORPORATION. COPIES OF SUCH AGREEMENT MAY BE OBTAINED UPON WRITTEN
REQUEST TO THE SECRETARY OF THE CORPORATION."

The foregoing legend shall be removed upon termination of the Right of
First Refusal in accordance with the provisions of Section 4.6.

4.6 Termination of Right of First Refusal. The Right of First
Refusal under this Section 4 shall terminate at such time as the covenants set
forth in Section 3 shall have terminated pursuant to Section 3.4 above.

5. Miscellaneous.

5.1 Successors and Assigns. Except as otherwise provided in this
Agreement, the terms and conditions of this Agreement shall inure to the benefit
of and be binding upon the respective permitted successors and assigns of the
parties (including transferees of any of the Series A, Series B, Series C or
Series D Preferred Stock or any Common Stock issued upon conversion thereof).
Nothing in this Agreement, express or implied, is intended to confer upon any
party other than the parties hereto or their respective successors and assigns
any rights, remedies, obligations, or liabilities under or by reason of this
Agreement, except as expressly provided in this Agreement. A Holder that is a
corporation may assign or transfer such Holder's rights and obligations to its
wholly-owned subsidiaries without restriction as to the number of shares
acquired.

5.2 Amendments and Waivers. Any term of this Agreement may be
amended or waived only with the written consent of the Company and the holders
of at least two-thirds (2/3) of the Registrable Securities then outstanding. Any
amendment or waiver effected in accordance with this paragraph shall be binding
upon each holder of any Registrable Securities then outstanding, each future
holder of all such Registrable Securities, and the Company.

-19-
<PAGE>

5.3 Notices. Unless otherwise provided, any notice required or
permitted by this Agreement shall be in writing and shall be deemed sufficient
upon delivery, when delivered personally or by overnight courier or sent by
telegram or fax, or forty-eight (48) hours after being deposited in the U.S.
mail, as certified or registered mail, with postage prepaid, and addressed to
the party to be notified at such party's address or fax number as set forth
below or on Exhibit A hereto or as subsequently modified by written notice.

5.4 Severability. If one or more provisions of this Agreement are
held to be unenforceable under applicable law, the parties agree to renegotiate
such provision in good faith. In the event that the parties cannot reach a
mutually agreeable and enforceable replacement for such provision, then (a) such
provision shall be excluded from this Agreement, (b) the balance of the
Agreement shall be interpreted as if such provision were so excluded and (c) the
balance of the Agreement shall be enforceable in accordance with its terms.

5.5 Governing Law. This Agreement and all acts and transactions
pursuant hereto shall be governed, construed and interpreted in accordance with
the laws of the State of California, without giving effect to principles of
conflicts of laws.

5.6 Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.

5.7 Titles and Subtitles. The titles and subtitles used in this
Agreement are used for convenience only and are not to be considered in
construing or interpreting this Agreement.

5.8 Aggregation of Stock. All shares of the Preferred Stock (or
Common Stock issuable or issued upon conversion thereof) held or acquired by
affiliated entities or persons shall be aggregated together for the purpose of
determining the availability of any rights under this Agreement.

[Signature Page Follows]

-20-
<PAGE>

The parties have executed this Fourth Amended and Restated Investors'
Rights Agreement as of the date first above written.

<TABLE>
<S> <C>
COMPANY: INVESTORS:

DRUGSTORE.COM, INC. -------------------------------------
Vulcan Ventures Incorporated

By: /s/ Peter M. Neupert By: /s/ William D. Savoy
--------------------------------- ----------------------------------
Peter M. Neupert, President
Name: William D. Savoy
--------------------------------
Address: 13920 SE Eastgate Way, Suite 300 (print)
Bellevue, WA 98005 Title: Vice President
-------------------------------

Kleiner Perkins Caufield & Byers VIII, L.P.

By: KPCB VIII Associates, L.P., its General Partner

By: /s/ Brook H. Byers
----------------------------------
a General Partner

Address: 2750 Sand Hill Road
Menlo Park, CA 94025

KPCB VIII Founders Fund, L.P.

By: KPCB VIII Associates, L.P., its General Partner

By: /s/ Brook H. Byers
----------------------------------
a General Partner

Address: 2750 Sand Hill Road
Menlo Park, CA 94025
</TABLE>
<PAGE>

KPCB Life Sciences Zaibatsu Fund II, L.P.

By: KPCB VII Associates, L.P., its
General Partner

By: /s/ Brook H. Byers
---------------------------
a General Partner

Address: 2750 Sand Hill Road
Menlo Park, CA 94025

Amazon.com, Inc.

By: /s/ Randy Tinsley
---------------------------

Name: Randy Tinsley
-------------------------

Title: Treasurer
------------------------

Address: 1516 2nd Avenue
Seattle, WA 98101

Peter Neupert

/s/ Peter M. Neupert
------------------------------

Address: 18650 NE 67th Court
Redmond, WA 98052

SIGNATURE PAGE TO
FOURTH AMENDED AND RESTATED INVESTORS RIGHTS AGREEMENT
<PAGE>

EXHIBIT A

INVESTORS

Name and Address
- -------------------------------------------

Kleiner Perkins Caufield & Byers VIII
2750 Sand Hill Road
Menlo Park, CA 94025

KPCB VIII Founders Fund, L.P.
2750 Sand Hill Road
Menlo Park, CA 94025

KPCB Information Sciences Zaibatsu Fund II, L.P.
2750 Sand Hill Road
Menlo Park, CA 94025

David Whorton
c/o Kleiner Perkins Caufield & Byers
2750 Sand Hill Road
Menlo Park, CA 94025

Amazon.com, Inc.
1516 2nd Avenue
Seattle, WA 98101
Attn: General Counsel

Peter Neupert
18650 NE 67th Court
Redmond, WA 98052

Maveron Equity Partners, L.P.
800 Fifth Avenue, Suite 4100
Seattle, WA 98104

Liberty DS, Inc.
8101 Prentice Avenue, Suite 500
Englewood, CO 80111

Vulcan Ventures Incorporated
110 110th Avenue Northeast, Suite 550
Bellevue, Washington 98004

<PAGE>

Exhibit 23.1

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the reference to our firm under the captions "Selected
Consolidated Financial Data," and "Experts" and to the use of our report dated
January 29, 1999, except for Note 7, as to which the date is July 7, 1999, in
Amendment No. 3 to the Registration Statement (Form S-1 No. 333-78813) and
related Prospectus of drugstore.com, inc. for the registration of 5,750,000
shares of its common stock.

Ernst & Young LLP

Seattle, Washington
July 8, 1999

<PAGE>

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