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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 2, 2005

Commission File Number: 0-26137

drugstore.com, inc.

(Exact Name of Registrant as Specified in its Charter)

411 108^th Avenue NE, Suite 1400, Bellevue, Washington 98004

(425) 372-3200

(Address, including zip code, and telephone number, including area code, of registrant’s Principal Executive Offices)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.0001 per share

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x    No ¨

The aggregate market value of Common Stock held by non-affiliates of the registrant was approximately $119,103,401 as of June 27, 2004.

As of March 2, 2005, the number of shares of the registrant’s Common Stock outstanding was 92,019,771.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this annual report, to the extent not set forth in this annual report, is incorporated by reference from the registrant’s definitive proxy statement relating to the registrant’s annual meeting of stockholders to be held on June 8, 2005, which definitive proxy statement shall be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this annual report relates.

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drugstore.com, inc.

FORM 10-K

For the Fiscal Year Ended January 2, 2005

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PART I

This annual report on Form 10-K and the documents incorporated into this annual report by reference contain forward-looking statements based on our expectations, estimates and projections as of the date of this filing. Actual results may differ materially from those expressed in forward-looking statements. See the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Special Note Regarding Forward-Looking Statements” in Part II, Item 7 of this annual report.

Overview

drugstore.com, inc. is a leading online provider of health, beauty, wellness and pharmacy products and solutions, through its website located on the Internet at www.drugstore.com. We also offer prestige beauty products through our website located at www.beauty.com (which is also accessible through the drugstore.com website); customized nutritional supplement programs through our wholly owned subsidiary, Custom Nutrition Services, Inc., or CNS, through websites located at www.DrWeilVitaminAdvisor.com, www.zoneprofiler.com and www.pritikin@home.com; and contact lenses and other vision products through our wholly owned subsidiary International Vision Direct Corp., or Vision Direct, through websites located at www.visiondirect.com, www.lensmart.com and www.lensquest.com. We operate toll-free telephone numbers, 1-800-DRUGSTORE and 1-800-VISIONDIRECT, through which customers can place orders and receive information. As of January 2, 2005, our lifetime customer base was nearly 6 million customers worldwide.

We operate primarily in the United States and Canada, but our products are available to consumers worldwide. We operate and manage our business in four segments: over-the-counter, or OTC, mail-order pharmacy, local pick-up pharmacy and vision. In 2004, OTC accounted for 43% of our consolidated revenues, mail-order pharmacy 18%, local pick-up pharmacy 26%, and vision 13%. Additional information regarding our business segments can be found in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this annual report and in Note 13 of our consolidated financial statements included in Part IV, Item 15 of this annual report.

drugstore.com, inc. was incorporated in April 1998 in the state of Delaware, launched our web store at www.drugstore.com in February 1999, and completed our initial public offering in July 1999. Our common stock is listed on the Nasdaq National Market under the symbol “DSCM.” Our principal corporate offices are located in Bellevue, Washington. As used in this annual report, “drugstore.com,” “we,” “our” and similar terms refer to drugstore.com, inc. and its subsidiaries, unless the context indicates otherwise.

Business Strategy

Our business strategy is to offer our customers a wide selection of products at competitive prices and a superior shopping online experience.

Convenience.    Our online stores are available to consumers 24 hours a day, 7 days a week, and may be reached from wherever they have either Internet access or a phone. We also offer:

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Selection.    Because we do not have the shelf display space limitations of bricks-and-mortar drugstores, we are able to offer a significantly broader assortment of products, with greater depth in each product category. With a single check-out, our customers are able to buy health, beauty, wellness and personal care products, prestige brands, salon hair care, natural products, nutritional products from General Nutrition Companies, Inc., or GNC, and other specialty items. In addition, we offer contact lenses and customized nutritional supplement programs through our subsidiary websites. We adjust and update our store offerings and content throughout the year in response to market trends, consumer demand and vendor introduction and advertisement of new products.

Information.    To help consumers to make informed purchasing decisions, we provide a broad array of interactive tools and information on our websites. Consumers can either access the information directly on our websites or get free help by e-mail or telephone from our customer care representatives and pharmacists. Our information services include:

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Privacy.    When shopping at a bricks-and-mortar drugstore, many consumers may feel embarrassed or uncomfortable about buying items or asking their pharmacist questions that may reveal personally sensitive aspects of their health or lifestyle to store personnel or to other shoppers. Our customers avoid these problems by shopping from the privacy of their home or office.

Business Segments

We offer products in four business segments: OTC, mail-order pharmacy, local pick-up pharmacy and vision. We sell products both through a multi-store format under the drugstore.com store umbrella and, for certain products, through separate subsidiary websites.

OTC

We stock over 20,000 non-prescription health, beauty and wellness products. Our primary OTC categories include medicine cabinet, beauty and spa, nutrition and wellness, personal care, household, and sexual well-being, in addition to a variety of specialty stores such as Dr. Weil Recommends, GNC Live Well, the Natural Store and Beauty.com. In addition, we sell customized nutritional supplements through the websites of our subsidiary CNS.

Medicine Cabinet.    The medicine cabinet category includes OTC remedies, such as digestion aids, diabetes supplies, cough, cold, allergy and pain relief medications, first aid products, medical devices for home healthcare and other health-related products.

Beauty and Spa.    The beauty and spa category offers mass-market cosmetics, hair care, fragrances, home spa products and a variety of skin care products.

Nutrition and Wellness.    The nutrition and wellness category includes nutritional foods and supplements, exercise, diet and weight loss products, massage and relaxation products and sports nutrition products.

Personal Care.    The personal care category includes products related to body and shaving, oral hygiene, baby and feminine needs.

Household.    The household category offers household products, including healthy and aromatherapeutic cleaning products and other cleaning solutions, small household appliances and healthy home products, such as air and water purification systems.

Dr. Weil Recommends.    The Dr. Weil Recommends store provides consumers with information, resources and a selection of health and wellness products recommended by Dr. Andrew Weil. Customers can also take the Vitamin Advisor questionnaire to obtain a personalized recommendation for vitamin supplements based on Dr. Weil’s research and sign up for daily or weekly e-mail newsletters from Dr. Weil.

Natural Store.    Our Natural Store features natural products, including those products without artificial coloring or flavoring, synthetic fragrance or other unnecessary chemicals, as well as products from companies with environmentally-conscious and cruelty-free business practices.

Nutritional Products.    Our GNC Live Well store is dedicated to GNC nutritional products and other products typically sold in GNC stores. We will be the exclusive online distributor of GNC brand products until July 2005, and will continue as a nonexclusive distributor until at least 2009. Through our subsidiary CNS, we

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also provide personalized nutrition services to consumers in the form of an online assessment of an individual’s specific nutritional supplement needs, and deliver the personalized vitamins, minerals, herbs, and supplements in pharmaceutical-grade, daily dose packages. In addition to providing customized nutritional supplement programs through our Dr. Weil Recommends store, we are the exclusive online distributor of nutritional supplement programs for Dr. Andrew Weil at www.DrWeil.com, Dr. Barry Sears at www.ZoneDiet.com and The Pritikin Longevity Center & Spa at www.Pritikin.com.

Beauty.com.    Our Beauty.com store, which is also accessible through www.beauty.com, serves the customer seeking high-end beauty and skin care products generally found in department stores, beauty specialty stores, spas and salons.

Sexual Well-Being.    Our Sexual Well-Being store, which is also accessible through www.sexualwellbeing.com, offers both information and a wide selection of sexual well-being products, all provided in an environment where customers can explore their sexual wellness needs in the privacy of their own home.

We also act as a wholesaler and fulfillment provider for certain OTC products sold through the Health & Personal Care store on the Amazon.com website, as described in the section below entitled “Key Strategic Relationships—Amazon.com.”

Mail-Order Pharmacy and Local Pick-Up Pharmacy

Our pharmacy product category is divided into two business segments: mail-order pharmacy and local pick-up pharmacy. Our mail-order pharmacy segment covers the prescription drugs and supplies delivered to customers through our mail-order facility, and our local pick-up pharmacy business segment covers the prescriptions picked up by customers at Rite Aid stores. New prescriptions may be ordered on the drugstore.com website for mail-order delivery. Refill prescriptions that have previously been filled through our mail order facility or at a Rite Aid store may be mailed to the customer or picked up by the customer at any Rite Aid store. Although most prescriptions are ordered through the drugstore.com website, we also accept prescription orders by telephone at 1-800-DRUGSTORE.

Product and Service Offering.    We are a full-service pharmacy stocking over 6,000 prescription drugs, consisting primarily of prescription medications for chronic illnesses and conditions, such as high blood pressure, diabetes, osteoporosis, depression, hair loss and birth control.

The pharmacy services at the drugstore.com online pharmacy are provided by experienced professionals using sophisticated information technologies to ensure private, personal customer service. We employ licensed pharmacists and are licensed to fill prescriptions in all 50 states in the United States. We have received Verified Internet Pharmacy Practices Sites, or VIPPS, certification from the National Association of Boards of Pharmacy, or NABP, a coalition of state pharmacy boards. The voluntary VIPPS program sets standards for Internet pharmacies and certifies those online pharmacies that are fully licensed and in compliance with state pharmacy laws and the NABP’s stringent pharmacy practice standards.

Filling Prescriptions.    We accept new and transferred prescriptions only from licensed health care providers. We do not prescribe medications or otherwise practice medicine. Like traditional retail and mail service pharmacies, our pharmacists verify the validity, accuracy and completeness of all prescription drug orders. We ask all prescription drug customers to provide our pharmacists with information regarding drug allergies, current medical conditions and current medications. Our pharmacists perform a drug utilization review in which they cross-check every prescription against the customer’s submitted information for drug, disease and allergy interactions.

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Services.    We seek to provide a high level of responsiveness and customer support. In addition to our Ask Your Pharmacist feature, our drug price index, our extensive drug information database, our specialized customer care features, and our email refill reminders, our pharmacy services include:

Insurance/PBM relationships.    We serve both cash-paying pharmacy customers and customers with insurance coverage. Through our relationships with insurance companies, pharmacy benefit managers, or PBMs, and Rite Aid Corporation, we are able to obtain insurance reimbursement coverage for most insured prescriptions ordered through the drugstore.com pharmacy. We are able to fill prescriptions for a majority of customers with pharmacy benefits covered by an insurance plan accepted by Rite Aid, and we have also entered into direct relationships with a number of insurance companies and managed care organizations. We participate in the retail pharmacy networks of many PBMs, including Aetna US Healthcare, Inc., Caremark Inc. and Express Scripts, Inc. In addition, we act as an outsourced mail-order pharmacy service provider for five PBMs and four third-party benefits companies, for whom we generally dispense medications in supplies of 90 days or more. During 2004, approximately 94% of the prescriptions in our local pick-up pharmacy segment and approximately 29% of the prescriptions in our mail-order pharmacy segment were paid for by insurance plans, with the balance reflecting prescriptions filled for customers who paid cash for the prescriptions.

We participate in the prescription drug discount card program established under the new federal Medicare legislation, which went into effect in June 2004, and participate in the retail networks of many Medicare card sponsors.

Vision

We sell prescription contact lenses and other vision products through our subsidiary Vision Direct, through websites located at www.visiondirect.com, www.lensmart.com, and www.lensquest.com, as well as by telephone at 1-800-VISIONDIRECT. Our vision websites are also accessible through the drugstore.com website.

Product Offering.    We provide customers with a broad assortment of contact lenses, in addition to reading glasses, contact lens cases and eye care products. We believe that we offer these products at a substantial price savings over eye care practitioners, national optical chains and many online competitors.

Prescription Verification.    We are subject to the prescription verification guidelines defined in the U.S. Fairness to Contact Lens Consumers Act, or FTCLCA, which became effective in February 2004, and the related regulations of the Federal Trade Commission, or FTC. In accordance with this law, we ask the patient’s eye care professional to verify the prescription before we ship an order, and allow eight business hours for the eye care professional to reply to our verification request. If the eye care professional indicates that the prescription is invalid, we cancel the order and notify the customer. If the eye care professional approves the prescription, or does not respond to our verification request within eight business hours, we ship the order to the customer as expressly permitted by the FTCLCA and FTC. If, at any time after we ship an order, the eye care practitioner notifies us that the prescription is invalid, we notify the customer.

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Services.    We offer a convenient process for customers to reorder from their accounts, and we can provide automatic shipments based on a customer’s delivery preferences.

How We Merchandise and Market

Merchandising

The key components of our merchandising strategy are as follows:

Marketing

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 are focused on frequently visited Internet portals, health- and beauty-related websites, search engines, and direct-to-consumer e-mail marketing programs. We also extend our market presence through our associates program, through which we permit associated websites to make our products and services available to their audiences through a link to our websites.

We also use business segment-specific marketing programs and initiatives:

OTC.    We currently offer three anchor customer loyalty programs: Everyday Free Shipping, drugstore.com dollars and Diamond Deals.

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We will continue to evaluate and refine or retire these programs, as well as other marketing strategies to drive customer orders, in our pursuit of cost-effective customer acquisition and retention strategies.

Pharmacy.    We have a strategic relationship with Rite Aid to promote our website. For example, Rite Aid includes the drugstore.com online store and pharmacy in a significant portion of Rite Aid’s own weekly circular advertisements, as well as on Rite Aid shopping bags, prescription vial caps, in-store signs and permanent links from its website. In addition, some PBMs actively promote their drugstore.com mail-order alternative and distribute brochures and other materials about us to their customers.

Vision.    We offer vision customers free shipping on orders of $99 or more. In addition, vision customers are currently eligible to participate in the drugstore.com Dollars program.

Pricing

Our goal is to offer shoppers the largest online assortment of health, beauty, wellness, vision and pharmacy products with competitive pricing. We strive to improve our operating efficiencies and to leverage our fixed costs so that we can pass along the savings to our customers in the form of lower prices and exclusive deals. We also seek to inform customers of additional cost savings opportunities when they become available. For example, in our pharmacy, we proactively highlight lower-cost generic drug alternatives to higher-priced brand-name drugs. We also encourage pharmacy customers to buy 90-day supplies of medication rather than 30-day supplies, when possible, by providing quantity price breaks as incentives. This strategy allows our customers to take advantage of price savings and enables us to realize fulfillment cost savings and achieve higher customer retention rates. Vision Direct offers a low price guarantee on all brands of contact lenses that we sell. In addition, we increase customer retention rates through our customer loyalty programs, such as drugstore.com Dollars and Diamond Deals, which provide lower prices for repeat customers.

Our Target Customer

We target busy, working women between the ages of 25 and 55, many of whom are married with children. This target customer makes the majority of her household’s buying decisions, uses online shopping as a means of maximizing the use of her time, browses multiple categories and finds online shopping a convenient, relaxing and rewarding experience. We also cater to a secondary target market of men over the age of 35 who use online shopping to maximize the use of their time and who tend to use more prescription medications as they grow older.

How We Serve our Customers

Order Fulfillment

All of our OTC orders and our pharmacy orders that are delivered by mail are processed from our primary distribution center in Swedesboro, New Jersey. Orders for products in our vision segment are processed from our

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distribution center in Ferndale, Washington. Our warehouse management system provides us with real-time data on inventory receiving, shipping, quantities and location. Due to the relatively short lead time required to fill orders for our products, usually 24 to 48 hours, order backlog is not material to our business.

When we fill a prescription at our pharmacy for mail-order delivery from our distribution center, we operate under our arrangement with Rite Aid. Our pharmacists, working together with a Rite Aid “pharmacist in charge,” perform all aspects of the prescription fulfillment process and customer service. When a customer orders a prescription to be picked up at a local Rite Aid store, we utilize Rite Aid as a fulfillment partner. Upon receiving and validating a customer’s order for local pick-up, we submit order information to Rite Aid for processing and purchase the inventory from Rite Aid, which fills the order and makes it available for pick-up by the customer. Under our agreement with Rite Aid, Rite Aid adjudicates and collects insurance reimbursement payments on our behalf.

Non-prescription orders over $49 qualify for free standard shipping. For orders under $49, we generally charge our customers a shipping charge that covers a portion of the expense of shipping. We ship anywhere in the United States that is served by United Parcel Service or the U.S. Postal Service, and ship to the military through APO addresses. In addition, through an agreement with Comerxia, Inc., we offer international shipment of OTC health, beauty, and wellness products to over 30 countries. Vision Direct ships contact lenses and other vision products worldwide, primarily to the United States and Canada. Customers who order a refill of an existing Rite Aid or drugstore.com prescription can choose to pick up the refill at any Rite Aid store or have it delivered by mail.

Customer Care

We maintain a pharmacy customer care center in our Bellevue, Washington headquarters and OTC and vision customer care centers in Halifax, Nova Scotia, Canada. Our customer care specialists are available 24 hours a day, 7 days a week to provide assistance via e-mail or telephone. To ensure timely and high-quality customer service, we have established specialty teams within our customer care department. Our customer care specialists handle customer inquiries and assist customers in finding desired products. Our website also contains a customer care area that outlines store policies and provides answers to customers’ frequently asked questions. In addition, our pharmacists provide advice to customers about medication, dosage, delivery systems, common side effects and other prescription drug- and health-related issues.

If a customer is not satisfied with the product purchased or the quality of customer service provided, we generally refund to customers all or a portion of the product’s selling price, including related shipping fees if applicable. Sales returns have not been significant to date.

Technology

We have implemented a broad array of services and systems for site management, product searching, customer interaction, transaction processing and order fulfillment functions, including, among other things:

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. To enhance the online and offline experience for our customers, we have integrated some of our information and pharmacy systems with Rite Aid’s systems. Rite Aid has granted us a nonexclusive, fully paid license to the Rite Aid systems that are integrated with our systems, subject to third-party rights to such technology.

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We also have a technology license and advertising agreement with Amazon.com, Inc. under which we have mutually agreed to license to each other certain existing and future technology used in the operation of our websites, 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. This agreement is described below in the section entitled “Key Strategic Relationships—Amazon.com.”

Our core merchandise catalog, customer interaction, order collection, fulfillment and back-end systems are proprietary to drugstore.com, but are available for use by Amazon.com under our technology license and advertising agreement with Amazon.com. Our systems are designed to provide real-time connectivity to the distribution center systems for both pharmacy and OTC products. They include an inventory-tracking system, a real-time order tracking system, an executive information system and an inventory replenishment system. Our Internet servers use SSL technology with Verisign-issued digital certificates to help conduct secure communications and transactions. Our systems infrastructure is hosted by SAVVIS Communications Corporation in Tukwila, Washington. Vision Direct uses a combination of internally developed and third-party software systems, some of which some are hosted by NaviSite in Pasadena, California.

We meet rigorous credit card association data security requirements. Ambiron, LLC has audited and certified our compliance with the card associations’ Multi-Card Compliance Program, or MCCP, and the MasterCard Site Data Protection Program, or SDP.

Purchasing

OTC.    We purchase our non-pharmaceutical inventory directly from various manufacturers and distributors.

Pharmacy.    Under our agreements with Rite Aid, we are required to purchase all of our brand-name pharmaceutical products through Rite Aid, unless we are able to obtain better overall terms from another vendor. We purchase our generic drugs directly from Rite Aid. Our arrangement with Rite Aid enables us to take advantage of volume discounts and credit terms obtained through Rite Aid, and therefore decreases our costs for pharmaceutical products. To date, we have not been able to obtain more favorable overall terms from any other supplier, and we currently expect to continue to purchase our pharmaceutical inventory through Rite Aid.

Vision.    We purchase our contact lens and vision products inventory directly from various manufacturers and distributors.

Key Strategic Relationships

Rite Aid

In June 1999, we entered into a ten-year strategic relationship with Rite Aid. Through our agreements with Rite Aid, which expire in 2009, we have access to Rite Aid customers through the RiteAid.com website, which is powered by the drugstore.com website. All pharmacy orders processed through the drugstore.com website or the RiteAid.com website can either be shipped to the customer from our distribution center or, in the case of refills of existing drugstore.com or Rite Aid prescriptions, picked up by the customer at any Rite Aid store. In addition to providing for multi-channel delivery options, we and Rite Aid agreed to promote each other’s services both online and offline. We also benefit from access to many of Rite Aid’s relationships with insurance companies and PBMs, which provides us with opportunities to meet the needs of more customers because of the availability of insurance coverage to those customers. Currently, we purchase all pharmaceutical inventory through Rite Aid, leveraging its volume efficiencies to obtain favorable pricing and credit terms. We also sell over 400 Rite Aid brand private-label OTC products throughout the drugstore.com web store. As a result of this agreement, Rite Aid is one of our largest suppliers.

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As part of our relationship, we agreed to certain exclusivity provisions that limit our ability to promote, or affiliate with, any other physical retail drugstore or to operate as a traditional physical drugstore, and Rite Aid agreed not to offer or sell products or services on the Internet other than through our website. In addition, our agreement requires us to purchase all of our pharmaceutical products through Rite Aid, unless we are able to obtain better overall terms from another vendor. The agreement also provides 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. We currently use these systems to adjudicate and process local pick-up and mail-order pharmaceutical orders.

GNC

In June 1999, we entered into a 10-year agreement with GNC under which we became the exclusive online provider of GNC-branded products. We have the exclusive right to sell GNC’s wellness products over the Internet until July 2005. When the exclusivity provisions of the agreement terminate, we will have the nonexclusive right to sell these products for the remaining term of the agreement. We have agreed that, 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. As part of our relationship with GNC, we have created the GNC Live Well Store within the drugstore.com website, which is dedicated to selling GNC products on a consignment basis. We retain a percentage of the gross revenues that we collect from sales of GNC products and recognize only the net amount we retain as revenues. We have also agreed with GNC to co-promote each other’s products and services in both traditional and online marketing efforts, including GNC’s placement of a link to our website on the GNC website.

Amazon.com

Effective in September 2003, we entered into an e-commerce agreement with Amazon.com. Under this agreement, which replaced our prior marketing agreements with Amazon.com, we are a nonexclusive wholesaler and fulfillment provider for certain OTC products sold through the Health & Personal Care store on the Amazon.com website. We ship these Amazon.com orders in Amazon.com-branded boxes from our distribution facility, in exchange for a fulfillment fee and an agreed-upon product price. We began shipping orders under this agreement in December 2003. The initial term of this agreement, which was amended in June 2004, ends in April 2007.

In August 1998, we entered into a ten-year technology license and advertising agreement with Amazon.com, under which we have the right to license substantially all of Amazon.com’s technology for use in our business and to receive certain technological and advertising support from Amazon.com, and Amazon.com has the right to license substantially all of our technology for use in its business. Neither party may use the other’s technology to compete against the other. Currently, neither party has licensed any technology from the other under this agreement. If we were to be acquired by a competitor of Amazon.com and Amazon.com did not vote in favor of the transaction, we would lose our rights to use Amazon.com’s technology, if we are then using any. This agreement also restricts us from promoting on our website any company, other than drugstore.com, that sells products or services competitive with those that Amazon.com offers or is preparing to produce or market.

Amazon.com is our largest stockholder, owning approximately 14% of our outstanding stock as of March 2, 2005. G. Charles “Cayce” Roy, 3rd, a vice president of Amazon.com, is currently serving as Amazon’s designee on our board of directors.

Competition

The market for health, beauty, wellness, vision and pharmacy products is intensely competitive and highly fragmented. We face intense competition in each of our business segments, as described below. In addition, we compete with Internet portals and online service providers that feature shopping services, and with other online or mail-order retailers that offer products within one or more of our business segments.

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Pharmacy.    In our mail-order pharmacy and local pick-up pharmacy segments, we compete with chain drugstores, pharmacy benefit managers, insurers and other health care providers, mail-order prescription drug providers and other online pharmacies. Foreign online pharmacies and “rogue” online pharmacies can often sell drugs to American residents at a lower price because they do not comply with U.S. pharmacy regulations, are not subject to U.S. regulatory oversight, or both.

OTC.    Our competitors in the OTC segment can be divided into several groups: chain drugstores, mass market retailers, warehouse clubs, supermarkets and, with respect to upscale health, prestige beauty and spa products, specialty retailers and major department stores.

Vision.    Our competitors in the vision segment include other online providers of contact lenses, national optical chains, eye care professionals, and mass-market retailers and warehouse clubs that provide prescription vision services.

We believe that there are a number of competitive factors in our market, including brand awareness and preference, company credibility, product selection and availability, convenience, price, privacy, actual or perceived value, website features, functionality and performance, ease of purchasing, customer service, quality and quantity of information supporting purchase decisions (such as product information and reviews), and reliability and speed of order shipment.

Government Regulation

Our business is subject to extensive federal, state and local regulations. We believe we are in compliance with existing federal and state requirements relating to pharmacy licensing and registration, the dispensing of prescription drugs, security, record keeping and reporting of pharmacy sales, and the dispensing and sale of contact lenses, and with other applicable laws and regulations. The National Association of Boards of Pharmacy has certified through its VIPPS program that we are in compliance with the licensing and inspection requirements of our state and each state to which we dispense pharmaceuticals, as well as other stringent criteria established by the NABP to ensure good pharmacy practice.

Entities engaging in the practice of pharmacy are subject to numerous federal and state regulatory and licensing requirements. For example, entities such as the drugstore.com pharmacy that distribute controlled substances are subject to the Controlled Substances Act of 1970 and regulations issued by the U.S. Drug Enforcement Administration and state laws and regulations pertaining to controlled substances. We are also subject to the Health Insurance Portability and Accountability Act of 1996, or HIPAA, which regulates the flow of health information throughout the health care system to protect the privacy of personal health records. We also sell prescription, OTC and homeopathic drug products, dietary supplements, medical devices, cosmetics, foods and other consumer products that are subject to regulation by the Food and Drug Administration, or FDA, the Consumer Product Safety Commission, the FTC and state regulatory authorities, as the case may be. In addition to regulating the claims made for specific types of products, the FDA and the FTC may attempt to regulate the format and content of websites that offer products to consumers. We are also subject to the prescription verification and other requirements of the FTCLCA and related FTC regulations.

As we expand our product and service offerings, more of our products and services will likely be subject to federal, state and foreign regulations. Regulatory requirements to which our business is subject may also expand over time. For example, some members of Congress have proposed additional regulation of Internet pharmacies in an effort to combat the illegal sale of prescription drugs over the Internet, and some members of Congress and some state legislatures have proposed, and a number of states have already enacted, restrictions on sales of certain products, such as products containing pseudoephedrine that could be used as precursors in the manufacture of illegal drugs.

The laws and regulations applicable to our business often require subjective interpretation, and we cannot be certain that our efforts to comply with applicable laws and regulations will be deemed sufficient by the appropriate regulatory

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agencies. Violations of any laws or regulations could result in various civil and criminal penalties, including, but not limited to, suspension or revocation of licenses or registrations, seizure of our inventory or monetary fines that could adversely affect our business, financial condition or operating results.

Intellectual Property

We regard our intellectual property as critical to our future success and we rely on a combination of patent, copyright, trademark, service mark and trade secret laws and contractual restrictions to establish and protect our proprietary rights in products and services. We enter into confidentiality and invention assignment agreements with all of our employees and contractors and nondisclosure agreements with our vendors, fulfillment partners, strategic partners and others to limit access to and disclosure of our proprietary information. The steps we take to protect our intellectual property, however, may not prevent misappropriation of our technology or proprietary information.

We have licensed in the past, and expect that we may license in the future, some of our proprietary rights to third parties. For example, Amazon.com has the right to license our technology and we have granted nonexclusive rights to our trademarks and copyrighted material in connection with advertising and affiliate relationships. While we attempt to ensure that such licensees maintain the quality of the drugstore.com brand, these licensees may take actions that could hurt the value of our proprietary rights or reputation. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective patent, copyright, trademark and trade secret protection may not be available in such jurisdictions.

We also rely on technologies that we license from third parties, such as Oracle Corporation and Microsoft Corporation, which are the suppliers of key database technology, the operating system and specific hardware components for our service. As part of our relationship with Rite Aid, we have also licensed information technology systems from Rite Aid. These third-party technology licenses may not 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 own a number of domain names, hold one patent and have applied for seven others, have registered several trademarks, including the drugstore.com logo, and have filed applications for the registration of a number of our other trademarks, including DRUGSTORE.COM and VISION DIRECT, and service marks in the United States and in some other countries. We may be unable to secure registrations for all of our marks. Our competitors or others may use marks similar to ours, which could impede our ability to build brand identity and lead to customer confusion, and owners of other registered trademarks or trademarks that incorporate variations of our marks could bring potential trade name or trademark infringement claims against us. Any claims or customer confusion related to our trademarks or any failure or inability to protect our trademarks, technology or other proprietary rights could substantially harm our business.

Seasonality

Our OTC business is subject to substantial seasonal variations in demand. Historically, net revenue has increased significantly in the fourth quarter of each year, primarily because of the greater number of sales and increased OTC customer acquisition arising from the holiday season. We believe that this is the general pattern associated with the direct-to-consumer and retail industries. We do not believe that our mail-order pharmacy, local pick-up pharmacy or vision business segments are substantially affected by seasonality.

Employees

As of January 2, 2005, we had 664 full-time employees. We hire temporary employees in the fourth quarter as needed to address our seasonal increase in OTC demand.

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Executive Officers and Directors

The following tables set forth information regarding our executive officers and directors as of the date of this annual report:

Executive Officers

Dawn G. Lepore has served as President, Chief Executive Officer and Chairman of the Board of drugstore.com since October 2004. Ms. Lepore served as Vice Chairman—Active Trader, Technology, Operations, Administration and Business Strategy of The Charles Schwab Corporation (“CSC”) from August 2003 to October 2004. CSC, through Charles Schwab & Co., Inc. (“Schwab”) and its other operating subsidiaries, is a financial services firm. Ms. Lepore served as Vice Chairman—Technology, Active Trader, Operations, and Administration of CSC and Schwab from May 2003 until August 2003, as Vice Chairman—Technology, Operations and Administration of CSC and Schwab from July 2002 until May 2003, as Vice Chairman—Technology and Administration of CSC and Schwab from 2001 to 2002, as Vice Chairman and Chief Information Officer of CSC and Schwab from 1999 to 2001 and as Executive Vice President and Chief Information Officer of CSC and Schwab from 1993 to 1999. She joined Schwab in 1983. Ms. Lepore serves as a director of eBay Inc. and Catalyst, Inc.

Robert A. Barton has served as Vice President and Chief Financial Officer of drugstore.com since January 2001. Mr. Barton also served as Acting Chief Executive Officer from June 2004 to October 2004. He has served in various senior financial management and operational roles at drugstore.com since September 1998, including Vice President and General Manager of Pharmacy from June 2000 to January 2001. From August 1995 to September 1998, Mr. Barton served as the Director of Business Planning and also managed various accounting and analysis groups for AT&T Wireless Services. From February 1989 to August 1995, he served as an auditor with Deloitte & Touche LLP.

Kathleen M. Gersch has served as Vice President, Chief Marketing Officer and General Manager of drugstore.com since November 2004. Ms. Gersch served as Executive Vice President of Marketing, Merchandising and Business Development and the leader of the Consumer Business Unit of GiftCertificates.com, an online provider of gift certificates, from August 2003 to November 2004. She served as an independent consultant providing international business consulting services for retail and consumer products companies from November 2002 to August 2003. She served with Nordstrom, Inc., a leading fashion specialty retailer, as Vice President of Finance, Strategic Planning and Administration (business unit chief financial officer) of Nordstrom Product Group (NPG) and Vice President of Faconnable International, from July 1998 to October 2002. She serves as a director and chairman of the board of the Youth Theatre Northwest and on the advisory board of a privately held retailer.

Christopher G. Hauser has served as Vice President, Operations of drugstore.com since July 1999. Before joining drugstore.com, Mr. Hauser served as Senior Vice President, Information Technologies and Operations for Multiple Zones International, a reseller of brand-name computer products and services.

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Ian D. Mummery has served as Vice President, Vision of drugstore.com since December 2003. Mr. Mummery co-founded International Vision Direct, a provider of contact lenses and vision accessories, in December 1998 and served as its President and Chief Executive Officer until its acquisition by drugstore.com in December 2003.

Louise Mummery has served as Vice President, Vision Operations of drugstore.com since December 2003. Ms. Mummery co-founded International Vision Direct, a provider of contact lenses and vision accessories, in December 1998 and served as its Chief Operations Officer until its acquisition by drugstore.com in December 2003.

Alesia L. Pinney has served as Vice President, General Counsel and Secretary of drugstore.com since October 2000. Ms. Pinney served as Assistant Secretary and Associate General Counsel of drugstore.com from January 1999 to October 2000. Before joining drugstore.com, Ms. Pinney was an attorney with the law firm Perkins Coie LLP.

Directors

Additional Factors That May Affect Our Business and Future Results

An investment in our securities involves certain risks. In evaluating drugstore.com and our business, investors should give careful consideration to the factors listed below. Other risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or operating results could be materially adversely affected.

We have a history of generating significant losses, and may never be profitable.

We have incurred net losses of $716.4 million from our inception in April 1998 through January 2, 2005. To date, we have not become profitable, and we may never achieve profitability. We expect to continue to incur operating and net losses for at least the next year, and possibly longer.

We may be unable to increase the migration of consumers of health, beauty, wellness, vision and pharmacy products from bricks-and-mortar stores to ou