S-1

As filed with the Securities and Exchange Commission on November 2, 2005

Registration No. _________          

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

DRUGMAX, INC.

(Exact name of registrant as specified in its charter)

NEVADA	5122	341755390
(State or Other Jurisdiction of Incorporation or Organization)	(Primary Standard Industrial Classification Code Number)	(I.R.S. Employer Identification Number)

312 Farmington Avenue

Farmington, CT 06032-1968

(860) 676-1222

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

Edgardo A. Mercadante

Co-Chairman, President and Chief Executive Officer

DrugMax, Inc.

312 Farmington Avenue

Farmington, CT 06032-1968

(860) 676-1222

(Name, address, including zip code, and telephone number, including area code, of agent for service)

WITH COPIES TO:

Thomas A. Rose, Esq.

Sichenzia Ross Friedman Ference LLP

1065 Avenue of the Americas

New York, New York 10018

(212) 930-9700

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, other than securities offered only in connection with dividend or interest reinvestment plans, please check the following box.   x

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.o

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. o

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. o

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. o

CALCULATION OF REGISTRATION FEE

Title of Each Class of Securities to be Registered	Amount to be Registered(1)		Proposed  Maximum Offering Price  per Unit(2)		Proposed  Maximum Aggregate  Offering Price		Amount of Registration Fee
Common stock, par value $0.001 per share		44,581,502		$1.55	$	69,101,328.10	$	8,133.23
Shares of common stock issuable upon exercise of warrants		22,046,715		$1.55	$	34,172,409.80	$	4,022.09
Total		66,628,217			$	103,273,737.90	$	12,155.32

(1)

Includes shares of our common stock that may be offered pursuant to this registration statement, which shares are issuable upon the exercise of warrants held by the selling shareholders. In addition to the shares set forth in the table, the amount to be registered includes an indeterminate number of shares issuable upon exercise of the warrants, as such number may be adjusted as a result of stock splits, stock dividends and similar transactions in accordance with Rule 416.

(2)

Estimated in accordance with Rule 457(c) solely for the purpose of computing the amount of the registration fee based on the average of the high and low closing prices of the Registrant’s common stock on the Nasdaq Capital Market on October 31, 2005.

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 the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

The information in this prospectus is not complete and may be changed. The selling stockholders named in this prospectus 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 is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED November 2, 2005

PROSPECTUS

Shares of Common Stock

66,628,217

We are registering 66,628,217 shares of our common stock for resale by the selling shareholders identified on page 5 of this prospectus. The shares may be offered through public or private transactions, at prevailing market prices or at privately negotiated prices. We will not receive any portion of the proceeds from the sale of these shares. See “Plan of Distribution” on page 8.

Our common stock is quoted on the Nasdaq Capital Market under the symbol “DMAX.”

On October 31, 2005, the last reported closing price of the common stock on the Nasdaq Capital Market was $1.60 per share. You are urged to obtain current market quotations for our common stock.

Our principal executive offices are located at 312 Farmington Avenue, Farmington, CT 06032, and our telephone number is (860) 676-1222.

YOU SHOULD CAREFULLY CONSIDER THE “RISK FACTORS” BEGINNING ON PAGE 2 IN DETERMINING WHETHER TO PURCHASE DRUGMAX COMMON STOCK.

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

The date of this prospectus is November 2, 2005.

TABLE OF CONTENTS

	Page
Prospectus Summary	1
Risk Factors	2
Caution about Forward-Looking Statements	5
Use of Proceeds	5
Selling Shareholders	5
Plan of Distribution	8
Description of Securities to be Registered	9
Legal Matters	9
Experts	9
Business	10
Selected Consolidated Historical Financial Data	17
Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Share Ownership of Directors, Certain Executive Officers and Principal Stockholders	46
Certain Relationships and Related Party Transactions	48
Index to Financial Statements	F-1
Financial Statements
Undertakings	II-7
Where You Can Find More Information	II-8

IMPORTANT NOTICE TO READERS

You should rely only on the information contained in this prospectus. We have not authorized any other person to provide you with different or additional information. If anyone provides you with different or additional information, you should not rely on it. The selling stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where such offers and sales are permitted. The information in this prospectus is accurate only as of the date on the front cover, regardless of the time of delivery of this prospectus or of any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since this date and may change again.

For investors outside the United States: We have not done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus

 

PART I

PROSPECTUS SUMMARY

DrugMax, Inc. (“DrugMax,” the “Company,” or “we” and other similar pronouns) is a specialty pharmacy and drug distribution provider formed by the merger (the “Merger”) on November 12, 2004 of DrugMax, Inc. and Familymeds Group, Inc. (“FMG”). We work closely with doctors, patients, managed care providers, medical centers and employers to improve patient outcomes while delivering low cost and effective healthcare solutions. As of October 31, 2005, we operated one drug distribution facility, under the Valley Drug Company name, and 77 specialty pharmacies in 13 states under the Arrow Pharmacy & Nutrition Center and Familymeds Pharmacy brand names. As a result of Hurricane Katrina, on August 30, 2005, we were forced to temporarily discontinue our distribution operations located in St. Rose, Louisiana known as Valley Drug Company South. Additionally, we have engaged an advisor to assist us in the sale of certain assets of our drug distribution facility in New Castle, Pennsylvania.

We are focused on building an integrated specialty drug distribution platform. Our platform is designed to provide services for the treatment of acute and complex health diseases including chronic medical conditions such as cancer, diabetes and pain management. We often serve defined population groups on an exclusive, closed panel basis to maintain costs and improve patient outcomes. We offer a comprehensive selection of brand name and generic pharmaceuticals, non-prescription healthcare-related products, and diagnostic supplies to our patients, independent pharmacies, physicians, clinics, long-term care and assisted living centers.

Pursuant to this prospectus, we are registering 66,628,217 shares of our common stock for resale by certain of our shareholders identified on page 5 of this prospectus. These shares may be offered by the selling shareholders through public or private transactions, at prevailing market prices or at privately negotiated prices. See “Plan of Distribution” on page 8. We will not receive any portion of the proceeds from the sale of these shares. Our common stock is quoted on the Nasdaq Capital Market under the symbol “DMAX.”

We are incorporated in the state of Nevada and our corporate offices are located at 312 Farmington Avenue, Farmington, CT 06032, telephone (860) 676-1222. General information, financial news releases and filings with the Securities and Exchange Commission, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to these reports are available free of charge on our website at www.drugmax.com. We are not including the information contained on our web site as part of, or incorporating it by reference into, this prospectus.

1

RISK FACTORS

An investment in our common stock involves a high degree of risk. You should consider carefully the following information about these risks, together with the other information contained or incorporated by reference in this prospectus, before you decide to invest. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer. In this case, the market price of our common stock could decline, and you could lose all or part of your investment.

There are a large number of shares that are available for future sale under this registration statement and under the registration statement dated July 7, 2005 as supplemented; the sale of these shares may depress the market price of our common stock.

With this registration statement, we have registered the resale of an aggregate of 66,628,217 shares which consists of 44,093,432 shares of common stock and 22,046,715 shares of common stock issuable upon the exercise of warrants, issued to investors pursuant to the securities purchase agreements on September 23, 2005 and September 26, 2005 and an additional 488,070 shares issued to certain former Series A Preferred Shareholders. Under the registration statement dated July 7, 2005, we registered 25,718,731 shares. Accordingly, the two registration statements cover the resale of 92,346,948 shares.

Generally, we are required to use our best efforts to keep the registration statement continuously effective until the date which is the earlier of (i) five years after the effectiveness of this registration statement, (ii) such time as all the securities included in this registration statement have been publicly sold; and (iii) such time as all of the shares of the selling shareholders included in this registration statement may be sold pursuant to Rule 144(k) as determined by our counsel pursuant to a written opinion. During the effectiveness of the registration statement, all the shares covered hereby generally will be freely trading. We have a relatively small daily trading volume and, thus, the sale of any of the foregoing shares in the public markets may materially adversely affect the market price of our common stock.

We have a history of losses. Our independent registered public accounting firm has issued an opinion with an explanatory paragraph discussing the substantial doubt about our ability to continue as a going concern for fiscal year January 1, 2005.

The opinion from the independent registered public accounting firm on our accompanying consolidated financial statements as of January 1, 2005 and for each of the three years in the period ended January 1, 2005 was issued with an explanatory paragraph regarding the substantial doubt surrounding our ability to continue as a going concern. Additionally we incurred net losses of $39.8 million, $12.2 million and $10.1 million for the years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively and $12.2 million for the six months ended July 2, 2005. These factors raise substantial doubt regarding our ability to continue as a going concern.

The Company has determined that it will exit the legacy drug distribution business primarily providing wholesale branded pharmaceuticals to independent pharmacies and regional chain stores. Additionally, Hurricane Katrina has forced us to close our St. Rose drug distribution facility due to its inability to ship and receive product. These changes to our drug distribution operations may have a negative adverse effect on our business, financial condition and results of operations.

Our strategy has been to reduce our cost of goods sold by integrating our specialty pharmacy operations and our drug distribution operations, reducing our cost of goods sold on generic pharmaceuticals, and increasing our generic and higher margin specialty pharmaceutical sales to existing customers. In August 2005, Hurricane Katrina had a major effect on certain portions of the Gulf Coast region and resulted in the closure of our distribution facility located in St. Rose, Louisiana known as Valley Drug Company South. Prior to this time, Valley Drug Company South supported our specialty pharmacies and more than $150 million annually of our pharmaceutical needs for our specialty pharmacies were directly sourced through the St. Rose facility. Since then, we have returned to a direct to pharmacy delivery model where pharmaceuticals are delivered directly from the wholesale distributor to our pharmacies. As of October 31, 2005, this facility is still closed and non-operational. The Company is currently evaluating whether to permanently close the St. Rose facility due to its inability to ship and receive product. Also, the Company determined that it will exit the legacy drug distribution business primarily providing wholesale branded pharmaceuticals to independent pharmacies and regional chain stores. The business expected to be exited consists principally of non-core, low margin branded drug distribution wholesale. The Company expects to exit this business component during the second half of 2005 and has engaged a nationally known advisor to conduct a sale of certain assets held by this business. The closure of our Valley Drug South facility could have a negative impact on our gross margins or operating costs. Additionally, the sale or disposition of assets of our drug distribution operations could result in write-downs of our long-lived assets related to the drug distribution operations. As of July 2, 2005, long-lived assets related to our drug distribution operations included goodwill of $19.9 million.

Our success is dependent upon entering into and maintaining profitable contracts with third-party payors including: health insurers, managed care organizations and pharmacy benefit managers. Changes in reimbursement policies or efforts by payors to recoup payments already made could have an adverse effect on our business, financial condition and results of operations.

We derive a majority of our revenue from health insurers, managed care organizations and pharmacy benefit managers called third-party payors. Our contracts with these organizations enable us to obtain reimbursement on behalf of our customers for the prescription products that they purchase at our pharmacies. If we are unable to maintain existing contracts or obtain additional contracts, we may not be able to obtain reimbursement for prescription products purchased at our retail, mail order and online pharmacies, which could decrease the demand for our services and products and impair our ability to retain and expand our customer base. Furthermore, recent efforts by third-party payors to control costs have resulted in reduced rates of reimbursement for our services. If these trends continue, they could adversely affect our results of operations.

Third-party payors also have certain contractual rights permitting them to audit our records to determine if they have overpaid us. Subject to the outcome of the audit, we may be required to reimburse the third-party payor for any overpayments. If we are required to reimburse the payor, it could have a material adverse effect on us.

Changes to current Medicare laws and the implementation of the Medicare Modernization Act may reduce the amounts paid by these programs. These changes could have a material adverse effect on our gross margins, results of operations and financial condition.

In recent years, our industry has undergone significant changes driven by various efforts to reduce costs. These changes include changes to Medicare, Medicaid or similar government health benefit programs or the amounts paid by those programs for our services. The Medicare Modernization Act, the MMA, includes a major expansion of the Medicare prescription drug benefit under new Medicare Part D. Beginning in 2006, Medicare beneficiaries may enroll in prescription drug plans offered by private entities that will provide coverage of outpatient prescription drugs. The MMA changes Medicare’s payment methodology over the next three years from a system based on average wholesale price, or AWP, to one based on average selling price, or ASP. As the ASP methodology of reimbursement is implemented, it may affect our current AWP based reimbursement structure with our private payors.

2

While we cannot predict the eventual results of these law changes, the effect of the MMA has been and will be to reduce prices and gross margins on some of the drugs that we distribute. Further, if other third-party payors revise their pricing based on new methods of calculating the AWP, or based on ASP, this could have a material adverse affect on our business, financial condition and results of operation, including reducing the pricing and margins on certain of our products.

The healthcare industry in which we operate is highly competitive. Our failure to compete effectively in this segment may adversely effect our business, financial condition and results of operations.

We face a highly competitive environment in the distribution of pharmaceuticals. Many of our competitors are offering similar products and services. Some of our competitors have greater resources than we have. These competitive pressures could have a material adverse effect on our business, financial condition or results of operations.

Because many of our specialty pharmacies are located at or near the point of care, our operations are dependent upon the activities of the healthcare providers in our trade area. Changes to the blend of the healthcare providers or to their prescribing practices may adversely affect our business, financial condition or operating results.

Our strategy has been to locate our specialty pharmacies at or near the point of care. As such, we are dependent upon the healthcare providers practicing in our trade areas. We rely on the number of patient visits, the number of prescriptions written, and the types of prescriptions written by the provider. These providers may choose to relocate or close their practices, may limit their patient visits, or may prescribe a mix of products with low gross margins such as branded prescription products. These changes could have a material adverse effect on our business, results of operations and financial condition.

The implementation of our business plan is dependent upon the continued employment of our management team and attracting and retaining qualified pharmacists.

Our success depends on our ability to attract, retain and motivate our executive management team, key employees and pharmacists. We have not experienced such difficulties in the recent past. However as is generally true in the industry, if any of our senior management or key personnel with an established reputation within the industry were to leave our employment, there can be no assurance that our customers or suppliers who have relationships with such person would not purchase products from such person’s new employer, rather than from us. Further, there is currently a national shortage of pharmacists. As a result, pharmacists’ wage requirements continue to increase, thus we may not be able to attract and retain an adequate number of pharmacists required in order to maintain our existing level of customer service. The shortage of pharmacists and the increased wage requirements of pharmacists could have a material adverse effect on our business, result of operations and financial condition.

Our business could be adversely affected if relations with our primary supplier are terminated; substantially all of our supplier agreements are terminable at will.

In December 2004, we entered into a new primary warehouse agreement with D&K Healthcare Resources, Inc. (“D&K”) pursuant to which we are required to purchase primarily all of our products for sale in our specialty pharmacies from D&K. Although we purchase products from many different brand name and generic pharmaceutical manufacturers and while we believe that if we were to cease to be able to purchase products directly from D&K, we could secure the same products through other sources, including other distributors; there is a risk that our costs would increase if our primary warehouse agreement is terminated. On August 30, 2005 D&K was acquired by McKesson Corporation. It is unclear as to whether the acquisition of D&K by McKesson Corporation will have any impact on our operations. McKesson Corporation has assumed the primary warehouse agreement previously held with D&K.

Our operations are subject to extensive regulations. Changes to these regulations or failure to comply with these regulations may adversely affect our business, financial condition or operating results.

We are subject to extensive federal, state and local licensing and registration laws and regulations with respect to our business, including our pharmacy and franchise operations and the pharmacists we employ. Regulations in these areas often involve subjective interpretation and we do not know if our attempts to comply with these regulations will be deemed sufficient by the appropriate regulatory agencies. While we believe we have satisfied our licensing and registration requirements and continue to actively monitor our compliance with these requirements, we cannot assure you that such monitoring will be adequate to achieve full compliance. Violations of any of these regulations could result in various penalties, including suspension or revocation of our licenses or registrations, and seizure of our inventory or monetary fines, any of which could adversely affect our operating results. See “Business.”

3

Our disclosure controls and procedures are not effective.

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

During the six months ended July 2, 2005, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures and have determined that the following material weaknesses exist with regard to our drug distribution operations:

• Inadequate staffing and supervision that may lead to the untimely identification and resolution of certain accounting matters;

• Failure to perform timely cutoff and reviews; and

• Inadequate preparation and insufficient review and analysis of certain financial statement account reconciliations.

  

We continue to improve and refine our internal controls and we are committed to remediating the material weaknesses in disclosure controls as expeditiously as possible. Lack of certain disclosure controls and procedures, could result in a misstatement of our consolidated financial statements.

Pharmaceutical manufacturers have prevented drug distributors from purchasing inventory in advance of pharmaceutical price increases. This trend could have a material adverse effect on our business, results of operations and financial condition.

Historically, our suppliers offered cash discounts for prompt payments, inventory buying opportunities, rebates, negotiated deals and other promotional opportunities. A portion of our gross margin was derived from our ability to purchase inventory in advance of pharmaceutical price increases. Pharmaceutical manufacturers have begun to increase their control over the pharmaceutical supply channel by using inventory management agreements (“IMAs”). Under most IMAs, we are prevented from purchasing product in advance of pharmaceutical price increases. Additionally, the IMAs restrict our ability to purchase products from alternate sources. We believe these changes have negatively impacted our results of operations and will continue to have a negative effect on our business, results of operations and financial condition.

We may require additional capital to implement our growth strategy.

In order to implement our growth strategy, we may need additional capital resources and may incur, from time to time, additional indebtedness, the terms of which will depend on market and other conditions. We cannot be certain that additional financing will be available to us on acceptable terms, if at all. As a result, we may not be able to fully pursue our growth strategy. Further, additional financing may involve the issuance of equity or debt securities that would reduce the percentage ownership of our then current shareholders.

  

4

CAUTION ABOUT FORWARD-LOOKING STATEMENTS

Some of the statements in this prospectus constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our business or our industry’s actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by any forward-looking statements. Such statements include, in particular, statements about our plans, strategies, prospects, changes and trends in our business and the markets in which we operate as described in this prospectus and any amendment or supplement to this prospectus. In some cases, you can identify forward-looking statements by terminology such as “may,”  “will,”  “could,”  “would,”  “should,”  “expect,”  “plan,”  “anticipate,”  “intend,”  “believe,”  “estimate,”  “forecast,”  “predict,”  “propose,”  “potential” or “continue” or the negative of those terms or other comparable terminology. These statements are only predictions.

Important factors that could cause actual results to differ materially from our forward-looking statements are set forth in the section of this prospectus entitled “Risk Factors” and in the section entitled “Risk Factors” in any amendment or supplement to this prospectus. These factors are not intended to represent a complete list of the general or specific factors that may affect us. It should be recognized that other factors, including general economic factors and business strategies, may be significant, now or in the future, and the factors set forth in this prospectus may affect us to a greater extent than indicated. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in this prospectus. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

We caution the reader that the risk factors contained in or incorporated into this prospectus may not be exhaustive. We operate in a continually changing business environment, and new risk factors emerge from time to time. Management cannot predict these new risk factors, nor can it assess the impact, if any, of these new risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward-looking statements. Accordingly, forward-looking statements should not be relied upon as a prediction of actual results.

USE OF PROCEEDS

We will not receive any proceeds from the sale of common stock by the selling shareholders. All of the net proceeds from the sale of our common stock will go to the selling shareholders. However, we will receive proceeds upon the exercise of warrants held by the selling shareholders.

SELLING SHAREHOLDERS

We are filing this registration statement to register the resale of an aggregate of 66,628,217 shares of our common stock and common stock issuable upon the exercise of warrants issued pursuant to securities purchase agreements entered into by us with certain qualified institutional buyers and accredited investors on September 23, 2005 and September 26, 2005 and shares issued to certain former Series A Preferred Stockholders.

The Securities Purchase Agreements

On September 23, 2005 and September 26, 2005, we entered into securities purchase agreements to sell to selling shareholders an aggregate of 44,093,432 shares of our common stock and warrants to purchase 22,046,715 shares of our common stock for an aggregate of $51,104,340. The offering was executed in two traunches at market price as determined by the closing bid price on each day. A purchase agreement for the first traunch was executed on September 23, 2005, for an aggregate of $47,814,265. The unit price for each share of common stock and corresponding warrant to purchase one half share of common stock was $1.1525. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.09 per share. A purchase agreement for the second traunch executed on September 26, 2005, for an aggregate of $3,290,075. The unit price of the common stock and corresponding warrant was $1.2625. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.20 per share. The Company used a Black Scholes pricing model to determine the fair value of each warrant which was determined to be $0.0625.

We are filing the registration statement of which this prospectus is a part in order to register the resale of the shares and the common stock underlying the warrants issued pursuant to the securities purchase agreements. We are required to keep the registration effective until the earlier of the date (i) five years after the effectiveness of this registration statement, (ii) the selling stockholders have distributed all of the shares subject to this prospectus and (ii) the selling stockholders’ common stock becomes eligible for sale pursuant to Rule 144(k) under the Securities Act of 1933, as amended.

The common stock and warrants were issued pursuant to an exemption from the registration requirements of the Securities Act of 1933, pursuant to Section 4(2) of the Act and/or Regulation D promulgated thereunder since, among other things, the transaction did not involve a public offering, the investors were accredited investors and/or qualified institutional buyers, the investors had access to information about us and their investment, the investors took the securities for investment and not resale, and we took appropriate measures to restrict the transfer of the securities.

5

Ownership Table

The following table sets forth the common stock ownership of the selling stockholders as of October 31, 2005, including the number of shares of common stock issuable to the selling shareholders upon the exercise of warrants held by the selling shareholders. Other than as set forth in the following table, the selling shareholders have not held any position or office or had any other material relationship with us or any of our predecessors or affiliates within the past three years. The selling shareholders may sell all, some or none of their shares in this offering. See “Plan of Distribution.”

The number and percentage of shares beneficially owned is determined in accordance with Rule 13d-3 of the Securities Exchange Act of 1934, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rule, beneficial ownership includes any shares as to which the selling shareholder has sole or shared voting power or investment power and also any shares, which the selling shareholder has the right to acquire within 60 days. The information as to the number of shares of our common stock owned by each selling security holder is based upon our books and records and the information provided by our transfer agent. The actual number of shares of common stock issuable upon the conversion of the convertible preferred stock is subject to adjustment depending on, among other factors, the future market price of the common stock, and could be materially less or more than the number estimated in the table.

We may amend or supplement this Prospectus, from time to time, to update the disclosures set forth in the following table. Because the selling shareholders identified in the table may sell some or all of the shares owned by them which are included in this Prospectus, and because there are currently no agreements, arrangements or understandings with respect to the sale of any of the shares, other than the lock up and registration rights agreement discussed above, no estimate can be given as to the number of shares available for resale hereby that will be held by the selling shareholders upon termination of this offering. Therefore, we have assumed for the purposes of the following table that the selling shareholders will sell all of the shares owned beneficially by them, which are covered by this Prospectus.

Name of selling security holder	Shares of Common Stock Included in Prospectus (1)		Number of Shares Beneficially Owned Before Offering		Percentage of Common Stock Owned Before the Offering		Beneficial Ownership After the Offering		Percentage of Common Stock Owned After Offering
MedCap Partners, L.P. (2)		11,713,667		7,809,111		11.91%		0		0
MedCap Master Fund, L.P. (3)		1,301,833		1,489,390		2.27%		0		0
Brookbend & Co., nominee for Janus Venture Fund (4)		9,150,000		6,100,000		9.31%		0		0
Third Point Partners L.P. (5)		967,500		645,000		*		0		0
Third Point Partners Qualified L.P. (6)		427,500		285,000		*		0		0
Third Point Offshore Fund, Ltd. (7)		4,777,500		3,185,000		4.86%		0		0
Third Point Ultra Ltd. (8)		352,500		235,000		*		0		0
BTG Investments, LLC (9)		5,206,074		3,470,716		5.30%		0		0
SF Capital Partners Ltd. (10)		3,906,000		2,604,000		3.97%		0		0
Trustman C/O STI Classic Small Cap Growth Fund (11)		3,904,500		2,603,000		3.97%		0		0
Prism Offshore Fund, Ltd. (12)		1,992,750		1,328,500		2.02%		0		0
Prism Partners QP, LP (13)		619,200		412,800		*		0		0
Prism Partners, LP (14)		1,138,050		758,700		1.16%		0		0
Zeke, L.P.(15)		2,602,500		1,735,000		2.65%		0		0
Midsummer Investment, LTD.(16)		2,737,369		2,612,259		2.64%		0		0
Bear Stearns Securities Corp. FBO Custodian J. Steven Emerson IRA II (17)		1,953,000		1,302,000		3.96%		0		0
Islandia L.P.(18)		1,825,036		1,741,588		2.64%		0		0
MicroCapital Fund LP(19)		1,050,000		700,000		*		0		0
Micro Capital Fund, Ltd.(20)		450,000		300,000		*		0		0
Straus Partners L.P. (21)		716,100		477,400		*		0		0
Straus-GEPT Partners L.P.(22)		585,900		390,600		*		0		0
Lazarus Investment Partners LLLP (23)		1,302,000		868,000		1.32%		0		0
SRB Greenway Capital (QP), L.P. (24)		789,000		526,000		*		0		0
SRB Greenway Capital, L.P. (25)		113,100		75,400		*		0		0
SRB Greenway Offshore Operating Fund, L.P. (26)		73,650		49,100		*		0		0
GRT Healthcare Offshore Ltd. (27)		303,600		202,400		*		0		0
GRT Healthcare, L.P. (28)		477,900		318,600		*		0		0
Heller Capital Investments, LLC (29)		525,000		350,000		*		0		0
Clarion Capital Corporation (30)		390,456		260,304		*		0		0
Meadowbrook Opportunity Fund LLC (31)		390,000		260,000		*		0		0
Bristol Investment Fund, Ltd. (32)		375,678		334,529		*		0		0
Diamond Opportunity Fund, LLC (33)		325,500		217,000		*		0		0
Nite Capital, L.P.(34)		260,302		173,535		*		0		0
Magnetar Capital Master Fund, Ltd.(35)		3,564,000		2,376,000		3.62%		0		0
The Crown Advisors #5 (36)		120,000		80,000		*		0		0
The Crown Advisors #3 (36)		75,000		50,000		*		0		0
Crown Investment Partners, LP (37)		166,052		159,253		*		0		0

6

*	Less than 1%
(1)	Includes of all of the shares issuable upon the exercise of the warrants. The selling shareholder has contractually agreed to restrict its ability to convert or exercise its warrants and receive shares of our common stock such that the number of shares of common stock held by it and its affiliates after such conversion or exercise does not exceed 4.99% of the then issued and outstanding shares of common stock.
(2)	C. Fred Toney may be deemed to be the control person of the shares owned by such entity.
(3)	C. Fred Toney may be deemed to be the control person of the shares owned by such entity.
(4)	William H. Bales may be deemed to be the control person of the shares owned by such entity.
(5)	Daniel S. Loeb the Managing Member of Third Point Advisors, LLC which is the General Partner of Third Point Partners Qualified L.P. may be deemed to be the control person of the shares held by Third Point Partners Qualified L.P.
(6)	Daniel S. Loeb, the Managing Member of Third Point Advisors, LLC which is the General Partner of Third Point Partners  L.P. may be deemed to be the control person of the shares held by Third Point Partners  L.P.
(7)	Daniel S. Loeb, Director of Third Point Offshore Fund, Ltd. may be deemed to be the control person of the shares held by such entity.
(8)	John Banks, Director of Third Point Ultra Ltd. may be deemed to be the control person of the shares held by such entity.
(9)	Gordon J. Roth and Byron C. Roth may be deemed to be the control persons of the shares owned by such entity.
(10)	Michael A. Roth and Brian J. Stark may be deemed to be the control persons of the shares owned by such entity.
(11)	Mark Garfinkel may be deemed to be the control person of the shares owned by such entity.
(12)	Charles Jobson, Managing Member, Delta Partners, LLC, Investment Manager may be deemed to be the control person of the shares owned by such entity.
(13)	Charles Jobson, Managing Member, Delta Partners, LLC, Investment Manager, Managing Member, Delta Investment Partners, LLC, General Partner, may be deemed to be the control person of the shares owned by such entity.
(14)	Charles Jobson, Managing Member, Delta Partners, LLC, Investment Manager, Managing Member, Delta Advisors, LLC, General Partner, may be deemed to be the control person of the shares owned by such entity.
(15)	Edward N. Antoian may be deemed to be the control person of the shares owned by such entity.
(16)	Midsummer Capital, LLC is the investment manager to Midsummer Investment Ltd. By virtue of such relationship, Midsummer Capital, LLC may be deemed to have dispositive power over the shares owned by Midsummer Investment Ltd. Midsummer Capital, LLC disclaims beneficial ownership of such shares. Mr. Michel Amsalem and Mr. Scott Kaufman have delegated authority from the members of Midsummer Capital, LLC with respect to the shares of common stock owned by Midsummer Investment Ltd. Messrs. Amsalem and Kaufman may be deemed to share dispositive power over the shares of our common stock owned by Midsummer Investment Ltd. Messrs. Amsalem and Kaufman disclaim beneficial ownership of such shares of our common stock and neither person has any legal right to maintain such delegated authority.
(17)	J. Steven Emerson may be deemed to be the control person of the shares owned by such entity.
(18)	Richard O. Berner, Edgar R. Berner and Thomas R. Berner may be deemed the control persons of the shares owned by such entity.
(19)	Chris A. Jarrous may be deemed to be the control person of the shares owned by such entity.
(20)	Chris A. Jarrous may be deemed to be the control person of the shares owned by such entity.
(21)	Melville Straus may be deemed to be the control person of the shares owned by such entity.
(22)	Melville Straus may be deemed to be the control person of the shares owned by such entity.
(23)	Justin Borus may be deemed to be the control person of the shares owned by such entity.
(24)	Steven R. Becker may be deemed to be the control person of the shares owned by such entity.
(25)	Steven R. Becker may be deemed to be the control person of the shares owned by such entity.
(26)	Steven R. Becker may be deemed to be the control person of the shares owned by such entity.
(27)	Timothy A. Krockuk, the Managing Member of GRT Capital Partners, LLC may be deemed to be the control person of the shares owned by GRT Healthcare Offshore Ltd.
(28)	Timothy A. Krockuk, the Managing Member of GRT Capital Partners, LLC, which is the Managing Member of GRT Health Care GP, LLC, which is the General Partner of GRT Healthcare, LP. may be deemed to be the control person of the shares owned by GRT Healthcare Offshore Ltd.
(29)	Ronald I. Heller may be deemed to be the control person of the shares owned by such entity.
(30)	Morton A. Cohen may be deemed to be control person of the shares owned by such entity.
(31)	Michael Ragins may be deemed to be control person of the shares owned by such entity.
(32)	Paul Kessler, as manager of Bristol Capital Advisors, LLC, the investment manager to Bristol Investment Funds, Ltd. has voting and investment control over the securities held by Bristol Investment Fund, Ltd. Mr. Kessler disclaims beneficial ownership of the securities held by Bristol Investment Fund, Ltd.
(33)	David Hoken in his capacity as Manager of Diamond Opportunity Fund, LLC may be deemed to be control person of the shares owned by such entity. Mr. Hoken disclaims beneficial ownership of these shares.
(34)	Keith Goodman, Manager of the General Partner, may be deemed to be control person of the shares owned by such entity. Mr. Goodman disclaims beneficial ownership of these shares.
(35)	Alec Libowitz, the control person of Magnetar Capital Partners, LLC, has a controlling interest in Magnetar Financial, LLC, the investment advisor to Magnetar Capital Master Fund Ltd.
(36)	Chris Pauli, President of the Crown Advisor, LLC, may be deemed the control person of the shares owned by such entity.
(37)	Chris Pauli, Managing Member of the General Partner, may be deemed the control person of the shares owned by such entity.

7

PLAN OF DISTRIBUTION

The Selling Stockholders and any of their pledgees, donees, transferees, assignees and successors-in-interest may, from time to time, sell any or all of their shares of Common Stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The Selling Stockholders may use any one or more of the following methods when selling shares:

• ordinary brokerage transactions and transactions in which the broker-dealer solicits Investors;

• block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction;

• purchases by a broker-dealer as principal and resale by the broker-dealer for its account;

• an exchange distribution in accordance with the rules of the applicable exchange;

• privately negotiated transactions;

• to cover short sales made after the date that this Registration Statement is declared effective by the Commission;

• broker-dealers may agree with the Selling Stockholders to sell a specified number of such shares at a stipulated price per share;

• a combination of any such methods of sale; and

• any other method permitted pursuant to applicable law.

The Selling Stockholders may also sell shares under Rule 144 under the Securities Act, if available, rather than under this prospectus.

Broker-dealers engaged by the Selling Stockholders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the Selling Stockholders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The Selling Stockholders do not expect these commissions and discounts to exceed what is customary in the types of transactions involved.

The Selling Stockholders may from time to time pledge or grant a security interest in some or all of the Shares owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell shares of Common Stock from time to time under this prospectus, or under an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act of 1933 amending the list of selling stockholders to include the pledgee, transferee or other successors in interest as selling stockholders under this prospectus.

Upon the Company being notified in writing by a Selling Stockholder that any material arrangement has been entered into with a broker-dealer for the sale of Common Stock through a block trade, special offering, exchange distribution or secondary distribution or a purchase by a broker or dealer, a supplement to this prospectus will be filed, if required, pursuant to Rule 424(b) under the Securities Act, disclosing (i) the name of each such Selling Stockholder and of the participating broker-dealer(s), (ii) the number of shares involved, (iii) the price at which such the shares of Common Stock were sold, (iv)the commissions paid or discounts or concessions allowed to such broker-dealer(s), where applicable, (v) that such broker-dealer(s) did not conduct any investigation to verify the information set out or incorporated by reference in this prospectus, and (vi) other facts material to the transaction. In addition, upon the Company being notified in writing by a Selling Stockholder that a donee or pledgee intends to sell more than 500 shares of Common Stock, a supplement to this prospectus will be filed if then required in accordance with applicable securities law.

The Selling Stockholders also may transfer the shares of Common Stock in other circumstances, in which case the transferees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus.

The Selling Stockholders and any broker-dealers or agents that are involved in selling the shares may be deemed to be “underwriters” within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. Discounts, concessions, commissions and similar selling expenses, if any, that can be attributed to the sale of Securities will be paid by the Selling Stockholder and/or the purchasers. Each Selling Stockholder has represented and warranted to the Company that it acquired the securities subject to this registration statement in the ordinary course of such Selling Stockholder’s business and, at the time of its purchase of such securities such Selling Stockholder had no agreements or understandings, directly or indirectly, with any person to distribute any such securities.

The Company has advised each Selling Stockholder that it may not use shares registered on this Registration Statement to cover short sales of Common Stock made prior to the date on which this Registration Statement shall have been declared effective by the Commission. If a Selling Stockholder uses this prospectus for any sale of the Common Stock, it will be subject to the prospectus delivery requirements of the Securities Act. The Selling Stockholders will be responsible to comply with the applicable provisions of the Securities Act and Exchange Act, and the rules and regulations thereunder promulgated, including, without limitation, Regulation M, as applicable to such Selling Stockholders in connection with resales of their respective shares under this Registration Statement.

The Company is required to pay all fees and expenses incident to the registration of the shares, but the Company will not receive any proceeds from the sale of the Common Stock. The Company has agreed to indemnify the Selling Stockholders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act.

8

DESCRIPTION OF SECURITIES TO BE REGISTERED

Common Stock. This registration statement relates to 66,628,217 shares of our common stock that is owned or may be acquired by the selling shareholders. As of October 31, 2005, there were 66,545,415 shares of common stock issued and outstanding, held of record by approximately 843 registered stockholders. Our common stock is traded on the Nasdaq Capital Market System under the symbol “DMAX.” Each holder of common stock is entitled to one vote per share held of record on all matters submitted to a vote of the stockholders. All shares of common stock are entitled to participate in any distributions or dividends that may be declared by the board of directors, subject to any preferential dividend rights of outstanding shares of preferred stock. Subject to prior rights of creditors, all shares of common stock are entitled, in the event of our liquidation, dissolution or winding up, to participate ratably in the distribution of all our remaining assets, after distribution in full of preferential amounts, if any, to be distributed to holders of preferred stock. There are no sinking fund provisions applicable to the common stock. Our common stock has no preemptive or conversion rights or other subscription rights. All of the shares of common stock offered under this prospectus will, when issued, be fully paid and non-assessable.

LEGAL MATTERS

Sichenzia Ross Friedman Ference LLP will review the validity of the common stock offered by this prospectus.

EXPERTS

The consolidated financial statements as of January 1, 2005 and December 27, 2003 and for each of the three years in the period ended January 1, 2005 included in this prospectus and the related consolidated financial statement schedule included elsewhere in the registration statement have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report appearing herein (which report expresses an unqualified opinion and includes explanatory paragraphs concerning (i) uncertainty regarding the Company’s ability to continue as a going concern and (ii) the changes in the methods of accounting for negative goodwill, goodwill and other intangible assets to conform to Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”), and has been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.

9

BUSINESS

DrugMax, Inc. (“DrugMax,” the “Company,” or “we” and other similar pronouns) is a specialty pharmacy and drug distribution provider formed by the merger (the “Merger”) on November 12, 2004 of DrugMax, Inc. and Familymeds Group, Inc. (“FMG”). We work closely with doctors, patients, managed care providers, medical centers and employers to improve patient outcomes while delivering low cost and effective healthcare solutions. As of October 31, 2005, we operated one drug distribution facility, under the Valley Drug Company name, and 77 specialty pharmacies in 13 states under the Arrow Pharmacy & Nutrition Center and Familymeds Pharmacy brand names. As a result of Hurricane Katrina, on August 30, 2005, we were forced to temporarily discontinue our distribution operations located in St. Rose, Louisiana known as Valley Drug Company South.

The Company has determined as part of its ongoing merger integration plan that it will exit the legacy drug distribution business primarily providing wholesale branded pharmaceuticals to independent pharmacies and regional chain stores. The business expected to be exited consists principally of non-core, low margin branded drug distribution wholesale operations. The Company believes that exiting this lower gross margin component of its distribution business, exiting will improve the Company's operating results, while maintaining its core strategy of specialty pharmaceutical distribution. The Company expects to exit this business during the second half of 2005 and has engaged a nationally known advisor to conduct a sale of certain assets owned by Valley Drug Company.

We are focused on building an integrated specialty drug distribution platform. Our platform is designed to provide services for the treatment of acute and complex health diseases including chronic medical conditions such as cancer, diabetes and pain management. We often serve defined population groups on an exclusive, closed panel basis to maintain costs and improve patient outcomes. We offer a comprehensive selection of brand name and generic pharmaceuticals, non-prescription healthcare-related products, and diagnostic supplies to our patients, independent pharmacies, physicians, clinics, long-term care and assisted living centers.

We are incorporated in the state of Nevada and our corporate offices are located at 312 Farmington Avenue, Farmington, CT 06032, telephone (860) 676-1222. Our common stock is listed on Nasdaq Capital Market under the stock symbol “DMAX.” General information, financial news releases and filings with the Securities and Exchange Commission, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to these reports are available free of charge on our website at www.drugmax.com.

Strategy

General

Our primary strategy is to build an integrated specialty drug distribution platform with multiple sales channels. We believe this can be accomplished through the integration of our drug distribution operations and specialty pharmacy operations and through internal growth and acquisitions. We believe the integration will uniquely enable us to supply specialty drugs to patients, physicians and other healthcare providers.

Our strategy is to locate specialty clinic pharmacy operations near or in medical facilities. The strategy is driven by the location concept whereby situating a clinical or specialty type pharmacy near the point of acute or chronic care provides us with a “first capture” opportunity to service patients when they visit their physicians. This also enables us to collaborate with the physician in the therapeutic regimen and may provide opportunities for lower cost generic or alternative pharmaceutical therapy. We have recently placed significant emphasis on the higher cost injectable and orally administered specialty pharmaceuticals. Our focus for the future is increasing pharmacy revenues through these “Specialty Pharmaceuticals.” As such, we believe that our pharmacies are most appropriately called “specialty pharmacies.”

We offer a comprehensive selection of branded and generic prescription and non-prescription pharmaceuticals, specialty injectables, generic biologics, compounded medicines, healthcare-related products and diagnostic products. These products are used for the treatment of acute or chronic medical conditions and may be purchased through our drug distribution centers, specialty pharmacies and online through www.familymeds.com and www.drugmax.com.

Specialty Pharmacy Operations

As of October 31, 2005, we operated 77 corporate pharmacies and franchisedseven pharmacies in 13 states. 37 of our pharmacies are located at the point of care between physicians and patients, oftentimes inside medical office buildings or on a medical campus. The majority of our revenues come from the sale of prescription pharmaceuticals which represented approximately 94% of our net revenues for the six months ended July 2, 2005 and fiscal year ended January 1, 2005. Our corporate pharmacies provide services to over 400,000 acute or chronically ill patients each year, many with complex specialty and medical product needs.

We operate our pharmacies under the trade names Familymeds Pharmacy (“Familymeds”) and Arrow Pharmacy and Nutrition Centers (“Arrow”). Familymeds is primarily used for pharmacies outside of New England. The Familymeds locations were primarily originated by acquiring the base pharmacy business from HMO’s, hospitals and regional independent operators. The locations are primarily clinic size with a small footprint, usually less than 1,500 sq. ft. The Arrow trade name is used in New England where most of the pharmacies were opened as a start-up or re-acquired from former Arrow franchise operators who opened these legacy pharmacy operations as start-ups. These locations are primarily apothecary size, approximately 2,000 sq. ft. and may be more visible as retail type locations, though primarily nearby hospitals or medical campus locations. Our locations in Michigan and certain locations elsewhere throughout our trading area may have a larger footprint to accommodate a comprehensive inventory of nutritional and home medical supplies.

There are more than 5,000 locations at or near the point of care available to open additional pharmacies nationwide. Because of our experience with operating pharmacies in these locations, we believe we are uniquely positioned to target these sites and increase our core pharmacy market presence. We also believe that we can grow our specialty pharmacy operations through selective acquisitions. By increasing our store count, through acquisitions or the opening of new pharmacies at or near the point of medical care, we believe we can increase our customer base, leverage our existing infrastructure and expand our geographic reach.

Our strategy also includes offering our customers multiple sales channels by which our customers can purchase our products. We offer them the opportunity to purchase a broad array of health-related products online including a comprehensive selection of prescription medications, vitamins and nutritional supplements, home medical equipment, and health and beauty aids directly from our specialty pharmacies, by mail order, and via the Internet. Familymeds.com is the foundation of our Internet offering. This website is one of the few sites certified as a Verified Internet Pharmacy Provider Site (VIPPS) by the National Association of Boards of Pharmacy (NABP). The VIPPS program is a voluntary certification program designed to approve and identify online pharmacies that are appropriately licensed and prepared to practice internet pharmacy. Familymeds.com is the non-prescription Internet commerce partner for select prescription benefit managers (PBMs) including Medco Health. We will continue to pursue opportunities to partner with managed care and others providers to increase our sales through our internet sales channel.

10

Our newest strategy is to operate and locate Worksite Pharmacies ^SM (pharmacies that service a single, defined population) for large employers who are seeking to control overall employee prescription drug benefit expenditures while maintaining high employee satisfaction through improved accessibility. Our Worksite Pharmacies ^SM offer prescription services exclusively to the employer’s covered population. We can deliver these services at or near the employer’s work site by opening, staffing and managing a pharmacy. Our initial results have proven that this strategy reduces healthcare costs for the employer. Our research has shown that many employers, especially large Fortune 500 companies are seeking more aggressive methods to control healthcare expenditures, especially the pharmacy component of benefits. We have identified key large employers, those with over 2,000 employees in a single location, to be target opportunities for this type of Employer Sponsored Worksite Pharmacy^SM. In late 2004, we opened a Worksite Pharmacy ^SM in the employee center of the Mohegan Sun Casino in Connecticut with more than 10,000 employees and dependents as potential patients. Through July 2, 2005, our performance at this location has exceeded our expectations.

We have developed special clinical compliance and generic therapeutic programs to attract patients and reduce pharmacy expenditures. We also have active programs designed to improve patient compliance and to reduce costs. We have three major programs, a prescription compliance program called Reliable Refill, a discount plan called Senior Save15 and an automated telephony system designed to notify patients of recalls, provide refill reminders and notify our customers of other important information. Reliable Refill is a compliance program that identifies prescriptions that are due to be filled and schedules them for filling before the patient has run out of the previous prescriptions. Our Senior Save15 program, introduced prior to the Medicare Modernization Act, is our own discount program that gives senior customers access to all of our prescription and over-the-counter products at discounted prices. Our programs are designed to improve medication therapy management among patients with chronic therapeutic needs especially the elderly population. Our data warehouse identifies these patients and allows us to target these patients with special needs. We believe our data warehouse and our medication therapy management programs uniquely position our company as a specialty pharmacy provider.

Although we do not offer franchises for sale at this time, in the case of renewing franchisees, we are subject to the disclosure requirements of the Federal Trade Commission and may be subject to pre-sale disclosure requirements and registration requirements of various state laws regulating the offer and sale of franchises. In addition, with respect to our existing franchisees, we also are subject to certain state laws regulating the franchisor-franchisee relationship. Failure to comply with these regulations could result in substantial financial penalties. As of October 31, 2005, we held franchise agreements for seven stores and are not materially dependent on these agreements. We believe the number of our franchised pharmacy locations will decrease over the next few years.

Drug Distribution Operations

Prior to the Merger, the distribution operations sold branded and generic pharmaceuticals, over-the-counter products, health and beauty aids, nutritional supplements and other related products through distribution centers located in Pittsburgh and New Castle, Pennsylvania and in St. Rose, Louisiana. In July 2004, the Pittsburgh facility was closed and its customers were transitioned to the Louisiana facility. Pharmaceuticals were distributed primarily to independent pharmacies and a limited number of small regional chain retail pharmacy operators. Historically, dock to dock services were also offered. These services included receiving pharmaceuticals on behalf of distributor directly from pharmaceutical companies then re-shipping to the distributor. While the dock to dock business component of the distribution operation has been a significant source of revenues historically, it had been a low margin business. Therefore, in 2004 prior to the Merger, the Company discontinued this service. The strategy, prior to the Merger, was to focus efforts on growing generic pharmaceutical revenues which have higher margins. Additionally, from time-to-time, the strategy included seeking to acquire additional complementary product lines that enhanced its ability to provide higher-margin pharmaceuticals.

Valley Drug Company, the New Castle facility, carries a full-line of pharmaceuticals and is an authorized distributor for the vast majority of branded pharmaceutical manufacturers. An outside sales force has been used to generate sales from this facility.

The Company has determined as part of its ongoing merger integration plan that it will exit the legacy drug distribution business primarily providing wholesale branded pharmaceuticals to independent pharmacies and regional chain stores. The business expected to be exited consists principally of non-core, low margin branded drug distribution wholesale operations. The Company believes that exiting this lower gross margin component of its distribution business, exiting will improve the Company's operating results, while maintaining its core strategy of specialty pharmaceutical distribution. The Company expects to exit this business during the second half of 2005 and has engaged a nationally known advisor to conduct a sale of certain assets owned by Valley Drug Company.

11

Hurricane Katrina and Impact on Strategy

Since the Merger, our strategy has been to reduce our cost of goods sold by integrating our specialty pharmacy operations and our drug distribution operations, reducing our cost of goods sold on generic pharmaceuticals, and increasing our generic and higher margin specialty pharmaceutical sales to existing customers. In August 2005, Hurricane Katrina had a major effect on certain portions of the Gulf Coast region and resulted in the closure of our distribution facility located in St. Rose, Louisiana known as Valley Drug South. Prior to this time, Valley Drug South supported our specialty pharmacies and more than $150 million annually of our pharmaceutical needs for our specialty pharmacies were directly sourced through the St. Rose facility. Since then, we have returned to a direct to pharmacy delivery model where pharmaceuticals are delivered directly from the wholesale distributor to our pharmacies. As of October 31, 2005, this facility is still closed and non-operational. The Company is currently evaluating whether to permanently close the St. Rose facility due to its inability to ship and receive product.

Industry Overview

The pharmaceutical distribution industry faces numerous challenges and opportunities. While we expect significant growth in this segment of healthcare due to an aging population, the introduction of new pharmaceuticals, rising pharmaceutical prices, increased use of injectable drug therapies, and the expiration of patents for branded pharmaceuticals; we also face challenges due to changes in contracting practices, new Medicare and Medicaid regulations, and third party reimbursement issues.

Recent or newer drug product introductions are fostering significant opportunities for specialty drug distribution and management. It is estimated, according to IMS Health 2004, that specialty drugs are greater than a $20 billion component of a more than $200 billion prescription drug market. Specialty pharmacy and distribution key drivers depend on many factors, but primarily (1) methods of administration and delivery of the drug; (2) reimbursement and billing relationships with payers and employers; and (3) key referrals and clinical services offered to patients and physicians.

In recent years, our industry has undergone significant changes driven by various efforts to reduce costs. These changes include changes to Medicare, Medicaid or similar government health benefit programs or the amounts paid by those programs for our services. The Medicare Modernization Act, or the MMA, includes a major expansion of the Medicare prescription drug benefit under new Medicare Part D. Beginning in 2006, Medicare beneficiaries may enroll in prescription drug plans offered by private entities that will provide coverage of outpatient prescription drugs. The MMA changes Medicare’s payment methodology over the next three years from a system based on average wholesale price, or AWP, to one based on average selling price, or ASP. As the ASP methodology of reimbursement is implemented, it may affect our current AWP based reimbursement structure with our private payors.

While we cannot predict the eventual results of these law changes, the effect of the MMA has been and will be to reduce prices and gross margins on some of the drugs that we distribute. Further, if other third-party payors revise their pricing based on new methods of calculating the AWP, or based on ASP, this could have a material adverse affect on our business, financial condition and results of operation, including reducing the pricing and margins on certain of our products.

While current federal laws prohibit the importation of pharmaceuticals, there is increasing pressure on the FDA to change current law to allow individuals to purchase pharmaceuticals from outside of the United States of America. Legislation has been introduced at the state and federal level advocating such a change. Some of the congressional sponsors of importation legislation say that the bill could lower drug prices for seniors by 30 to 50 percent. If these laws are changed to permit the re-importation of pharmaceuticals into the United States, this could have a negative impact on our results of operations.

Despite the potential negative effects of legislation that would permit re-importation, the National Association of Chain Drug Stores (“NACDS”) expects an increase in the number of prescriptions dispensed, going from 3.2 billion in 2003 to nearly 4.5 billion in 2010, yet the supply of all community pharmacists is expected to increase only 9.2% versus an estimated 47% increase in prescriptions. If we are unable to successfully attract and retain pharmacists this trend could have a negative impact on our business and results of operations in the future.

Historically, our suppliers offered cash discounts for prompt payments, inventory buying opportunities, rebates, negotiated deals and other promotional opportunities. A portion of our gross margin was derived from our ability to purchase inventory in advance of pharmaceutical price increases. Pharmaceutical manufacturers have begun to increase their control over the pharmaceutical supply channel by using inventory management agreements (“IMAs”). Under most IMAs, we are prevented from purchasing product in advance of pharmaceutical price increases. Additionally, the IMAs restrict our ability to purchase products from alternate sources. We believe these changes have negatively impacted our results of operations and will continue to have an ongoing negative impact on our legacy drug distribution business, results of operations and financial condition in the future.

New Credit Facility

On October 12, 2005, we entered into a secured senior credit agreement with Wells Fargo Retail Finance, LLC (“WFRF”), which matures in October 2010. Available credit under this facility is based on eligible receivables, inventory and prescription files, as defined in the agreement. The $65 million of maximum availability is reduced by a $7.0 million reserve. While the credit facility currently does not require compliance with financial covenants, the company has the ability to reduce this reserve by agreeing to implement certain financial covenants. As of October 31, 2005, $24.3 million was outstanding on the line and $20.1 million was available for additional borrowings. The New Credit Facility is secured by substantially all of our assets.

12

Change in Primary Supplier Relationship

Prior to the Merger between DrugMax and FMG, our specialty pharmacies relied primarily on AmerisourceBergen Drug Corporation ("ABDC") for our prescription drugs, over-the-counter products and personal care items through a direct to store (“DSD”) method of distribution. Under the agreement with ABDC dated May 1, 2003, our specialty pharmacies were required to purchase a minimum of 90% of our pharmaceuticals from ABDC. This agreement was due to expire May 1, 2006. Our drug distribution operations also maintained a relationship with ABDC. In September 2004, prior to the Merger with FMG, ABDC ceased supplying product on credit to our drug distribution operations. On October 22, 2004, ABDC filed a lien in Louisiana against Valley Drug Company South’s assets. In December 2004, we entered into a prime warehouse supplier agreement with D&K Healthcare Resources, Inc. (“D&K”). Under the terms of this agreement, D&K agreed to be our primary supplier of prescription drugs, over-the-counter pharmaceuticals, and other merchandise generally available from D&K. The D&K agreement contains certain volume requirements and has an initial term of two years, which renews automatically for successive one-year periods unless either party provides the other party a written non-renewal notice. Either party may terminate this agreement for material breach, and subsequent failure to cure, including failure to make payments when due. On August 30, 2005 D&K was acquired by McKesson Corporation and our agreement was assumed by McKesson.

Further, on March 14, 2005, we entered into a new strategic relationship with ABDC, which includes a new supply agreement pursuant to which ABDC will supply us with certain branded and generic prescription products, thus providing us with a secondary source for our prescription product needs. The ABDC agreement has a term of 3 years and has no minimum purchase requirements.

On March 21, 2005, we converted the remaining $23,000,000 in accounts payable that we owed to ABDC (after having repaid $6,000,000 on March 23, 2005 in connection with the closing of the new vendor supply agreement) into a subordinated convertible debenture in the original principal amount of $11,500,000 (the “Subordinated Debenture”) and a subordinated promissory note in the original principal amount of $11,500,000 (the “Subordinated Note”). In connection therewith, ABDC released its lien against the assets of Valley Drug Company South.

Competition

The healthcare industry in which we operate is highly competitive. Our failure to compete effectively in this segment may adversely affect our business, financial condition and results of operations. Many of our competitors are offering similar products and services. Some of our competitors have greater resources than we have. These competitive pressures could have a material adverse effect on our business, financial condition or results of operations.

We compete on the basis of breadth of our product lines, marketing programs, support services and pricing. Increased competition may result in price reductions, reduced gross margins and loss of market share. Competitors, many of which have significantly greater financial, technical, marketing and other resources, include:

• Chain drugstores including CVS, Rite Aid and Walgreen’s;

• Mass marketers including Target and Wal-Mart;

• Warehouse clubs including BJ’s, Costco and Sam’s Club;

• Mail order prescription providers including Express Scripts and Medco;

• Online drugstores including drugstore.com;

• Specialty medication providers including Accredo Health and Priority Healthcare; and

• Wholesale drug distributors including AmerisourceBergen Drug Corporation and Cardinal Health.

In addition, certain of our competitors have developed or may be able to develop e-commerce operations that compete with our pharmacy and e-commerce operations, and may be able to devote substantially more resources to web site development and systems development. The online commerce market is rapidly evolving and intensely competitive. We expect competition to intensify in the future because barriers to entry are minimal, and current and new competitors can launch new web sites at relatively low cost.

Government Regulations and Legal Uncertainties

We are subject to extensive federal, state and local licensing and registration laws and regulations with respect to our business, including our pharmacy and franchise operations and the pharmacists we employ. Regulations in these areas often involve subjective interpretation and we do not know if our attempts to comply with these regulations will be deemed sufficient by the appropriate regulatory agencies. We believe we have satisfied our licensing and registration requirements and continue to actively monitor our compliance with these requirements. However, violations of any of these regulations could result in various penalties, including suspension or revocation of our licenses or registrations, and seizure of our inventory or monetary fines, any of which could adversely affect our operations and damage our brand.

We also are subject to requirements under the Controlled Substances Act and Federal Drug Enforcement Agency regulations, as well as state and local laws and regulations related to our pharmacy operations such as registration, security, record keeping 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 distribution of adulterated or misbranded homeopathic remedies or other drugs is prohibited. Violations could result in substantial fines and other monetary penalties, seizure of the misbranded or adulterated items, and/or criminal sanctions. We also are required to comply with the Dietary Supplement Health and Education Act when selling dietary supplements and vitamins.

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In addition, our pharmacy compounding services are subject to FDA regulation. The FDA also regulates drug advertising and promotion, including direct-to-patient advertising, done by or on behalf of manufacturers and marketers. If we expand our product and service offerings, more of our products and services will likely be subject to Food and Drug Administration regulation. Failure to comply with these regulations could result in significant penalties which may be material. We also are subject to federal statutes and state legislation that prohibit the offer, payment, solicitation, or receipt of any remuneration directly or indirectly in exchange for, or intended to induce, the referral of patients or the sale or purchase of services and supplies covered by certain governmental programs (Anti-Kickback Laws). We also are subject to the Ethics in Patient Referrals Act of 1989, commonly referred to as “Stark Law,” which prohibits the billing of federally-funded health care programs for certain health care services provided by entities with which the referring physician have certain financial arrangements. Violations of these laws are punishable by civil sanctions, including significant monetary penalties and exclusion from participation in the Medicare and Medicaid programs, and criminal sanctions in the case of the Anti-Kickback Law. Due to the breadth and complexity of these laws, there can be no assurance that we, any of our personnel, or any of our significant customers or business partners, will not become subject to sanctions that could have a material adverse effect on our business, financial condition and results of operations. Additionally, the sanctioning or exclusion of a manufacturer or recipient of our products or services, even for activities unrelated to us, could also have a material adverse effect on our business, financial condition and results of operations.

Pursuant to the Omnibus Budget and Reconciliation Act of 1990 and similar state and local laws and regulations, our pharmacists are required to offer counseling 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 our pharmacists. In the event that our pharmacists or our mail order and online pharmacies provide erroneous or misleading information to our customers, we may be subject to liability or negative publicity that could have an adverse impact on our business. Although we carry general, professional and product liability insurance, our insurance may not cover potential claims of this type or may not be adequate to protect us from all liability that may be imposed.

The Health Insurance Portability and Accountability Act of 1996, and regulations promulgated thereunder (collectively “HIPAA”), require health care providers, like us, to comply with specified standards for electronic billing and other transactions and to adopt and comply with policies and procedures to protect the security and privacy of an individual’s protected health information consistent with HIPAA requirements, and prohibit the use or dissemination of an individual’s protected health information without the individual’s consent. There are significant civil monetary and criminal penalties for failure to comply.

Although we do not offer franchises for sale at this time, in the case of renewing franchisees, we are subject to the disclosure requirements of the Federal Trade Commission and may be subject to pre-sale disclosure requirements and registration requirements of various state laws regulating the offer and sale of franchises. In addition, with respect to our existing franchisees, we also may be subject to certain state laws regulating the franchisor-franchisee relationship. Failure to comply with these regulations could result in substantial financial penalties. As of October 31, 2005, we held franchise agreements for seven stores and are not materially dependent on these agreements.

We also are subject to laws governing our relationship with employees, including minimum wage requirements, overtime and working conditions. Increases in the federal minimum wage rate, employee benefit costs or other costs associated with employees could adversely affect our results of operations. Other legislation being considered at the federal and state level could affect our business including state legislation related to the regulation of nonresident pharmacies. We believe we are currently in material compliance with the state and federal laws and regulations governing our business.

As a publicly traded company, we are subject to numerous federal securities laws and regulations. These laws include the Securities Act of 1933 and the Securities Exchange Act of 1934 and related rules and regulations promulgated by the SEC. These laws and regulations impose significant requirements in the areas of financial reporting, accounting practices, and corporate governance among others.

In recent years, our industry has undergone significant changes driven by various efforts to reduce costs. These changes include changes to Medicare, Medicaid or similar government health benefit programs or the amounts paid by those programs for our services. The Medicare Modernization Act, the MMA, includes a major expansion of the Medicare prescription drug benefit under new Medicare Part D. Beginning in 2006, Medicare beneficiaries may enroll in prescription drug plans offered by private entities that will provide coverage of outpatient prescription drugs. The MMA changes Medicare’s payment methodology over the next three years from a system based on average wholesale price, or AWP, to one based on average selling price, or ASP. As the ASP methodology of reimbursement is implemented, it may affect our current AWP based reimbursement structure with our private payors.

While current federal laws prohibit the importation of pharmaceuticals, there is increasing pressure on the FDA to change current law to allow individuals to purchase pharmaceuticals from outside of the United States of America. Legislation has been introduced at the state and federal level advocating such a change. Some of the congressional sponsors of importation legislation say that the bill could lower drug prices for seniors by 30 to 50 percent. If these laws are changed to permit the re-importation of pharmaceuticals into the United States, this could have a negative impact on our results of operations.

Recently, many states have passed or have proposed laws and regulations that are intended to protect the integrity of the supply channel. These laws and regulations may also restrict our ability to purchase drugs from alternate source supplier and are likely to increase the overall regulatory burden and costs associated with our drug distribution operations.

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The costs associated with complying with various federal and state regulations could be significant and the failure to comply with any such legal requirements could have a significant impact on our business, results of operations and financial condition.

Intellectual Property

We hold various trademarks, trade names, service marks, and business licenses that are essential to the operation of our business. These trademarks, service marks and licenses have varying statutory lives and are generally renewable indefinitely. Although we believe that our trademarks and other proprietary products do not infringe upon the intellectual property rights of any third parties, third parties may assert infringement claims against us from time to time.

Employees

At October 31, 2005, we employed 865 persons, 492 of which represented full-time employees. Approximately 21 % of our employees are pharmacists. Labor unions do not represent any of these employees.

PROPERTIES.

We do not own or hold any legal or equitable interest in any real estate, but instead lease all of our locations, including our corporate headquarters, which is located at 312 Farmington Avenue, in Farmington, Connecticut. Our headquarters contains approximately 30,000 square feet. The lease for our headquarters expires April 30, 2007, with a monthly lease payment of $51,496.

We also lease our various pharmacy locations many of which are within medical complexes. The leases vary as to rental amounts, expiration dates, renewal options and other rental provisions.

We also lease an administrative facility containing approximately 5,216 square feet of office space, located at 25400 US Highway 19 North, Suite 137, Clearwater, Florida 33763. The term of the lease for the Clearwater office is for five years expiring January 14, 2008, with an initial monthly lease payment of $6,303. We are currently attempting to either sublet this facility or negotiate a termination of this lease.

Our drug distribution operations are operated out of two locations, one in New Castle, Pennsylvania and one in St. Rose, Louisiana. The Pennsylvania facility is located at 209 Green Ridge Road, New Castle, Pennsylvania 16105. We lease this premises from Becan Development LLC, a related party. This facility consists of approximately 45,000 square feet of office, warehouse, shipping and distribution space. The premises are leased pursuant to a lease with a base term of 15 years expiring December 30, 2018, with a monthly lease payment of $17,000.

We also lease our Louisiana facility, which is located at 10016 River Road, St. Rose, Louisiana, 70087, from River Road Real Estate LLC, a related party. The building consists of approximately 39,000 square feet of air-conditioned office and warehouse space. The lease for the St. Rose location is for a term of five years expiring October 2006, and carries a monthly lease payment of $15,000. As a result of Hurricane Katrina, on August 30, 2005, we were forced to temporarily discontinue operations at this facility. Because area wide logistics continue to inhibit the delivery and receipt of merchandise, the Company is currently evaluating the feasibility of reopening this facility.

With the exception of our St. Rose, Louisiana facility, we believe all of our as presently conducted properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.

LEGAL PROCEEDINGS.

We are not presently subject to any material legal proceedings other than as set forth below:

In March 2000, prior to the Merger with FMG, we acquired all of the issued and outstanding shares of common stock of Desktop Corporation, a Texas corporation located in Dallas, Texas, pursuant to an Agreement and Plan of Reorganization by and among the Company, K. Sterling Miller, Jimmy L. Fagala and HCT Capital Corp. On February 7, 2002, Messrs. Miller and Fagala filed a complaint in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, Florida, alleging, among other things, that we had breached the Reorganization Agreement by failing to pay 38,809 shares of our common stock to the plaintiffs. The complaint also includes a count of conversion and further alleges that we breached the employment agreements with Messrs. Miller and Fagala, for which the plaintiffs seek monetary damages. On March 11, 2002, we filed our answer, affirmative defenses and counterclaim against plaintiffs and HCT Capital Corp. (“HCT”), in which we alleged, among other things, that plaintiffs had breached the Reorganization Agreement by misrepresenting the state of the acquired business, that we were entitled to set off our damages against the shares which the plaintiffs are seeking and further seeking contractual indemnity against the plaintiffs. On April 16, 2002, HCT filed its answer, counterclaim against us and cross-claim against the plaintiffs. In December 2003, we entered into a Settlement Agreement and Release with HCT whereby we unconditionally, fully and finally released each other from any future claims relative to the matter. HCT paid $1,000 to us in consideration for the release. There has been little activity by Messrs. Miller and Fagala with regard to this matter, and we are currently considering how to proceed in light of this inactivity. We intend to vigorously defend the actions filed against us and to pursue our counterclaim. We cannot reasonably estimate any possible future loss or recovery as a result of this matter. While it is known that the plaintiffs are seeking 38,809 shares of our stock and monetary damages for breach of contract and conversion, we are unable to estimate the exact amount of the damages sought by the plaintiffs as they have not yet made a demand for a specific amount of damages. Accordingly, we have made no provision in the accompanying financial statements for resolution of this matter.

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On November 12, 2003, prior to the Merger with FMG, Phil & Kathy’s, Inc. d/b/a Alliance Distributors (“Alliance”) served a complaint against us seeking to recover the non-payment of open invoices approximating $2.0 million based upon an alleged breach of contract for the sale of pharmaceuticals. On December 18, 2003, we filed an answer and counterclaim. The counterclaim seeks to recover lost profits and other damages relating to the sale of twenty allegedly counterfeit bottles of Lipitor by Alliance to us, which we later sold to QK Healthcare, Inc. (“QK”). Alleging that the Lipitor was counterfeit, QK later sued us for breach of contract, violations of the implied warranty of merchantability and fraud. Accordingly, one of our subsidiaries, Valley Drug Company (“Valley”), also filed a separate action against Alliance for breach of an indemnification agreement related to the sale of the twenty bottles of Lipitor that precipitated a lawsuit against Valley by QK in New York. We intend to vigorously defend Alliance’s breach of contract action and prosecute our counterclaim. At January 1, 2005, the amount that we recorded as a trade payable balance due Alliance on the above was approximately $1.5 million. Under our indemnification agreement with Alliance, pursuant to which Alliance is required to indemnify us for all losses, expenses and damages sustained by us as a result of product sold to us by Alliance, and our right to offset our losses, expenses and damages against any amounts due to Alliance, we reduced the payable to Alliance by the cost of the faulty Lipitor sold to us by Alliance plus the settlement and litigation expenses incurred by us directly as a result of the Lipitor, or an aggregate of $0.5 million. We have recorded the foregoing trade payable of $1.5 million as of July 2, 2005, and we believe this estimate is reasonable based on the information we have at this time; however, we cannot reasonably estimate the total future possible loss that we will sustain as a result of the Alliance complaint or the possible recovery through our counterclaim or Valley’s consolidated action. We expect to mediate this matter during the month of November 2005.

On February 23, 2005, a former employee of DrugMax, James Hostetler, filed suit in the United States District Court for the Northern District of Illinois Eastern Division claiming DrugMax breached a compensation agreement. Specifically, Mr. Hostetler claims he is owed a commission of an unspecified amount as a result of the sale of securities consummated on December 2, 2004. For an aggregate purchase price of $17 million, we sold to certain qualified institutional buyers and accredited investors an aggregate of 17,000 shares of our Series A convertible redeemable preferred stock. We have filed our response and intend to defend ourselves vigorously. Management does not believe Mr. Hostetler is entitled to any such commissions as he played no role in the sale of these securities. As a result of the early stage of this proceeding, we cannot currently estimate its outcome and have made no provision in the accompanying financial statements for the resolution of the matter.

From time to time, we may become involved in additional litigation arising in the ordinary course of our business. In the opinion of management, after consultation with counsel, the disposition of these matters arising in the normal course of business is not likely to have a material adverse effect, individually or in the aggregate, on our financial position or results of operations.

 

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MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Our common stock is traded on the Nasdaq Capital Market under the symbol “DMAX.” The following table sets forth the closing high and low bid prices for our common stock on the Nasdaq Capital Market for each calendar quarter during our last two fiscal years and the first three quarters of fiscal 2005, as reported by Nasdaq. Prices represent inter-dealer quotations without adjustment for retail markups, markdowns or commissions and may not represent actual transactions.

	Common Stock
	High		Low
2003
First Quarter	$	1.43	$	1.00
Second Quarter	$	1.85	$	1.03
Third Quarter	$	2.65	$	1.21
Fourth Quarter	$	2.80	$	1.85
2004
First Quarter	$	5.87	$	1.99
Second Quarter	$	4.96	$	4.01
Third Quarter	$	4.79	$	3.06
Fourth Quarter	$	4.04	$	3.28
2005
First Quarter	$	3.55	$	2.98
Second Quarter	$	3.25	$	2.35
Third Quarter	$	2.59	$	1.09

As of October 31, 2005, there were approximately 843 shareholders of record of our common stock and 65,545,415 shares of common stock outstanding. Historically, we have not declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings to fund the development and growth of our business. Any future determination to pay dividends on our common stock will depend upon our results of operations, financial condition and capital requirements, applicable restrictions under any credit facilities or other contractual arrangements and such other factors deemed relevant by our Board of Directors. Our current credit facility prohibits the payment of dividends. See, “Management’s Discussion and Analysis of Financial Condition and Operating Results.”

SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA

The selected consolidated financial information below has been derived from DrugMax’s (formerly Familymeds Group, Inc.) consolidated financial statements. On November 12, 2004, Familymeds Group, Inc. (“FMG”) merged with DrugMax, Inc. and for accounting purposes FMG was the acquirer. The historical information below is that of FMG and includes financial results for the acquired operations of DrugMax, Inc. for the post-Merger period from November 12, 2004 through January 1, 2005 for the year ended January 1, 2005. The results for the six months ended July 2, 2005 include both the results of FMG and that of the acquired operations of DrugMax, Inc. See Note 2 of the Notes to Consolidated Financial Statements on page F-9 for a discussion of the basis of the presentation and significant accounting policies of the consolidated financial information set forth below. You should read this information in conjunction with DrugMax’s (formerly Familymeds Group, Inc.) consolidated financial statements and unaudited condensed consolidated financial statements and related notes included elsewhere in this prospectus. As described below, in 1999 and 2000 we acquired certain pharmacy stores, and in 2001 we closed certain underperforming stores which affect the comparability of period to period results. In 2001, we decided to close our automated distribution facility and significantly reduced the capacity of our mail order and e-commerce business. Additionally, as discussed above, the drug distribution operations are included subsequent to November 12, 2004 which also affects the comparability of period to period results.

The data as of January 1, 2005 and December 27, 2003, and for the three years in the period ended January 1, 2005, is derived from our audited consolidated financial statements included elsewhere herein. The data as of December 28, 2002, December 29, 2001 and December 30, 2000 and for the years ended December 29, 2001 and December 30, 2000 is derived from our audited consolidated financial statements not included elsewhere herein. The data as of July 2, 2005 and for the six month periods ended July 2, 2005 and June 26, 2004 is derived from our unaudited condensed consolidated financial statements, included elsewhere herein, which, in the opinion of management, reflects all adjustments (consisting only of normal recurring accruals) necessary to present fairly, in accordance with accounting principles generally accepted in the United States of America, the information contained therein. The results of operations for the six months period ended July 2, 2005 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2005.

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	Six Months Ended						Fiscal Years Ended
in thousands, except for share amounts	July 2, 2005(1)			June 26, 2004			January 1, 2005			December 27, 2003			December 28, 2002			December 29, 2001			December 30, 2000
							(53 weeks) (1)			(52 weeks)			(52 weeks)			(52 weeks)(2)(3)			(52 weeks)(3)(4)
Statements of Operations Data
Net revenues	$	169,286		$	112,027		$	239,231		$	218,015		$	223,513		$	264,180		$	205,446
Gross margin		23,129			23,388			46,844			47,418			46,022			46,695			41,393
Selling, general and administrative expenses		30,987			22,185			46,681			47,492			47,799			60,246			70,432
Depreciation and amortization expense(5)		2,412			2,412			4,773			5,297			5,076			9,918			7,289
Impairments of long-lived assets(6)		—			—			31,260			792			593			18,231			2,435
(Gain) loss on disposal of fixed assets and intangible assets		8			(773	)		(1,027	)		(365	)		(610	)		288			—
Operating loss		(10,279	)		(436	)		(34,843	)		(5,798	)		(6,836	)		(41,988	)		(38,763	)
Interest expense(7)		(2,182	)		(1,494	)		(5,654	)		(7,200	)		(4,026	)		(4,443	)		(5,023	)
Interest income		14			24			46			70			13			260			712
Other income (expense)		286			157			607			754			1,443			(41	)		(277	)
Loss before cumulative change in accounting principles		(12,161	)		(1,749	)		(39,844	)		(12,174	)		(9,406	)		(46,212	)		(43,351	)
Cumulative effect of changes in accounting principles(8)		—			—			—			—			(710	)		—			—
Net loss		(12,161	)		(1,749	)		(39,844	)		(12,174	)		(10,116	)		(46,212	)		(43,351	)
Preferred stock dividends		(2,254	)		(2,593	)		(10,796	)		(5,657	)		(5,657	)		(5,263	)		(2,759	)
Net loss available to common stockholders	$	(14,415	)	$	(4,342	)	$	(50,640	)	$	(17,831	)	$	(15,773	)	$	(51,475	)	$	(46,110	)
Common Share Data
Basic and diluted loss per share:
Loss available to common shareholders before cumulative changes in accounting principles	$	(0.73	)	$	(3.37	)	$	(13.57	)	$	(13.83	)	$	(11.69	)	$	(40.00	)	$	(35.83	)
Cumulative effect of adoption of SFAS No. 141 and SFAS No. 142		—			—			—			—			(0.55	)		—			—
Net loss available to common shareholders	$	(0.73	)	$	(3.37	)	$	(13.57	)	$	(13.83	)	$	(12.24	)	$	(40.00	)	$	(35.83	)
Shares used in basic and diluted net loss per share(9)		19,754			1,289			3,731			1,289			1,289			1,287			1,287
Dividends declared		—			—			—			—			—			—			—

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	As of
	July 2, 2005			January 1, 2005			December 27, 2003			December 28, 2002			December 29, 2001			December 30, 2000
Balance Sheet Data
Working (deficit) capital	$	(17,992	)	$	(7,875	)	$	(37,604	)	$	4,683		$	(19,301	)	$	18,909
Total assets		94,310			95,598			44,153			49,319			61,093			109,769
Revolving credit facility, promissory notes payable and current portion of long-term debt		47,457			35,155			37,696			34,873			31,597			35,787
Long-term accounts payable(10)		—			22,425			—			—			—			—
Subordinated notes payable(10)		20,064			—			—			—			—			—
FMG Redeemable preferred stock		—			—			109,325			103,668			98,011			83,172
Total stockholders’ equity (deficit)		(2,930	)		5,855			(133,888	)		(116,234	)		(100,712	)		(50,204	)
Store Locations
Corporate-owned		77			77			82			85			93			112
Franchised		7			8			7			7			19			43

   

(1)	Includes results for the drug distribution operations subsequent to the November 12, 2004 Merger.
(2)	In 2001, FMG closed 21 underperforming stores and opened one location. At fiscal year-end 2001, FMG operated 93 corporate-owned locations. In December 2001, FMG decided to close its automated distribution facility.
(3)	Includes amortization of goodwill in the amount of $0.2 million in 2001, $0.1 million in 2000 and $0.1 million in 1999. In 2002, FMG adopted SFAS No. 142 (Goodwill and other intangible assets) and thus, beginning in 2002, no longer amortizes goodwill.
(4)	In December 2000, FMG made a 38-store acquisition, purchased four stores and closed four stores. At fiscal year-end 2000, FMG operated 113 corporate-owned locations.
(5)	Depreciation and amortization expense decreased from fiscal 2001 to fiscal 2002 as a result of the reduction in operations in the e-commerce business.
(6)	Write-downs of long-lived assets in fiscal 2004 include a goodwill impairment charge of $31.0 million relating to goodwill acquired from the Merger. Write-downs of long-lived assets in fiscal 2001 includes $4.8 million related to FMG’s automated distribution facility and mail order and e-commerce business, $3.0 million related to impairment of prescription files at underperforming locations and $10.4 million related to a strategic alliance agreement related to the e-commerce business.
(7)	Includes $0.4 million and $0.1 million of noncash interest for the six months ended July 2, 2005 and June 26, 2004, respectively. Includes $1.7 million, $4.3 million and $0.2 million of noncash interest in fiscal 2004, 2003 and fiscal 2002, respectively. $4.0 million of the $4.3 million noncash interest expense in fiscal 2003 relates to interest on convertible notes issued to former FMG shareholders, which notes were converted to common stock in connection with the Merger.
(8)	During fiscal 2002, FMG adopted new accounting standards related to goodwill resulting in a charge of $0.9 million and negative goodwill resulting in a benefit of $0.2 million.
(9)	The weighted average shares used in the calculation of net loss per share have been retroactively restated to give effect to the Merger of DrugMax with FMG. The transaction was accounted for as a reverse Merger, with FMG deemed the accounting acquirer. Accordingly, for periods prior to the Merger, the shares outstanding represent the number of shares that former FMG common shareholders would have received in the transaction, on an as-if converted basis, had the Merger consideration not been distributed to the preferred shareholders based on liquidation values. For periods subsequent to the Merger, shares outstanding represent actual weighted average shares outstanding.
(10)	Represents the long-term portion of the $23.0 million of accounts payable that were converted into two subordinated notes payable on March 21, 2005.

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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The following Pro Forma Unaudited Condensed Consolidated Statement of Operations for the year ended January 1, 2005 assumes the Merger had occurred as of the beginning of the year presented. The Pro Forma Unaudited Condensed Consolidated Statement of Operations gives effect to the Merger using purchase accounting as required by accounting principles generally accepted in the United States. For accounting purposes FMG was deemed to be the acquiror.

The pro forma financial information should be read in conjunction with, and is qualified in its entirety by, the historical consolidated financial statements and interim condensed consolidated financial statements, including the notes thereto, of DrugMax, Inc. (formerly FMG and its subsidiaries) included herein. The pro forma financial information, while helpful in illustrating the financial characteristics of the combined company under one set of assumptions, does not reflect the impact of possible revenue enhancements, expense reductions or asset dispositions, among other factors, that may result as a consequence of the Merger and, accordingly, does not attempt to predict or suggest future results. It also does not necessarily reflect what the historical results of the combined company would have been had the companies been combined as of the beginning of the period presented.

PRO FORMA UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(in thousands, except per share data)

	DrugMax (formerly Familymeds Group, Inc. and subsidiaries)			Acquired Drug Distribution Operations(1)
	Fiscal Year Ended January 1, 2005			January 1, 2004 to November 12, 2004			Pro Forma Adjustments			Pro Forma Adjusted
Net revenues	$	239,231		$	141,318					$	380,549
Cost of sales		192,387			141,062						333,449
Gross margin		46,844			256						47,100
Operating expenses:
Selling, general and administrative expenses		46,681			11,034			5,849	(2)		63,564
Depreciation and amortization		4,773			209			386	(3)		5,368
Impairments on long-lived assets		31,260			—						31,260
Gain on disposal of fixed assets and intangible assets		(1,027	)		—						(1,027	)
Total operating expenses		81,687			11,243			6,235			99,165
Operating loss		(34,843	)		(10,987	)		(6,235	)		(52,065	)
Other income (expense)		607			(792	)					(185	)
Interest expense, net		(5,608	)		(1,473	)					(7,081	)
Loss before income tax expense		(39,844	)		(13,252	)		(6,235	)		(59,331	)
Income tax expense		—			(1,418	)					(1,418	)
Net loss		(39,844	)		(14,670	)		(6,235	)		(60,749	)
FMG redeemable preferred stock dividends		(10,665	)		—			10,665	(4)		—
DrugMax preferred stock dividends		(131	)		—						(131	)
Net loss available to common stockholders	$	(50,640	)	$	(14,670	)	$	4,430		$	(60,880	)
Per Share Information:
Net loss available to common stockholders basic and diluted	$	(13.57	)	$	(1.93	)				$	(3.14	)
Weighted average shares outstanding—basic and diluted		3,731	(5)		7,621						19,345	(6)

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NOTES TO PRO FORMA UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

Overview

On March 19, 2004, Familymeds Group, Inc. (“FMG”) entered into an Agreement and Plan of Merger which was amended on July 1, 2004 and also on October 11, 2004 (as amended, the “Merger Agreement”) with DrugMax, Inc. (“DrugMax”). Under the terms of the Merger Agreement, on November 12, 2004, FMG merged into DrugMax, and DrugMax became the surviving corporation in the Merger (the “Merger”). The separate existence of FMG ceased and the name of the surviving corporation is DrugMax. DrugMax issued 10,470,507 shares of DrugMax common stock to certain FMG preferred shareholders and FMG note holders in connection with the Merger. The FMG note holders received 2,106,982 DrugMax shares in exchange for their notes and the remaining 8,363,525 DrugMax shares were allocated to FMG’s preferred shareholders based on liquidation preferences. FMG’s common shareholders received no consideration in the Merger. In addition, DrugMax issued 656,047 shares of DrugMax restricted common stock and options to purchase 1,574,369 shares of DrugMax common stock at $0.57 per share to certain employees and directors of FMG that remained employees and directors of DrugMax after the Merger. Additionally, DrugMax issued warrants to purchase 3,532,890 shares of DrugMax common stock at $2.61 per share to the former FMG stockholders, warrant holders and note holders. The warrants were allocated among the FMG stockholders, warrant holders and note holders in the same manner as the DrugMax common stock.

The Merger was treated as a purchase of DrugMax by FMG for accounting purposes. Accordingly, for periods prior to the Merger, the information herein is historical information of FMG. The purchase price of approximately $44.6 million represents the sum of (i) the fair value ($37.8 million) of the 8,196,652 shares of DrugMax common stock, $.001 par value, retained by the existing common stockholders of DrugMax, Inc. (the fair value of the shares of DrugMax common stock is based on the average closing price of DrugMax common stock of $4.61 per share for the five-day period from March 18, 2004 to March 24, 2004, which includes two business days before and after the announcement of the Merger), (ii) $5.2 million based on a Black Scholes valuation for 2.2 million outstanding DrugMax options, all of which vested in connection with the Merger, and (iii) FMG Merger costs of approximately $1.6 million.

The assets acquired and liabilities assumed of DrugMax were recorded based upon their estimated fair values at the acquisition date. In order to record amounts at fair value, historical carrying amounts for accounts receivable, inventories, accounts payable and other amounts were adjusted to reflect estimated realizable amounts as of the acquisition date. Additionally, $1.9 million of outstanding checks not previously recorded by DrugMax in error were recorded primarily via a charge to cost of sales. The effect of these adjustments is reflected in the accompanying historical statement of operations for the acquired drug distribution operations for the period from January 1, 2004 to November 12, 2004. The results of operations of the acquired drug distribution operations have been included in DrugMax’s consolidated statement of operations since the date of acquisition. The excess of the purchase price over the estimated fair values of the underlying assets acquired and liabilities assumed was allocated to goodwill. The allocation of the purchase price is based upon preliminary estimates and assumptions. Accordingly, the allocation is subject to revision when DrugMax receives final information, including appraisals and other analyses. Revisions to the fair values, which may be significant, will be recorded by DrugMax as further adjustments to the purchase price allocations. DrugMax is also in the process of integrating the operations of all its acquired businesses and expects to incur costs relating to such integrations. These costs may result from integrating operating systems, relocating employees, closing facilities, reducing duplicative efforts and exiting and consolidating other activities. These costs will be recorded on DrugMax’s consolidated balance sheets as adjustments to the purchase price or on DrugMax’s consolidated statements of operations as expenses, as appropriate.

Following is a summary of the preliminary purchase price allocation (in thousands):

Cash and cash equivalents	$	346
Accounts receivable		11,321
Inventories		13,551
Prepaid expenses and other current assets		501
Property and equipment		1,565
Goodwill		50,813
Identified intangibles		5,600
Debt		(12,323	)
Accounts payable		(23,692	)
Accrued expenses		(3,124	)
Purchase price	$	44,558

The fair value adjustments included in the preliminary allocation of purchase price above primarily consisted of (i) $1.8 million to DrugMax’s authorized distributor licenses with an estimated life of 15 years, (ii) $3.2 million to trademarks and copyrights with an estimated life of 15 years and (iii) $0.6 million to customer lists with an estimated life of 5 years. The purchase price is based on certain preliminary estimates and subject to change as more information is available.

Goodwill was tested for impairment as of January 1, 2005. The fair value of the reporting unit was estimated using future cash flows, and a non-cash impairment charge of $31.0 million was recognized. The impairment of the drug distribution reporting unit is a result of lower revenues and profitability since the Merger terms were announced on March 20, 2004 and a decline in the fair value of DrugMax. Since the Merger terms were announced and the purchase price was determined, the drug distribution operations have experienced declining profitability as opportunities for forward buying and increased competition have negatively impacted estimated future cash flows. Additionally, DrugMax’s stock price decreased from $4.61 for the five-day period from the Merger announcement date to $3.28 as of January 1, 2005 which also negatively impacted the fair value of the reporting unit.

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In connection with the Merger, DrugMax terminated certain DrugMax employees. Total severance obligations to these employees are approximately $966,000, none of which had been paid as of January 1, 2005 and all of which are expected to be paid during fiscal 2005. The severance obligation was reflected as an accrued expense as of the Merger date. Additionally, an accrued lease liability of $85,000 was recorded related to an office location that will no longer be used.

Following is a summary of Pro Forma Adjustments:

(1) Represents DrugMax, Inc.’s operations of predecessor prior to the Merger.

(2) To record additional compensation expense in connection with the issuance of stock options and restricted stock to former FMG employees and directors.

(3) To record the amortization of the finite-lived intangible assets resulting from the Merger as follows:

	January 1, 2004 to  November 12, 2004
Patents and trademarks	$	176
Distributor contracts		105
Customer list		105
Total amortization	$	386

(4) To eliminate dividends on FMG preferred stock which stock was exchanged for common stock in connection with the Merger.

(5) Prior to the Merger, the weighted average shares outstanding reflect the number of shares that former FMG common shareholders would have received in the transaction, on an as—if converted basis, had the Merger consideration not been distributed to the preferred shareholders based on liquidation values, or approximately 1.3 million shares. For periods subsequent to the Merger, shares outstanding represent actual shares outstanding.

(6) Represents the average outstanding shares during the fiscal year ended January 1, 2005 assuming shares outstanding at the Merger date and additional shares issued in connection with the Merger had been outstanding the entire period. As of the Merger date, there were 8,202,053 shares of DrugMax common stock outstanding. In connection with the Merger, the shareholders and noteholders of FMG received an aggregate of 10,470,507 shares of DrugMax common stock and 646,047 restricted shares of DrugMax common stock was issued to certain employees and directors of FMG. Subsequent to the Merger date, 160,466 shares of common stock were issued upon exercise of employee options.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and the related notes. This discussion contains forward-looking statements based upon our current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions, as set forth under “Cautionary Statement Regarding Forward-Looking Statements.” Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to, those set forth in the following discussion and under “Risk Factors” and elsewhere in this prospectus.

Merger and Change in Fiscal Year End

On March 19, 2004, Familymeds Group, Inc. (“FMG”) entered into an Agreement and Plan of Merger with DrugMax, Inc. (“DrugMax”) which was amended on July 1, 2004 and also on October 11, 2004. Under the terms of the amended Merger agreement, on November 12, 2004, FMG merged into DrugMax, and DrugMax was the surviving corporation in the Merger (the “Merger”). The separate existence of FMG ceased and the name of the surviving corporation is DrugMax.

DrugMax issued 10,470,507 shares of DrugMax common stock to certain FMG preferred shareholders and FMG note holders in connection with the Merger. The FMG note holders received 2,106,982 DrugMax shares in exchange for their notes and the remaining 8,363,525 DrugMax shares were allocated to FMG’s preferred shareholders based on liquidation preferences. FMG’s common shareholders received no consideration in the Merger. In addition, DrugMax issued 656,047 shares of DrugMax restricted common stock and options to purchase 1,574,369 shares of DrugMax common stock at $0.57 per share to certain employees and directors of FMG that remained employees and directors of DrugMax after the Merger and issued warrants to purchase 3,532,890 shares of DrugMax common stock at $2.61 per share to the former FMG stockholders, warrant holders and note holders. The warrants were allocated among the FMG stockholders, warrant holders and note holders in the same manner as the DrugMax common stock. Immediately after the Merger, our pre-Merger stockholders, as a group, owned approximately 40%, and the FMG stockholders, employees and directors, as a group, owned approximately 60%, of our issued and outstanding shares of common stock, assuming the exercise of all stock options and warrants issued in connection with the Merger.

For accounting purposes, the Merger was accounted for as a reverse acquisition, with FMG as the acquirer. As a result, the historical financial statements of FMG became our historical financial statements, and the assets and liabilities of DrugMax acquired by FMG were accounted for under the purchase method of accounting. The results of operations of DrugMax are included in our financial statements from November 12, 2004, the effective date of the Merger. Additionally, in connection with the Merger, our board of directors converted our fiscal year end from March 31, to a 52-53 week fiscal year ending on the Saturday closest to December 31.

The fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002 are referred to herein as fiscal 2004, 2003, and 2002, respectively. Fiscal 2004 includes 53 weeks while fiscal 2003 and 2002 each included 52 weeks. The Company’s second fiscal quarter ends on the Saturday closest July 1. The second fiscal quarter of 2005 and 2004 each include 13 weeks.

Overview

DrugMax, Inc. (“DrugMax,” the “Company,” or “we” and other similar pronouns) is a specialty pharmacy and drug distribution provider formed by the merger (the “Merger”) on November 12, 2004 of DrugMax, Inc. and Familymeds Group, Inc. (“FMG”). We work closely with doctors, patients, managed care providers, medical centers and employers to improve patient outcomes while delivering low cost and effective healthcare solutions. As of October 31, 2005, we operated one drug distribution facility, under the Valley Drug Company name, and 77 specialty pharmacies in 13 states under the Arrow Pharmacy & Nutrition Center and Familymeds Pharmacy brand names. As a result of Hurricane Katrina, on August 30, 2005, we were forced to temporarily discontinue our distribution operations located in St. Rose, Louisiana known as Valley Drug Company South. Additionally, we have engaged an advisor to assist us in the sale of certain assets of our drug distribution facility located in New Castle, Pennsylvania.

We are focused on building an integrated specialty drug distribution platform. Our platform is designed to provide services for the treatment of acute and complex health diseases including chronic medical conditions such as cancer, diabetes and pain management. We often serve defined population groups on an exclusive, closed panel basis to maintain costs and improve patient outcomes. We offer a comprehensive selection of brand name and generic pharmaceuticals, non-prescription healthcare-related products, and diagnostic supplies to our patients, independent pharmacies, physicians, clinics, long-term care and assisted living centers.

Strategy

General

Our primary strategy is to build an integrated specialty drug distribution platform with multiple sales channels. We believe this can be accomplished through the integration of our drug distribution operations and specialty pharmacy operations and through internal growth and acquisitions. We believe the integration will uniquely enable us to supply specialty drugs to patients, physicians and other healthcare providers.

The strategy is driven by the location concept whereby situating a clinical or specialty type pharmacy near the point of acute or chronic care provides us with a “first capture” opportunity to service patients when they visit their physicians. This also enables us to collaborate with the physician in the therapeutic regimen and may provide opportunities for lower cost generic or alternative pharmaceutical therapy. We have recently placed significant emphasis on the higher cost inject able and orally administered specialty pharmaceuticals. Our focus for the future is increasing pharmacy revenues through these “Specialty Pharmaceuticals.” As such, we believe that our pharmacies are most appropriately called “specialty pharmacies.”

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Specialty Pharmacy Operations

As of October 31, 2005, we operated 77 corporate pharmacies and franchised seven pharmacies in 13 states, respectively. 37 of our pharmacies are located at the point of care between physicians and patients, oftentimes inside medical office buildings or on a medical campus. The majority of our revenues come from the sale of prescription pharmaceuticals, which represented approximately 94% of our net revenues for the six months ended July 2, 2005. Our corporate pharmacies provide services to over 400,000 acute and chronically ill patients each year, many with complex specialty and medical product needs.

Although we do not offer franchises for sale at this time, in the case of renewing franchisees, we are subject to the disclosure requirements of the Federal Trade Commission and may be subject to pre-sale disclosure requirements and registration requirements of various state laws regulating the offer and sale of franchises. In addition, with respect to our existing franchisees, we also are subject to certain state laws regulating the franchisor-franchisee relationship. Failure to comply with these regulations could result in substantial financial penalties. As of October 31, 2005, we held franchise agreements for seven stores and are not materially dependent on these agreements. We believe the number of our franchised pharmacy locations will decrease over the next few years.

Drug Distribution Operations

Prior to the Merger in November 2004 between DrugMax and FMG, the distribution operations sold branded and generic pharmaceuticals, over-the-counter products, health and beauty aids, nutritional supplements and other related products through distribution centers located in Pittsburgh and New Castle, Pennsylvania and in St. Rose, Louisiana. In July 2004, the Pittsburgh facility was closed and its customers were transitioned to the Louisiana facility. Pharmaceuticals were distributed primarily to independent pharmacies and a limited number of small regional chain retail pharmacy operators. Historically, dock to dock services were also offered. These services included receiving pharmaceuticals on behalf of distributor directly from pharmaceutical companies then re-shipping to the distributor. While the dock to dock business component of the distribution operation has been a significant source of revenues historically, it had been a low margin business. Therefore, in 2004 prior to the Merger, the company discontinued this service. The strategy, prior to the Merger, was to focus efforts on growing generic pharmaceutical revenues which have higher margins. Additionally, from time-to-time, the strategy included seeking to acquire additional complementary product lines that enhanced its ability to provide higher-margin pharmaceuticals.

Valley Drug Company, the New Castle facility, carries a full-line of pharmaceuticals and is an authorized distributor for the vast majority of branded pharmaceutical manufacturers. An outside sales force has been used to generate sales from this facility.

The Company has determined as part of its ongoing Merger integration plan that it will exit the legacy drug distribution business primarily providing wholesale branded pharmaceuticals to independent pharmacies and regional chain stores. The business expected to be exited consists principally of non-core, low margin branded drug distribution wholesale operations. The Company believes that by exiting this lower gross margin component of its distribution business, it will improve overall operating company results, while maintaining its core strategy of specialty pharmaceutical distribution. The Company expects to exit this business component during the second half of 2005 and has engaged a nationally known advisor to conduct a sale of certain assets owned by the business.

Hurricane Katrina and Impact on Strategy

Since the Merger, our strategy has been to reduce our cost of goods sold by integrating our specialty pharmacy operations and our drug distribution operations, reducing our cost of goods sold on generic pharmaceuticals, and increasing our generic and higher margin specialty pharmaceutical sales to existing customers. In August 2005, Hurricane Katrina had a major effect on certain portions of the Gulf Coast region and resulted in the temporary closure of our distribution facility located in St. Rose, Louisiana known as Valley Drug South. Prior to this time, Valley Drug South supported our specialty pharmacies and more than $150 million annually of our pharmaceutical needs for our specialty pharmacies were directly sourced through the St. Rose facility. Since then, we have returned to a direct to pharmacy delivery model where pharmaceuticals are delivered directly from the wholesale distributor to our pharmacies. As of October 31, 2005, this facility is still closed and non-operational. The Company is currently evaluating whether to permanently close the St. Rose facility due to its inability to ship and receive product.

Comparison of Operating Results for the Three Months and Six Months Ended July 2, 2005 and June 26, 2004.

We refer to prescription products as Rx products and to the remaining products, such as over-the-counter medications, home medical equipment and home health appliances, as non-Rx products. While non-Rx reflects a smaller percentage of our overall revenues, the gross margin for non-Rx products is higher than the gross margin for Rx products. The Rx portion of the specialty pharmacy business is dependent upon a number of third party customers that pay a portion or all of the Rx cost on behalf of the customers, (“Third Party Customers”).

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Prescriptions generated by Third Party Customers represented approximately 94% of specialty pharmacy’s Rx sales in the three months ended July 2, 2005 and for the three months ended June 26, 2004. Prescriptions generated by Third Party Customers represented approximately 94% of specialty pharmacy’s Rx sales in the six months ended July 2, 2005 and for the six months ended June 26, 2004. Revenues from our drug distribution operations were $28.1 million and $58.8 million for the three months and six months ended July 2, 2005, respectively.

Net Revenues

Net revenue performance is detailed below:

	For the Three Months Ended						For the Six Months Ended
	July 2, 2005			June 26, 2004			July 2, 2005			June 26, 2004
SPECIALTY PHARMACY OPERATIONS
Net revenues (in millions) (1)	$	54.0		$	55.8		$	110.4		$	112.0
Rx % of store net revenues		94.1	%		93.7	%		94.1	%		93.5	%
Third party % of Rx net revenues		94.2	%		94.1	%		94.0	%		93.9	%
Number of corporate stores		77			76			77			76
Average same store net revenue per store (in millions)	$	0.7		$	0.7		$	1.4		$	1.5
DRUG DISTRIBUTION OPERATIONS (2)
Net revenues (in millions) (2)	$	28.1			—		$	58.8			—

(1)	Store net revenues are net of contractual allowances.
(2)	As described above, we expect to dispose of a portion of our drug distribution operations. This portion represents $19.8 million and $41.0 million of net revenues for the three and six months ended July 2, 2005, respectively.

	Three Months Ended July 2, 2005 versus June 26, 2004			Six Months Ended July 2, 2005 versus June 26, 2004
Net revenues increases (decreases) are as follows (in millions):
Specialty Pharmacy Operations:
Net effect of store openings/closings(1)	$	1.0		$	1.5
Prescription sales(2)		(2.2	)		(1.9	)
Non-Rx sales (3)		(0.7	)		(1.1	)
Drug Distribution Operations (4)		28.1			58.8
Net increase	$	26.2		$	57.3

 

(1)	The net effect of store openings/closings represents the difference in revenues by eliminating stores that were not open during the full periods compared.
(2)	Represents the impact of increased lower priced generic prescription product being sold during the periods instead of higher priced brand prescription products partially offset by the effect of price increases.
(3)	The three months and six months ended June 26, 2004 included an additional $0.8 million and $1.4 million, respectively, of net revenues from specialty diabetic sales. These sales were not recurring post May 2004.
(4)	Drug distribution operations revenue was $28.1 million in the three months ended July 2, 2005 versus none in the three months ended June 26, 2004, which was prior to the Merger. Drug distribution operations revenue was $58.8 million in the six months ended July 2, 2005 versus none in the six months ended June 26, 2004, which was prior to the Merger.

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Gross Margin

Gross margin was $10.8 million or 13.2% for the three months ended July 2, 2005 compared to $11.7 million or 20.9% for the three months ended June 26, 2004. Gross margin was $23.1 million or 13.7% for the six months ended July 2, 2005 compared to $23.4 million or 20.9% for the six months ended June 26, 2004. The decrease in the gross margin percentage is primarily the result of the inclusion of the lower gross margin drug distribution operations during the three months and six months ended July 2, 2005, which negatively impacted the gross margin percentage by approximately 710 basis points and 700 basis points, respectively. Gross margins associated with our specialty pharmacy operations were $11.0 million or 20.3% for the three months ended July 2, 2005 versus $11.7 million and 20.9% for the three months ended June 26, 2004. Gross margins associated with our specialty pharmacy operations were $22.8 million or 20.7% for the six months ended July 2, 2005 versus $23.4 million and 20.9% for the six months ended June 26, 2004. Gross (negative) margins associated with our drug distributions were ($0.2) million or (0.6)% and $0.3 million or 0.5% for the three months and six months ended July 2, 2005, respectively. Gross margin improvements are expected from purchasing synergies that will positively impact the specialty pharmacy operations and will partially offset the decline in gross margin percentage on an overall basis. Information that helps explain our gross margin trend is detailed below:

	Three Months Ended July 2, 2005 versus June 26, 2004			Six Months Ended July 2, 2005 versus June 26, 2004
Gross margin increases (decreases) are as follows (in millions):
Specialty Pharmacy Operations:
Net effect of store openings/closings(1)	$	0.2		$	0.3
Prescription gross margin		(0.6	)		(0.5	)
Non-Rx gross margin		(0.3	)		(0.4	)
Drug Distribution Operations (2)		(0.2	)		0.3
Net decrease	$	(0.9	)	$	(0.3	)

(1)

The net effect of store openings/closings represents the difference in gross margin by eliminating stores that were not open during the full periods compared.

(2)

Represents gross margin for drug distribution operations for the three months and six months ended July 2, 2005, since no gross margin was recorded for the drug distribution operations in the three months or six months ended June 26, 2004, which was prior to the Merger. Factors which negatively impacted the drug distribution operation gross margins for the three months and six months ended July 2, 2005 included lower than expected rebates and chargebacks, declines in pharmaceutical price increases, competitive selling price pressure as well as the realization of purchasing synergies for only a portion of the three months and six months ended July 2, 2005.

Total Operating Expenses

Operating expenses include selling, general and administrative (“SG&A”) expenses, depreciation and amortization expense and the gain or loss on disposal of fixed assets and intangible assets. Intangible assets include the amounts allocated to prescription files for prescriptions acquired in previous purchase business combinations of the specialty pharmacy operations. A prescription file refers to the actual prescription maintained by a pharmacy for each prescription filled. Each prescription file has monetary value to a pharmacy because when pharmacies and/or prescription files are sold, the customers are more likely to leave their accounts with the purchaser than to transfer their business to a third-party pharmacy, as such the prescription base is thought of as a repeatable source of revenue. Accordingly, when pharmacies are sold, the number of prescription files is taken into consideration when determining the purchase price of the pharmacy. Intangible assets also include goodwill, trademarks, and authorized distributor licenses which were recorded in connection with the Merger. The authorized distributor licenses permit the drug distribution operations to purchase pharmaceutical products directly from the manufacturers. Total operating expenses were $16.7 million or 20.2% of net revenues for the three months ended July 2, 2005. This compares to $11.8 million, or 21.1% of net revenues for the three months ended June 26, 2004. Total operating expenses were $33.4 million or 19.7% of net revenues for the six months ended July 2, 2005. This compares to $23.8 million, or 21.2% of net revenues for the six months ended June 26, 2004. Information that helps explain our operating expense trend is detailed below:

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	Three Months Ended July 2, 2005 versus June 26, 2004			Six Months Ended July 2, 2005 versus June 26, 2004
Operating expenses increases (decreases) are as follows (in millions):
Selling, general and administrative expenses	$	4.7	(1)	$	8.7	(2)
Gain on disposal of fixed assets and intangible assets (3)		0.0			0.8
Other, net		0.1			0.1
Net increase	$	4.8		$	9.6

(1)	The increase is mainly due to corporate office expenses of $1.2 million, which includes the costs associated with being a publicly traded Company, the inclusion of drug distribution operating expenses of $1.4 million and $2.0 million of noncash compensation charges associated with restricted stock and options granted.
(2)	The increase is due to corporate office expenses of $2.7 million, which includes the costs associated with being a publicly traded Company, the inclusion of drug distribution operating expenses of $2.7 million and $3.9 million of noncash compensation charges associated with restricted stock and options granted. Partially offsetting the increase was a reduction of $0.6 million due to fewer retail stores within the specialty pharmacy operations.
(3)	Gain on disposal of fixed assets and intangible assets related to the sale of six stores during the six months ended June 26, 2004.

Interest Expense, Net

Interest expense, net was $1.4 million and $0.7 million for the three months ended July 2, 2005 and June 26, 2004, respectively. Interest expense, net was $2.2 million and $1.5 million for the six months ended July 2, 2005 and June 26, 2004, respectively. The increase in interest expense relates to increased borrowings under the senior credit facility and interest on the ABDC subordinated notes effective March 21, 2005.

Income Taxes

No income tax benefit has been recorded in any period presented due to the uncertainty of realization of any related deferred tax asset.

Net Loss

We incurred a net loss of $7.2 million for the three months ended July 2, 2005 versus a net loss of $0.9 million for the three months ended June 26, 2004. We incurred a net loss of $12.2 million for the six months ended July 2, 2005 versus a net loss of $1.7 million for the six months ended June 26, 2004. Factors impacting these losses are discussed above.

Net Loss Available to Common Stockholders Per Share

The net loss available to common stockholders per basic and diluted share for the three months ended July 2, 2005 was $0.44 compared to a net loss per basic and diluted share for the three months ended June 26, 2004 of $1.67. The net loss available to common stockholders per basic and diluted share for the six months ended July 2, 2005 was $0.73 compared to a net loss per basic and diluted share for the six months ended June 26, 2004 of $3.37. The weighted average shares used in the calculation of net loss per share for the 2004 period have been restated to give effect to the Merger of DrugMax with FMG. The transaction was accounted for as a reverse Merger, with FMG deemed the accounting acquirer. Accordingly, for periods prior to the Merger, the shares outstanding represent the number of shares that former FMG common shareholders would have received in the transaction, on an as-if converted basis, had the Merger consideration not been distributed to the preferred shareholders based on liquidation values, or approximately 1.3 million shares. For periods subsequent to the Merger, shares outstanding represent actual shares outstanding.

Inflation and Seasonality

Management believes that inflation had no material effect on the operations or our financial condition for the three months and six months ended July 2, 2005 and June 26, 2004. Management does not believe that our business is materially impacted by seasonality; however, significant promotional activities can have a direct impact on sales volume for our distribution operations in any given quarter.

Comparison of Operating Results for the Fiscal Years Ended January 1, 2005, December 27, 2003 and December 28, 2002.

Prescriptions generated by Third Party Customers represented approximately 95% of specialty pharmacy’s Rx sales in the fiscal year ended January 1, 2005 and 94% for the fiscal year ended December 27, 2003. Revenues from our drug distribution operations were $15.8 million from the date of Merger through January 1, 2005, of which 90% represented branded pharmaceuticals, 7% represented generic pharmaceuticals and 3% represented non-Rx products.

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Net Revenues

Net revenue performance is detailed below:

	For the Fiscal Year Ended
	2004			Change %			2003			Change %			2002
SPECIALTY PHARMACY OPERATIONS
Net revenues (in millions)	$	223.4			2.5	%	$	218.0			(2.5	)%	$	223.5
Same store revenue increase(1)		3.5	%					4.9	%					4.9	%
Rx % of store net revenues(2)		93.8	%					94.3	%					95.2	%
Third party % of Rx net revenues		94.8	%					94.0	%					91.9	%
Prescriptions filled (in millions)		3.7						3.9						4.3
Number of corporate stores		77						82						85
Average same store net revenue per store (in millions)(1)	$	2.9					$	2.7					$	2.6

	2004(3)
DRUG DISTRIBUTION OPERATIONS
Net revenues (in millions)	$	15.8
Branded pharmaceuticals net revenues		90	%
Generic pharmaceuticals net revenues		7	%
Non-Rx net revenues		3	%

(1)	Computed using consolidated revenues for specialty pharmacy stores open a full year or longer.
(2)	Store net revenues are net of contractual allowances.
(3)	Includes revenues for the period from the November 12, 2004 Merger through January 1, 2005.

	Fiscal 2004 Compared to Fiscal 2003			Fiscal 2003 Compared to Fiscal 2002
Net revenues increases (decreases) are as follows (in millions):
Specialty Pharmacy Operations:
Contracted business(1)	$	—		$	(7.7	)
Net effect of store openings/closings(2)		(2.9	)		(9.8	)
Franchise royalties(3)		(0.1	)		(1.1	)
Prescription sales(4)		2.3			11.1
Effect of 53 weeks in 2004 vs. 52 weeks in 2003(5)		4.0			—
Non-Rx mail order contracts		—			0.7
Non-Rx sales		2.1			1.1
Other, net		—			0.2
Drug Distribution Operations(6)		15.8			—
Net increase (decrease)	$	21.2		$	(5.5	)

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(1)	From 1999 to early 2002, the specialty pharmacy operations contracted with several managed care companies to provide services from its automated distribution facility. In this Prospectus, we will refer to this business as Contracted Business. In December 2001, FMG decided to close its automated distribution facility and significantly reduce its mail order and e-commerce operations, including its Contracted Business. These operations accounted for $7.7 million of net revenues related to the Contracted Business prior to the reduction in operations at the end of the first quarter of fiscal 2002. Our specialty pharmacy operations now use smaller-scale mail order and e-commerce operations to service Rx and non-Rx customers.
(2)	The net effect of store openings/closings represents the difference in revenues by eliminating stores that were not open during the full periods compared. During 2002, we closed 16 stores that accounted for $11.8 million of net revenues during fiscal 2002 and opened/acquired eight new stores during fiscal 2002, which added $6.3 million of net revenues. We closed five stores during fiscal 2003 that accounted for $3.2 million of net revenues. We sold seven stores during fiscal 2004 that accounted for $2.8 million of net revenue and opened two new stores during the year that added $0.2 million of net revenues.
(3)	The reduction in franchise royalties from fiscal 2002 to fiscal 2003 is mainly due to the termination of certain franchise agreements related to the specialty pharmacy operations.
(4)	Represents the net impact of price increases for brand name prescription products offset by an increase in lower priced generic prescription products.
(5)	The Company’s fiscal year is a 52 or 53 week period ending on Saturday nearest to December 31. Fiscal 2004, which ended on January 1, 2005, included 53 weeks. Fiscal 2003 and fiscal 2002, which ended on December 27, 2004 and December 28, 2003, respectively, each included 52 weeks.
(6)	Represents post-Merger revenues from November 12, 2004 through January 1, 2005 for the drug distribution operations. The drug distribution operations net revenues for calendar year 2004 prior to the Merger from January 1, 2004 to November 11, 2004, were an additional $141.3 million (unaudited) or $157.1 million in total for calendar year 2004. We expect the drug distribution operations net revenues to decline in 2005 compared to 2004 as a result of the elimination of forward-buying, IMAs, and our strategy of focusing on higher margin products which have lower net revenues as discussed elsewhere in this Prospectus.

Gross Margin

Gross margin was $46.8 million or 19.6 % in fiscal 2004. This compares to $47.4 million or 21.7% in fiscal 2003 and $46.0 million or 20.6% in fiscal 2002. The decrease in the gross margin percentage is primarily the result of the inclusion of the lower gross margin drug distribution operations from the date of the Merger, through January 1, 2005, which negatively impacted the fiscal 2004 gross margin percentage by approximately 130 basis points. This trend will continue in 2005 as a result of the inclusion of a full year of operating results for the lower margin distribution operations, however, gross margin improvements are expected from purchasing synergies that will positively impact the specialty pharmacy operations and will partially offset the decline in gross margin percentage on an overall basis. Information that helps explain our gross margin trend is detailed below:

	Fiscal 2004 Compared to Fiscal 2003			Fiscal 2003 Compared to Fiscal 2002
Gross margin increases (decreases) are as follows (in millions):
Specialty Pharmacy Operations:
Contracted business(1)	$	—		$	(0.2	)
Net effect of store openings/closings(2)		(0.6	)		(1.9	)
Franchise royalties		(0.1	)		(1.1	)
Prescription gross margin(3)		(1.2	)		4.0
Non-Rx mail order contracts		—			0.2
Non-Rx gross margin		0.1			0.2
Effect of 53 weeks in 2004 vs. 52 weeks in 2003(4)		0.9			—
Other, net		0.1			0.2
Drug Distribution Operations(5)		0.2			—
Net (decrease) increase	$	(0.6	)	$	1.4

(1)	Gross margins benefited from the reduction of our Contracted Business in early 2002, which had gross margins of approximately 2.5%, the impact of which was not significant on fiscal 2003 or fiscal 2004 gross margins.
(2)	The net effect of store openings/closings represents the difference in gross margin by eliminating stores that were not open during the full periods compared.

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(3)	Fiscal 2004 reflects the adverse affect by the efforts of managed care organizations, pharmacy benefit managers and other third party payors to reduce their prescription costs. In recent years, our industry has undergone significant changes driven by various efforts to reduce costs. As employers and managed care organizations continue to focus on the costs of branded and specialty pharmaceuticals, we expect there will continue to be negative pressure on gross margins. Rx gross margin for the specialty pharmacy operations benefited from an increase in generic drug sales in fiscal 2003, which normally yield higher gross margin dollars and percentages than brand name Rx sales.
(4)	The Company’s fiscal year is a 52 or 53 week period ending on Saturday nearest to December 31. Fiscal 2004, which ended on January 1, 2005, included 53 weeks. Fiscal 2003, which ended on December 27, 2004, included 52 weeks.
(5)	The gross margin earned on sales of the drug distribution operations was approximately 2% from the Merger date, November 12, 2004, through January 1, 2005. Estimated future gross margin percentages are uncertain because of the reduced opportunities for forward-buying, IMAs, reduced vendor charge-backs and credits as discussed elsewhere herein.

Total Operating Expenses

Operating expenses include selling, general and administrative (“SG&A”) expenses, depreciation and amortization expense, write-downs of long-lived assets, and the gain or loss on disposal of fixed assets and intangible assets. Intangible assets include the amounts allocated to prescription files for prescriptions acquired in previous purchase business combinations of the specialty pharmacy operations. A prescription file refers to the actual prescription maintained by a pharmacy for each prescription filled. Each prescription file has monetary value to a pharmacy because when pharmacies and/or prescription files are sold, the customers are more likely to leave their accounts with the purchaser than to transfer their business to a third-party pharmacy, as such the prescription base is thought of as a repeatable source of revenue. Accordingly, when pharmacies are sold, the number of prescription files is taken into consideration when determining the purchase price of the pharmacy. Intangible assets also include goodwill, trademarks, and authorized distributor licenses which were recorded in connection with the Merger. The authorized distributor licenses permit the drug distribution operations to purchase pharmaceutical products directly from the manufacturers. Total operating expenses were $81.7 million or 34.2% of net revenues in fiscal 2004. This compares to $53.2 million, or 24.4% of net revenues, in fiscal 2003 and $52.9 million, or 23.6% of net revenues, in fiscal 2002. Information that helps explain our operating trend is detailed below.

	Fiscal 2004 Compared to Fiscal 2003			Fiscal 2003 Compared to Fiscal 2002
Operating expenses increases (decreases) are as follows (in millions):
Specialty Pharmacy Operations:
Selling, general and administrative expenses(1)	$	(1.4	)	$	(0.3	)
Depreciation and amortization expense(2)		(0.5	)		0.2
Impairments of long-lived assets, excluding goodwill(3)		(0.5	)		0.2
Goodwill impairment charge(4)		31.0			—
Gain on disposal of fixed assets and intangible assets		(0.7	)		0.2
Drug Distribution Operations(5)		0.6			—
Net increase	$	28.5		$	0.3

(1)	Selling, general and administrative expenses for the specialty pharmacy operations were $46.1 million, $47.5 million and $47.8 million for fiscal 2004, 2003 and 2002, respectively. Fiscal 2004 includes a $1.3 million non-cash charge relating to 656,047 restricted shares and 1,574,369 stock options granted to FMG employees in connection with the Merger. Specialty pharmacy selling, general and administrative expenses as a percentage of net specialty pharmacy revenues were 20.6%, 21.8% and 21.4% for fiscal 2004, 2003 and 2002, respectively. The decrease in selling, general and administrative expenses during fiscal 2004 is primarily due to a reduction in the number of stores and employees.
(2)	Depreciation and amortization expense was approximately $4.8 million, $5.3 million, and $5.1 million for fiscal 2004, 2003 and 2002, respectively. Fiscal 2004 includes amortization expense of $0.1 million related to intangible assets recorded in connection with the Merger for the period from November 12, 2004 to January 1, 2005. Such amortization for fiscal 2005 will be approximately $0.5 million.
(3)	During fiscal 2004, 2003 and 2002, we expensed approximately $0.3 million, $0.4 million and $0.4 million, respectively, related to the impairment of prescription file intangible assets and estimated lease obligations for sold stores.
(4)	As of January 1, 2005, we completed an assessment of the carrying value of the goodwill related to our drug distribution reporting unit and we determined that a goodwill write-off of $31.0 million was required as a result of a decrease in the fair value of the reporting unit resulting from the decline in the price of our common stock since the Merger terms were announced and declining profitability in the drug distribution operations as opportunities for forward buying and increased competition have negatively impacted estimated future cash flows.
(5)	Represents post-Merger expenses from November 12, 2004 through January 1, 2005 for the drug distribution operations.

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Interest Expense, Net

Interest expense, net was $5.7 million, $7.2 million and $4.0 million for fiscal 2004, 2003 and 2002, respectively. The increase in interest expense, net from fiscal 2002 to 2003 primarily results from $4.0 million of interest on FMG’s $4.0 million subordinated convertible notes issued in January 2003. These notes provided for interest at maturity of $4.0 million. Accordingly, all interest was accrued as of the original maturity date (October 2003) and no interest on the notes was recorded during the fiscal year ended January 1, 2005. These notes and the related interest were converted into shares of DrugMax common stock in connection with the Merger.

Also in connection with the Merger, DrugMax issued warrants to purchase 3,500,090 shares of DrugMax common stock at $2.61 per share to the former FMG stockholders, warrant holders and note holders. The warrants were allocated among the FMG stockholders, warrant holders and note holders in the same manner as the DrugMax common stock. DrugMax recorded noncash interest expense of approximately $1.7 million in fiscal 2004 related to the portion of the warrants issued to the former FMG note holders. The charge was based on the fair value of the warrants to purchase 704,324 shares at $2.61 per share issued to the FMG noteholders, using a Black Scholes valuation as of the Merger date.

Income Taxes

No income tax benefit has been recorded in any period presented due to the uncertainty of realization of any related deferred tax asset.

Cumulative Effect of Changes in Accounting Principles

As a result of adopting Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, we eliminated unamortized negative goodwill resulting in a benefit of $0.2 million and recorded a charge of approximately $0.9 million related to the write-off of goodwill as a cumulative effect of changes in accounting principles during fiscal 2002.

Net Loss

We incurred a net loss of $39.8 million in fiscal 2004 versus $12.2 million in fiscal 2003 and $10.1 million in fiscal 2002. Factors impacting these losses are discussed above.

Net Loss Per Share

The net loss per basic and diluted share for fiscal 2004 was $13.57 compared to a net loss per basic and diluted share for fiscal 2003 of $13.83 and $12.24 for fiscal 2000. As discussed above, we recorded a goodwill impairment charge in fiscal 2005 of approximately $31.0 million, which increased the net loss per basic and diluted share by $8.30. The weighted average shares used in the calculation of net loss per share have been restated to give effect to the Merger of DrugMax with FMG. The transaction was accounted for as a reverse Merger, with FMG deemed the accounting acquirer. Accordingly, for periods prior to the Merger, the shares outstanding represent the number of shares that former FMG common shareholders would have received in the transaction, on an as—if converted basis, had the Merger consideration not been distributed to the preferred shareholders based on liquidation values, or approximately 1.3 million shares. For periods subsequent to the Merger, shares outstanding represent actual shares outstanding. As of January 1, 2005, approximately 19.5 million shares were outstanding. Future calculations of net loss per share or earnings per share will be based on the actual weighted average number of shares outstanding.

Inflation and Seasonality

Management believes that inflation had no material effect on the operations or our financial condition for fiscal 2004, 2003 and 2002. Management does not believe that our business is materially impacted by seasonality; however, significant promotional activities can have a direct impact on sales volume for our distribution operations in any given quarter.

LIQUIDITY AND CAPITAL RESOURCES

In September 2005 we raised approximately $51.1 million from the sale of our common stock and warrants to purchase our common stock. In October 2005 we refinanced our primary credit facility. Proceeds from the new credit facility and the common stock private placement were used to repay the amounts outstanding on our old credit facility. As of October 31, 2005, $24.3 million was outstanding on the new credit facility, $32.0 million was available for additional borrowings on the new credit facility and cash and cash equivalents were approximately $7.1 million. We believe that cash and cash equivalents and borrowing capacity on our new credit facility are adequate to meet our needs for the next year.

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New Credit Facility

On October 12, 2005, the Company entered into a Loan and Security Agreement with Wells Fargo Retail Finance, LLC (“Wells Fargo”), pursuant to which Wells Fargo will provide the Company with a senior secured revolving credit facility up to $65 million (the “New Credit Facility”). The $65 million of maximum availability is reduced by an $7.0 million reserve. While the credit facility currently does not require compliance with financial covenants, the Company has the ability to reduce this reserve by $3.5 million by agreeing to implement one or more financial covenants. Available credit is based on eligible receivables, inventory and prescription files, as defined in and determined pursuant to the agreement, and may be subject to reserves as determined by the lender from time to time. Interest on the revolving line of credit is calculated at the Prime index rate plus an applicable Prime margin (as defined in the agreement), unless the Company or the lender chooses to convert the loan to a LIBOR-based loan. In each case, interest is adjusted quarterly. The applicable index margin as of October 31, 2005 was 1.75%. As of October 31, 2005, the interest rate including applicable margin, used to calculate accrued interest was 6.75%. Interest is payable monthly.

The New Credit Facility includes usual and customary events of default (subject to applicable grace periods) for facilities of this nature and provides that, upon the occurrence of an event of default, payment of all amounts payable under the New Credit Facility may be accelerated and/or the lenders’ commitments may be terminated. In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, all amounts payable under the New Credit Facility shall automatically become immediately due and payable, and the lenders’ commitments shall automatically terminate.

The New Credit Facility includes an early termination fee of $650,000 if paid in full before the third anniversary date. The New Credit Facility is secured by substantially all assets of the Company. As of October 31, 2005, $24.3 million was outstanding on the line and $20.1 million was available for additional borrowings, based on eligible receivables and inventory.

The proceeds of the New Credit Facility were used to repay in full the Company’s existing line of credit with GECC (the “Senior Credit Facility”) and also expected to be used to provide financing for working capital, letters of credit, capital expenditures, future acquisitions and/or other general corporate purposes. Accordingly, on October 12,2005, the Company terminated its $65 million Amended and Restated Credit Agreement with General Electric Capital Corporation (“GECC”) and in connection therewith repaid all outstanding amounts due under the credit facility to GECC along with a $0.5 million termination fee.

Sale of Securities

On September 23, 2005 and September 26, 2005 we entered into securities purchase agreements to sell to selling shareholders an aggregate of 44,093,432 shares of our common stock and warrants to purchase 22,046,715 shares of our common stock for an aggregate of $51,104,340. The offering was executed in two traunches at market price as determined by the closing bid price on each day. A purchase agreement for the first traunch was executed on September 23, 2005, for an aggregate of $47,814,265. The unit price of the common stock and corresponding warrant was $1.1525. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.09 per share. A purchase agreement for the second traunch executed on September 26, 2005, for an aggregate of $3,290,075. The unit price of the common stock and corresponding warrant was $1.2625. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.20 per share. The Company used a Black Scholes pricing model to determine the fair value of each warrant which was determined to be $0.0625.

Preferred Stock Sale

On December 2, 2004, for an aggregate purchase price of $17 million, we sold to certain qualified institutional buyers and accredited investors an aggregate of 17,000 shares of Series A convertible redeemable preferred stock in separate transactions. In addition, the investors received warrants to purchase an aggregate of 1,378,374 shares of our common stock. The exercise price of each warrant is $4.25 per share, the warrants are exercisable into common stock and expire on the fifth anniversary of the closing. Holders of the Series A stock were entitled to receive cumulative dividends, before any dividends are paid to the common stockholders, at the rate per share of 7% per annum until the fourth anniversary, 9% per annum from the fourth anniversary of the closing until the fifth anniversary, 11% per annum from the fifth anniversary of the closing until the sixth anniversary and 14% per annum thereafter. The payment of dividends can be made by delivery of shares of common stock under certain circumstances. Except as provided in the certificate of designation, the shares of Series A stock did not have any voting rights. The holders of the Series A stock may at their option, from time to time, convert their shares into shares of common stock.

Effective April 20, 2005, the Company suspended sales under the previously filed registration statement to resell such securities. Under the terms of the registration agreement, the investors were entitled to liquidated damages until such time as the registration statement was declared effective. On July 7, 2005, we amended the certificate of designation to reduce the conversion price from $3.70 to $2.80. In exchange, investors representing 95% of the preferred shareholders agreed to waive liquidated damages under the registration rights agreement through the date of the amendment and to amend the registration rights agreement to require the filing of a registration statement covering the registrable securities by July 8, 2005 and to require the effectiveness of such registration statement to be no later than October 1, 2005.

On September 26, 2005, the Company entered into agreements with its Series A Preferred Stock to have their shares of Series A Preferred Stock redeemed for cash upon the closing of the sale of the common stock and warrants described below. Accordingly, in connection with the closing of the private placement described elsewhere in this document, the Company has redeemed all of the Series A Preferred Stock. The redemption price was 100% of stated value, $17 million. In addition, the Company issued 488,070 shares of common stock to certain of the holders of its Series A Preferred Stock in connection with the redemption.

In connection with the redemption, the holders also agreed:

·   to waive any right of first refusal, participation or similar right they may have had with respect to the offering described above or any other offerings by the Company; and

·   to amend the terms of the warrants issued to the purchasers of Series A Preferred Stock in order to reduce the exercise price of warrants to $1.09 and to remove any right to further adjustment of the exercise price (other than equitable adjustments).

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Subordinated Note and Convertible Debenture

On March 22, 2005, we converted $23.0 million in accounts payable owed to ABDC (after having repaid $6,000,000 on March 23, 2005 in connection with the closing of the new vendor supply agreement) into (a) a subordinated convertible debenture in the original principal amount of $11.5 million (the “Subordinated Convertible Debenture”) and (b) a subordinated promissory note in the original principal amount of $11.5 million (the “Subordinated Note”).

The Subordinated Convertible Debenture and Subordinated Note are guaranteed by DrugMax and certain of DrugMax’s subsidiaries, including Valley Drug Company, Valley Drug Company South, Familymeds, Inc. and Familymeds Holdings, Inc. pursuant to Continuing Guaranty Agreements dated as of March 21, 2005. We also entered into a subordinated security agreement dated as of March 21, 2005, pursuant to which we agreed that upon the occurrence of certain defaults and the passage of applicable cure periods we shall be deemed at that point to have granted to ABDC a springing lien upon and a security interest in substantially all of our assets to secure the Subordinated Convertible Debenture and the Subordinated Note. Should this occur, we shall be deemed in default of our Senior Credit Facility. However, pursuant to a subordination agreement dated March 21, 2005, ABDC has agreed to subordinate the Subordinated Convertible Debenture, the Subordinated Note, the Guarantees and the Security Agreement to all “Senior Debt.” Senior Debt consists of all senior indebtedness now or hereafter owing, including indebtedness under the Senior Credit Facility and any debt incurred by us to replace or refinance such debt.

Pursuant to the Subordinated Note, principal is due and payable in 20 successive quarterly installments each in the amount of $0.6 million beginning on December 1, 2005 and continuing until September 1, 2010, on which date all outstanding amounts are required to be paid. The Subordinated Note bears interest at a variable rate equal to the prime rate plus 2.0% per annum. The interest rate adjusts on each quarterly payment date based upon the prime rate in effect on each such quarterly payment date; provided that in no event shall the interest rate in effect be less than 5.0% per annum or greater than 10% per annum. Interest accrued on the unpaid principal balance of the Subordinated Note is due and payable on each quarterly payment date and interest payments commenced on June 1, 2005. Interest of $0.2 million and $0.3 million was expensed during the three and six months ended July 2, 2005, respectively.

Pursuant to the Subordinated Convertible Debenture, principal is due and payable in 19 successive quarterly installments each in the amount of $0.6 million commencing on March 1, 2006 and continuing until August 15, 2010, on which date all outstanding amounts are required to be paid. Quarterly principal payments are payable in cash or in shares of common stock in an amount equal to $0.6 million divided by $3.4416 (the “Issue Price”). The Subordinated Convertible Debenture bears interest at a rate which adjust on each quarterly payment date and which is equal to (a) 10%, if the quarterly interest payment is made in common stock or (b) the prime rate on the date the quarterly interest payment is due plus 1% per annum, if the quarterly interest payment is made in cash; provided that in no event shall the interest rate in effect be less than 5.0% per annum or greater than 10% per annum. Quarterly interest payments to be paid in common stock through February 28, 2006. Commencing March 1, 2006, quarterly interest payments may be paid in cash or common stock in an amount equal to the interest then due and owing divided by the Issue Price, or a combination thereof. The first interest payment of $0.2 million was made on June 1, 2005 by issuing 67,757 shares of common stock. Interest of $0.3 million was expensed during the three and six months ended July 2, 2005.

If common stock is used to make principal and interest payments on the Subordinated Convertible Debenture, and the proceeds ABDC receives upon any sale of our common stock (or the proceeds ABDC would have received upon a sale in the event no shares are sold by ABDC) are less than the principal and interest due, we are required to pay such difference to ABDC in cash on the date of maturity of the Subordinated Convertible Debenture. Through December 31, 2005, ABDC may not sell any shares of the Company’s common stock received that, in the aggregate, exceed 25% of the average trading volume of our common stock for the preceding 10 trading days.

In connection with the Subordinated Convertible Debenture, DrugMax entered into a registration rights agreement dated March 21, 2005 with ABDC pursuant to which we agreed to file a registration statement with the SEC to register the resale of all common stock issuable to ABDC in connection with the Subordinated Convertible Debenture no later than May 30, 2005. Further on May 26, 2005, ABDC granted us a 45 day extension to file the registration statement. On July 7, 2005, the Company filed a registration statement on Form S-1. The SEC declared the Form S-1 effective on August 10, 2005.

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Operating, Investing and Financing Activities

Following are the components of our operating, investing and financing activities for the six months ended July 2, 2005, using the direct cash flow method (in millions):

   

	For the  Six Months Ended  July 2, 2005			For the  Six Months Ended  June 24, 2004
Cash receipts	$	171.6		$	113.2
Cash paid to suppliers and employees		(179.0	)		(109.6	)
Interest expense paid		(1.8	)		(1.2	)
Net cash (used in) provided by operating activities		(9.2	)		2.4
Cash paid to acquire property and equipment		(1.1	)		(0.2	)
Proceed from sale of prescription files, net		—			0.8
Net cash (used in) provided by investing activities		(1.1	)		0.6
Proceeds (payments) on revolving credit facility, net		9.8			(3.3	)
Proceeds from the exercise of stock options		0.5			—
Deferred financing		(0.4	)		(0.1	)
Repayment of promissory notes payable and capital lease obligations, net		(0.7	)		—
Net cash provided by (used in) financing activities		9.2			(3.4	)
Net decrease in cash and cash equivalents		(1.1	)		(0.4	)
Cash and cash equivalents, beginning of period		2.3			1.3
Cash and cash equivalents, end of period	$	1.2		$	0.9

Operating Cash Flows

Net cash (used in) provided by operating activities was ($9.2) million and $2.4 million for the six months ended July 2, 2005 and June 26, 2004, respectively. The decrease in operating cash flows is due principally to higher net losses and increased inventory levels, partially offset by $3.9 million of non-cash compensation expense. During the six months ended July 2, 2005 our inventory levels increased by $3.4 million due to our transition to a new primary supplier and the increase in inventory at our warehouse in Louisiana, which now is responsible for providing the majority of the pharmaceutical requirements of our specialty pharmacies.

Net cash provided by (used in) operating activities was $0.4 million, ($0.7) million and ($1.5) million for fiscal 2004, 2003 and 2002, respectively. During fiscal 2004 inventories increased by $2.1 million and accounts payable increased by $3.5 million primarily related to amounts owed to ABDC. During 2004 our inventory levels increased due to our transition to a new primary supplier.

Investing Cash Flows

Net cash (used in) provided by investing activities was ($1.1) million, and $0.6 million for the six months ended July 2, 2005 and June 26, 2004, respectively. Investing activities during the six months ended July 2, 2005 included capital expenditures of $1.1 million. The $0.8 million of cash provided by investing activities for the six months ended June 26, 2004 relates to the sale of six specialty pharmacy locations.

Net cash used in investing activities was $0.0 million, $1.1 million and $0.8 million for fiscal 2004, 2003 and 2002 respectively. Investing activities during fiscal 2004 included capital expenditures of $1.1 million, and proceeds from intangible assets for seven stores that were sold during the year of $1.1 million. These stores were sold as part of our strategy to eliminate underperforming locations and to consolidate certain stores within existing markets. We currently have no plans to close additional stores; however, store performance is continuously evaluated and we may decide to close additional stores in the future. Net cash used in investing activities during fiscal 2003 and 2002 was primarily due to the costs associated with opening of two new stores and the remerchandising and remodeling of several existing locations.

Capital expenditures were $1.1 million during fiscal 2004, compared to $1.3 million during fiscal 2003 and $1.2 million in 2002. During fiscal 2004, approximately 26% of our total capital expenditures were for new store construction, 47% for store expansion and improvement and 27% for technology and other. During fiscal 2005, we plan to invest approximately $2.0 million in capital improvements, which will include the opening of new locations, technology initiatives and remerchandising and remodeling projects at certain specialty pharmacy locations.

The following is a summary of our corporate-owned store activity for the periods presented:

	Six Months Ended July 2, 2005		Fiscal Year 2004			Fiscal Year 2003			Fiscal Year 2002
Total stores (beginning of period)		77		82			85			93
New stores		—		2			2			8
Closed stores		—		(7	)		(5	)		(16	)
Total stores (end of period)		77		77			82			85

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Financing Cash Flows

Net cash provided by (used in) financing activities was $9.2 million for the six months ended July 2, 2005 and ($3.5) million for the six months ended June 26, 2004, respectively. The increase in financing activities relates to increased borrowings on the company’s Senior Credit Facility.

Net cash provided by financing activities was $0.6 million, $2.5 million and $2.0 million for fiscal 2004, 2003 and 2002, respectively. The increase in financing cash flows was primarily due to the sale of $17 million convertible preferred stock as described above. In December 2004, net proceeds of $15.9 million, after consideration of $1.1 million in fees, were used in part to reduce trade payables in the ordinary course of our business, increases in our inventory levels as a result of integration of our distribution and specialty pharmacy operations and transition to a new supplier, payment of Merger related expenses and other working capital and general corporate purposes. The increase from fiscal 2002 to 2003 was primarily due to lower payments on capital lease obligations due to maturities of capital leases and deferred financing costs incurred in fiscal 2003.

Contractual Obligations

The following table summarizes our contractual obligations as of July 2, 2005.

	Payments due by period
	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Debt(1)	$	44,521,301	$	1,857,405	$	42,663,896	$	—	$	—
ABDC(2)		23,000,000		2,935,526		9,442,104		9,442,104		1,180,266
Capital lease obligations		7,750		7,750		—		—		—
Purchase obligations(3)		300,000,000		150,000,000		150,000,000		—		—
Operating leases		11,695,125		3,087,312		4,448,989		2,629,022		1,529,802
Interest expense(4)		12,515,531		3,675,119		8,168,520		671,892		—
Total	$	391,739,707	$	161,563,112	$	214,723,509	$	12,743,018	$	2,710,068

(1)	As of July 2, 2005, $42.7 million was outstanding on our Senior Credit Facility which matured on December 8, 2007. In October 2005, the Senior Credit Facility was replaced with the New Credit Facility. As of October 31, 2005 $23.4 million was outstanding under the New Credit Facility.
(2)	In March 2005, $23.0 million of ABDC accounts payable converted to subordinated notes payable.
(3)	Purchase obligations represent an annual $150 million minimum purchase commitment determined on a rolling 12 month basis under our existing supply agreements.
(4)	Estimated future interest expense for long-term debt, including the Senior Credit Facility. Interest on the Senior Credit Facility is based on the amounts outstanding and interest rate as of January 1, 2005.

Off-Balance Sheet Arrangements

We do not make use of any off-balance sheet arrangements that currently have or that we expect are reasonably likely to have a material effect on our financial condition, results of operations or cash flows. We utilize operating leases for many of our store locations. We do not use special-purpose entities in any of our leasing arrangements.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains a discussion of the Company’s consolidated financial statements and condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. On an on-going basis, we evaluate estimates and judgments, including the most significant judgments and estimate. We based our estimates and judgments on historical experience and on various other facts that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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Goodwill and Identifiable Intangible Assets—Merger Related

The Merger resulted in $50.8 million of goodwill and $5.6 million of other intangible assets. The value assigned to goodwill and intangibles, as well as their related useful lives, are subject to judgment and estimation by the Company. Goodwill and identifiable intangible assets related to the Merger were determined based on the purchase price allocation. The valuation of the identifiable intangible assets acquired was based on the estimated cash flows related to those assets, while the initial value assigned to goodwill was the residual of the purchase price over the fair value of all identifiable assets acquired and liabilities assumed. Judgments were required to estimate future cash flows in order to determine the fair values of the identifiable intangible assets acquired as well as estimate the useful lives for the identifiable assets to be amortized over. Useful lives for identifiable intangibles are determined based on the expected future period of benefit of the asset, the assessment of which considers various characteristics of the asset, including historical cash flows.

After goodwill is initially recorded, annual impairment tests are required, or more frequently if impairment indicators are present. The amount of goodwill cannot exceed the excess of the fair value of the related reporting unit (which is based on the Company’s stock price) over the fair value of reporting units identifiable assets and liabilities. Downward movement in the Company’s common stock price has a material effect on the fair value of goodwill in future measurement periods.

As of January 1, 2005, we completed an impairment test of the goodwill related to the Merger and determined that a write off of $31.0 million was required which was recorded in fiscal 2004. The impairment of the drug distribution reporting unit is a result of lower revenues and profitability and a decline in the fair value of the Company’s common stock since the Merger terms were announced and the purchase price was determined. Additionally, the drug distribution operations have experienced declining profitability as opportunities for forward buying and increased competition have negatively impacted profitability. The Company’s stock price decreased from $4.61 for the five-day period from the Merger announcement date to $3.28 as of January 1, 2005. Significant judgments and estimates were required in connection with the impairment test to determine the estimated future cash flows and fair value of the reporting unit. To the extent our estimates change in the future or our stock price decreases from January 1, 2005, further goodwill writedowns may occur. As of July 2, 2005 and January 1, 2005, we had remaining goodwill of $19.9 million and $19.8 million recorded, respectively.

Impairment of Other Long-lived Assets

The Company reviews other long-lived assets, including property plant and equipment and prescription file intangible assets, to be held and used, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the undiscounted expected future cash flows is less than the carrying amount of the related assets, the Company recognizes an impairment loss. Impairment losses are measured as the amount by which the carrying amount of the assets, including prescription file intangible assets, exceeds the future cash flows for the assets. For purposes of recognizing and measuring impairment of other long-lived assets, the Company evaluates assets at the store level for specialty pharmacy operations.

Our impairment loss calculations contain uncertainty since we must use judgment to estimate future sales, profitability and cash flows. When preparing these estimates, we consider historical results and current operating trends and our consolidated revenues, profitability and cash flow results and forecasts. These estimates can be affected by a number of factors including, but not limited to, general economic conditions, the cost of real estate, the continued efforts of third party customers to reduce their prescription drug costs, the continued efforts of competitors to gain market share and consumer spending patterns. If these projections change in the future, we may be required to write-down our long-lived assets. Long-lived assets evaluated for impairment include property and equipment as well as intangible assets, which as of July 2, 2005 were approximately $5.3 million and $9.5 million, respectively, $5.3 million and $10.6 million, respectively, at January 1, 2005, and $4.8 million and $7.5 million, respectively, at December 27, 2003.

Trade Receivables—Allowance for Doubtful Accounts

At July 2, 2005, January 1, 2005 and December 27, 2003, trade receivables included approximately $20.5 million, $24.5 million and $11.6 million, respectively, of amounts due from various insurance companies, governmental agencies and individual customers. Of these amounts, there was approximately $2.3 million, $3.9 million and $1.7 million reserved as of July 2, 2005, January 1, 2005 and December 27, 2003, respectively, for a balance of net trade receivables of $18.3 million, $20.8 million and $9.9 million, respectively. As of July 2, 2005 accounts receivable for drug distribution operations were $7.1 million, which is net of a reserve of $0.8 million. We use historical experience, market trends and other analytical data to estimate our allowance for doubtful accounts. Based upon these factors, the reserve at July 2, 2005 is considered adequate. Although we believe that the reserve estimate is reasonable, actual results could differ from our estimate, and such differences could be material. If the estimate is too low, we may incur higher bad debt expenses in the future resulting in lower net income or higher net losses. If the estimate is too high, we may experience lower bad debt expense in the future resulting in higher net income or lower net losses.

Vendor Rebates, Allowances and Chargebacks

As of July 2, 2005, January 1, 2005 and December 27, 2003, amounts due from vendors relating to rebates, allowances and chargebacks were $1.6 million $1.2 million and $0, respectively, of which approximately $0.2 million and $0.2 million was reserved as of July 2, 2005 and January 1, 2005, respectively. We are eligible for vendor rebates, allowances and chargebacks from pharmaceutical vendors and manufacturers based on contractual arrangements. Rebates and allowances are recorded as a component of cost of goods sold in the period they are received from the vendor or manufacturer unless such rebates and allowances are reasonably estimable at the end of a reporting period. We record chargeback credits due from our vendors in the period when the sale is made to the customer which is eligible for contract pricing from the manufacturer. The amounts due are often difficult to estimate based on changes in industry practices and amounts received may differ from our estimates. If our estimate of amounts due from vendors is too high our earnings (losses) will be adversely effected in the future.

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Inventories

Inventories consist of pharmaceuticals and other retail merchandise owned by us. Inventories are stated at the lower of cost (first-in, first-out method for pharmaceutical inventory and retail method for retail merchandise inventory) or market. Physical inventory counts are taken on a regular basis in each location to ensure that the amounts reflected in the consolidated financial statements are properly stated. We use historical data to estimate our inventory loss reserves and we have not made any material changes in the accounting methodology used to establish our inventory loss reserves during the past three years. If the estimate of inventory losses is too low we may incur higher cost of sales in the future resulting in lower net income or higher net losses. If the estimate of inventory losses incurred is too high, we may experience lower cost of sales in the future resulting in higher net income or lower net losses. Inventories as of July 2, 2005, January 1, 2005 and December 27, 2003 were approximately $37.9 million, $34.5 million and $18.9 million, respectively, net of approximately $1.1 million, $1.2 million and $1.0 million of inventory loss reserves, respectively.

New Accounting Pronouncements

In December 2004 the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment which requires that the cost resulting for all share-based payment transactions be recognized in the financial statements. This statement is effective for the Company for the first fiscal year beginning after June 15, 2005 (as a result of the deferral of the effective date in April 2005) and applies to all awards granted in periods after the effective date and unvested awards as of the effective date. The Company is in the process of evaluating the method of adoption and the resulting impact of SFAS No. 123R on the Company upon adoption.

In November 2004 the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS No. 151 is effective for inventory costs incurred after October 31, 2005. The Company does not believe SFAS No. 151 will have a material impact on its consolidated financial statements.

Impact of Inflation and Changing Prices

The consolidated financial statements and related data presented in this Prospectus have been prepared in conformity with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. We believe that inflation has not had a material impact on our results of operations during each of the three years in the period ended January 1, 2005 or the six months ended July 2, 2005.

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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS

ON ACCOUNTING AND FINANCIAL DISCLOSURE

For accounting purposes, our Merger with FMG was accounted for as a reverse acquisition, with FMG as the acquirer. As a result, the historical financial statements of FMG became our historical financial statements.

For the two years prior to the Merger, FMG, the accounting acquirer in the Merger, retained Deloitte & Touche LLP as its independent accountants, and DrugMax retained BDO Seidman, LLP (“BDO”)as its independent accountants. On November 12, 2004, the newly appointed audit committee of DrugMax approved the retention of Deloitte & Touche LLP and the dismissal of BDO, as the independent accountants of the merged company.

During the two most recent fiscal years and any subsequent interim period prior to engaging Deloitte & Touche LLP, DrugMax did not consult with Deloitte & Touche LLP regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on DrugMax’s financial statements; or (ii) any matter that was either the subject matter of a disagreement (as defined in Item 304(a)(1)(iv) of Regulation S-K and related instructions) or a reportable event (as defined in Item 304(a)(1)(v) of Regulation S-K).

The reports of BDO on DrugMax’s financial statements for the fiscal years ended March 31, 2004 and 2003 did not contain a disclaimer of opinion or an opinion that was adverse or was qualified or modified for uncertainty, audit scope, or accounting principle. Furthermore, during those fiscal years and through the subsequent period ending on November 12, 2004, there were no disagreements with BDO on matters of accounting principle or practice, financial statement disclosure, or audit scope or procedure which, if not resolved to BDO’s satisfaction, would have caused BDO to refer to the subject matter of the disagreements in their report. In addition, during those fiscal years, there have been no reportable events (as defined in Item 304(a)(1)(v) of Regulation S-K), except as follows:

As reported in DrugMax’s annual report on Form 10-K for the year ended March 31, 2004, in connection with the completion of its audit of, and the issuance of an unqualified report on, DrugMax’s consolidated financial statements for the fiscal year ended March 31, 2004, BDO communicated to DrugMax’s Audit Committee that the following matters involving DrugMax’s pre-Merger internal controls and operation were considered to be “reportable conditions,” as defined under standards established by the American Institute of Certified Public Accountants, or AICPA:

• Processes relating to account analysis and reconciliations, including lack of timely management review, which contributed to fourth quarter adjustments relating to inventories, accounts receivable and accounts payable; and

• DrugMax’s recognition of accruals in connection with litigation.

  
Reportable conditions are matters coming to the attention of the independent auditors that, in their judgment, relate to significant deficiencies in the design or operation of internal controls and could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. In addition, BDO advised us that they considered these matters to be “material weaknesses” that, by themselves or in combination, resulted in a more than remote likelihood that a material misstatement in DrugMax’s financial statements will not be prevented or detected by its employees in the normal course of performing their assigned functions.

On November 18, 2004, we authorized BDO to respond fully to the inquiries of Deloitte & Touche LLP concerning the foregoing matter and requested that BDO provide us with a letter addressed to the Securities and Exchange Commission stating whether it agrees with the statements made by us in response to this item and, if not, stating the respects in which it does not agree. BDO’s letter was filed on December 8, 2004.

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

As of October 31, 2005, $24.3 million was outstanding on our new senior credit facility. Borrowings on the line are calculated at a variable rate of interest. Assuming $24.3 million was outstanding on the new senior credit facility for a full year, a 1% change in interest rates would change our interest expense by $0.2 million per year.

We do not currently utilize derivative financial instruments to address market risk.

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Management—Directors and Executive Officers

Directors and Executive Officers

Set forth below is the business experience and other biographical information regarding the Company’s executive officers and directors as of October 31, 2005:

Name	Age		Position
Edgardo A. Mercadante(3)		50		Co-Chairman of the Board, President and Chief Executive Officer
James E. Searson		52		Senior Vice President, Chief Financial Officer, Treasurer and Director
Allison D. Kiene		38		Senior Vice President, General Counsel and Secretary
Philip P. Gerbino(2)(4)		58		Director
Peter J. Grua(1)(2)(3)(4)		51		Director
Mark T. Majeske(1)		48		Director
Rakesh K. Sharma(1)		48		Director
Jugal K. Taneja		61		Co-Chairman of the Board
Laura L. Witt (2)(3)(4)		37		Director

(1) Member of Compensation Committee.

(2) Member of Audit Committee.

(3) Member of Executive Committee.

(4) Member of Nominating and Governance Committee

Pursuant to the Company’s bylaws, each director serves for a term of one (1) year or until his successor is duly qualified. Officers are appointed annually by the board of directors (subject to the terms of any employment agreement), at the annual meeting of the Board, to hold such office until an officer’s successor is duly appointed and qualified, unless an officer sooner dies, resigns or is removed by the Board. There are no family relationships among any of the Company’s directors and executive officers.

Information regarding Directors and Executive Officers:

Edgardo A. Mercadante has served as the Company’s Chief Executive Officer and Co-Chairman of the Board since the Merger of DrugMax, Inc. with FMG on November 12, 2004. He served as FMG’s Chairman of the Board, Chief Executive Officer and President since 1997. Mr. Mercadante has over twenty-five years of experience in the prescription health care and managed care industries including significant experience in retail pharmacy. Mr. Mercadante was President of Arrow Corporation between the years of 1987 to 1996. He was President and Chief Executive Officer of APP, a pharmacy benefit management company, which he co-founded in 1991. Mr. Mercadante is active in many national and state professional pharmacy organizations. Mr. Mercadante is a licensed pharmacist and holds a B.S. in Pharmacy from Philadelphia College of Pharmacy and Science. Mr. Mercadante served as Division Manager from 1980 to 1986 with Rite Aid Corporation. Mr. Mercadante holds directorships with General Nutrition Centers, and ProHealth. He holds a Trusteeship with the University of Sciences in Philadelphia.

James E. Searson has served on the Company’s board of directors since February 24, 2005 and on May 23, 2005, he became the Company’s Chief Financial Officer. A Certified Public Accountant, Mr. Searson worked at Ernst & Young from 1975 through 2004, most recently as an audit partner who managed the firm’s office in Hartford, CT. He also served in Ernst & Young’s offices in Chicago, IL; Zurich, Switzerland; Hamburg, Germany; and Munich, Germany. During his tenure at Ernst & Young, Mr. Searson provided audit, accounting, financial due diligence and reporting counsel and services to multinational manufacturing, distribution and service companies. Mr. Searson has a BSBA degree in accounting from John Carroll University, and also has completed the International Executive Management and Executive Management programs at Northwestern University. He is a member of the American Institute of Certified Public Accountants (AICPA).

Allison D. Kiene is the Company’s Senior Vice President, General Counsel and Secretary. Prior to joining FMG in September 2002, Ms. Kiene served as Regulatory Law Counsel for The Stop & Shop Supermarket Company headquartered in Quincy, MA from March 2000 until September 2002. Ms. Kiene previously served as a Pharmacy Manager for Stop & Shop Pharmacy from April 1994 until March 2000. Ms. Kiene is admitted to the Bar in Connecticut, Massachusetts, and New York. She also maintains her license to practice pharmacy in both Connecticut and New York. Ms. Kiene received her Bachelor of Science degree in Pharmacy from the University of Connecticut School of Pharmacy and her Juris Doctor degree from the University of Connecticut School of Law.

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Philip P. Gerbino has served on the Company’s board of directors since November 12, 2004. Previously, he served as a director of FMG since December 1996. Dr. Gerbino has been President of the University of the Sciences in Philadelphia and the Philadelphia College of Pharmacy since January 1995. Dr. Gerbino is also a past president of the American Pharmaceutical Association and is a well established consultant in the pharmaceutical and health care industry. He earned his PharmD. in 1970 from the Philadelphia College of Pharmacy and Science.

Peter J. Grua has served on the Company’s board of directors since November 12, 2004. Previously, he served as a director of FMG. He also is a Managing Partner of HLM Venture Partners, where he has been employed since 1992. He has over 20 years of experience as an investor focused on the health care industry. Prior to joining HLM in 1992, Mr. Grua was a Managing Director and Senior Analyst at Alex. Brown and Sons, where he led the firm’s health care services and managed care research efforts. Previously, he was a research analyst at William Blair & Company and a strategy consultant at Booz Allen Hamilton. Mr. Grua is also a director of Health Care REIT, Renal Care Group, and two other private companies. Mr. Grua holds an AB degree from Bowdoin College and an MBA from Columbia University.

Mark T. Majeske has served on the Company’s board of directors since November 12, 2004. From July 1996 to June 2000, Mr. Majeske served as Group President of McKesson HBOC/Pharmaceutical Group. Prior to becoming Group President, Mr. Majeske served as Executive Vice President Customer Operations and Regional Executive Vice President for McKesson. Since leaving McKesson in 2000, he has been a private investor and advisor to startup companies and most recently served as Chief Executive Officer of Day Runner, Inc., which was sold to MeadWestvaco Corporation in late 2003.

Rakesh K. Sharma has served on the Company’s board of directors since November 12, 2004. He is an Interventional Cardiologist and is a member of the medical staff of several hospitals in the Tampa Bay area, where he has practiced for over ten years. Since August, 1999, he has been a partner and director of The Heart and Vascular Institute of Florida, LLC. Dr. Sharma also is Chief-of-Staff at HCA-Largo Medical Center since September 2005, he serves on the board of trustees for HCA- Largo Medical Center. He also serves as a chairman of Medical Executive committee of the Hospital. He served as Vice Chief of staff from June 2004 to August 2005 and during that time he was also chairman of Credential committee. Dr. Sharma is Medical Director of Cardiac Catheterization Labs at HCA-Largo Medical Center and also serves as the Director of Emergency Cardiac Services at Largo Medical Center. Since March, 1999, Dr. Sharma is a Fellow of American college of Cardiology (FACC) and Fellow of Society of Cardiac Angiography & Interventions (FSCAI). Dr. Sharma is also member of Board of Directors of the American Association of Cardiologist of Indian Origin (AAPI) and the International Society of Intravascular Ultrasound (ISCU). Dr. Sharma serves on the board of directors of Dynamic Health Products, Inc., a publicly traded company. He was the Co-Founder, president and director of Doctorsurf.com a public company in 1999 and was a director of Eonnet Media, Inc which was borne out of the merger of Doctorsurf.com and Monet Technologies.  

Jugal K. Taneja has served as the Company’s Co-Chairman of the Board since November 12, 2004. Previously, since April 1996, other than from March 2000 to October 2000, Mr. Taneja served as the Company’s Chief Executive Officer. In addition to his service to the Company, Mr. Taneja operates several other companies. He is presently the Chairman of the Board of Dynamic Health Products, Inc. (“Dynamic”), a position he has held since Dynamic’s inception in 1991. From November 1991 to June 1998, he served as Chief Executive Officer of Dynamic. Dynamic, a publicly traded company, is a distributor of proprietary and nonproprietary dietary supplements, over-the-counter drugs, and health and beauty care products. Mr. Taneja has served as the Chairman of the Board of Innovative Companies, Inc., now known as GeoPharma, Inc., a publicly traded company that manufactures and distributes generic drugs, health and beauty aids, nutritional and health products since June 1998. Mr. Taneja is the chairman of Bancequity Petroleum Corporation, a private company owns and operates 290 oil and gas wells. Mr. Taneja holds degrees in Petroleum Engineering, Mechanical Engineering, and a Masters in Business Administration from Rutgers University.

Laura L. Witt has served on the board of directors since November 12, 2004. Previously, she served as a director of FMG. She is a General Partner of ABS Capital Partners, a private equity firm which she joined in 1997. Prior to joining ABS Capital Partners, Ms. Witt was a consultant with Monitor Company and with Oliver, Wyman & Company, both strategy consulting firms. Ms. Witt received a Bachelor of Arts from Princeton University and an M.B.A. from the Wharton School of Business, University of Pennsylvania. She currently serves as a director of Cyveillance, Inc. and of NSI Software, Inc.

Audit Committee Information

DrugMax has a separately-designated standing audit committee established in accordance with section 3(a)(58)(A) of the Securities Exchange Act of 1934. Currently, DrugMax’s Audit Committee consists of Mr. Grua and Dr. Gerbino and Ms. Witt. Each of the members of the Audit Committee is independent pursuant to Rule 4200(a)(15) of the National Association of Securities Dealers’ listing standards. DrugMax has determined that it has at least one audit committee financial expert serving on its audit committee, as that term is defined by Item 401 of Regulation S-K. Currently, Ms. Witt serves as the audit committee’s financial expert. The Audit Committee operates under a written charter adopted by the Board of Directors, a copy of which has previously been filed with the SEC.

Director Compensation

Upon election to the board of directors, each outside director receives an award of restricted stock in the amount of $50,000. Such shares vest ¹/3 upon the date of grant and ¹/3 on the first and second anniversary thereafter. Further, on each year following his or her election to the Board, each outside director receives an award of restricted stock in the amount of $25,000. The foregoing shares are granted under the Company’s 2003 Restricted Stock Plan. In addition, each outside director is issued an option to purchase 10,000 shares of common stock annually each year following his or her election to the board of directors. Each outside director who serves as a member of a committee is issued an option to purchase 5,000 shares of the Company’s common stock annually. The chairperson of each committee, other than the Audit Committee, is issued an option to purchase an additional 5,000 shares of common stock annually. The chairperson of the Audit Committee and the Chairmen of the Board is issued an option to purchase 10,000 shares of the Company’s common stock annually. The foregoing options are granted under the Company’s 1999 Stock Option Plan.

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All of the Company’s outside directors receive $2,000 for each meeting of the board of directors that they attend, $5,000 per quarter and reimbursement of their reasonable out-of-pocket expenses incurred in connection with such meetings. In addition, each outside director who serves on a committee receives $1,000 for each meeting attended.

Compensation to Executive Officers

The following summary compensation table sets forth the cash and non-cash compensation paid during the past three fiscal years to (a) those individuals serving as the Company’s Chief Executive Officer during the fiscal year ended January 1, 2005 and (b) the four most highly compensative executive officers of the Company, receiving compensation of at least $100,000, during the fiscal year ended January 1, 2005 (the “Named Executive Officers”):

	Annual Compensation						Long Term Compensation
Name and Principal Position	Fiscal Year Ended (2)		Salary		Bonus		Restricted Stock Awards (3)		Securities Underlying Options (#)		All Other Compensation (4)
Edgardo A. Mercadante,		2004	$	340,157	$	30,000	$	966,348		—	$	14,823
Co-Chairman of the Board, President		2003		329,500		30,000		—		—		14,341
and Chief Executive Officer (1)		2002		293,077		50,000		—		—		14,821
Jugal K. Taneja,		2004		207,692		40,000		—		—		24,100
Co-Chairman of the Board		2003		197,439		18,500		—		42,500		23,850
		2002		144,500		18,500		—		42,500		22,000
Dale J. Ribaudo,		2004		228,167		50,000		462,500		—		4,795
Former Chief Financial		2003		221,019		38,874		—		—		7,752
Officer (1)(5)		2002		179,539		50,000		—		—		9,610
William L. LaGamba,		2004		181,731		30,000		—		—		24,100
Former President and Chief		2003		174,469		5,500		—		30,000		22,100
Operating Officer (5)		2002		163,500		5,500		—		30,000		22,600
James S. Beaumariage,		2004		188,395		20,000		185,000		—		5,050
Senior Vice President, Familymeds,		2003		182,492		20,000		—		—		6,338
Inc. (1)		2002		151,731		30,000		—		—		5,231

(1) On November 12, 2004, FMG merged with and into the Company, and in connection therewith Messrs. Mercadante, Ribaudo and Beaumariage became officers of the Company. Prior to the Merger, such officers served FMG in the same capacities that they currently serve with the Company. The annual, long term and other compensation shown in this table includes the amount such officers received from FMG prior to the Merger.

(2) On November 12, 2004, the Company in connection with the Merger changed its fiscal year end from March 31 to a 52-53 week fiscal year ending on the Saturday closest to December 31.

(3) Represents the value of vested restricted stock paid to the named executive officers based upon the closing price of the Company’s common stock on the grant date of their respective shares. The restricted stock was granted under the Company’s 2003 Restricted Stock Plan in connection with the Merger between the Company and FMG on November 12, 2004 and vest on or before June 15, 2005. Based on the closing price of the Company’s stock ($3.28) on January 1, 2005, the aggregate number and value of all restricted stock held by the named executive officers as of that date were as follows: Mr. Mercadante, 261,175 shares, $856,654; Mr. Ribaudo, 125,000 shares, $410,000; and Mr. Beaumariage, 50,000 shares, $164,000. For restricted stock grants, the holder is not entitled to receive any dividends during the vesting period.

(4) All Other Compensation for 2004 consists of Company-matched 401(k) plan contributions (Mr. Mercadante, $4,100, Mr. Ribaudo, $4,100 and Mr. Beaumariage, $4,100), life insurance premiums in 2004 (Mr. Mercadante, $10,723, Mr. Ribaudo, $695 and Mr. Beaumariage, $950) and director compensation (Mr. Taneja, $24,100 and Mr. LaGamba, $24,100).

(5) Since January 1, 2005, both Mr. Ribaudo and Mr. LaGamba have resigned from their respective positions with the Company.

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OPTION GRANTS IN LAST FISCAL YEAR

The following table provides information as to options granted to each of the Named Executive Officers of the Company during fiscal year ended January 1, 2005. All such options were granted under the 1999 Stock Option Plan.

Name	Number of Securities Underlying Options Granted (1)	% of Total Options Granted to Employees in Fiscal Year			Exercise Price ($ per Share)		Market Price  per Share on Date of Grant	Expiration Date		Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term (2)
										5%		10%		0%
Edgardo A. Mercadante	1,221,672	73	%	$	0.57	$	3.60	11/22/2014	$	6,467,557	$	10,710,976	$	3,701,666
Jugal K. Taneja	—	—			—		—	—
Dale J. Ribaudo	140,281	8	%		0.57		3.60	11/22/2014		742,651		1,229,910		425,051
William L. LaGamba	—	—			—		—	—
James S. Beaumariage	143,314	9	%		0.57		3.60	11/22/2014		758,707		1,256,502		434,241

(1) The options were granted on November 12, 2004 in connection with the Merger and became fully vested on the date of grant. All options may be exercised after January 4, 2006 and terminate on the tenth anniversary of the date of grant.

(2) Potential realizable value is based on the assumption that the Common Stock appreciates at the annual rate shown (compounded annually) from the due date of grant until the expiration of the option term. These numbers are calculated based on the requirements of the SEC and do not reflect the Company’s estimate of future price growth.

AGGREGATED OPTIONS EXERCISED IN LAST FISCAL YEAR

AND FISCAL YEAR END OPTION VALUES

The following table provides information as to options exercised by each of the Named Executive Officers of the Company during the fiscal year ended January 1, 2005. The table sets forth the value of options held by such officers at year-end measured in terms of the closing price of the Company’s Common Stock on January 1, 2005.

					Number of Securities Underlying Unexercised Options at Fiscal Year End				Value of Unexercised In-The-Money Options at Fiscal Year End
Name	Shares Acquired on Exercise		Value Realized		Exercisable		Unexercisable		Exercisable		Unexercisable
Edgardo A. Mercadante		—	$	—		—		1,221,672	$	—	$	3,310,731
Jugal K. Taneja		—		—		217,500		—		85,850		—
Dale J. Ribaudo		—		—		—		140,281		—		380,162
William L. LaGamba		—		—		160,000		—		—		—
James S. Beaumariage		—		—		—		143,314		—		388,381

Equity Compensation Plan Information

The following table summarizes the Company’s equity compensation plan information as of January 1, 2005. Information is included for both equity compensation plans approved by the Company’s stockholders and equity compensation plans not approved by the stockholders.

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Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights	Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))(1)
	(a)		(b)	(c)
Equity compensation plan approved by securities holders (2)	3,969,940	$	1.91	5,235,738
Equity compensation plan not approved by security holders (3)	294,322		3.28	—
Total	4,264,262		2.16	5,235,738

1. Equity compensation plans approved by stockholders include the 1999 Stock Option Plan and the 2003 Restricted Stock Plan. All shares to be issued upon exercise in column (a) and the weighted average exercise price in column (b) represent shares to be issued upon the exercise of options granted under the 1999 Stock Option Plan.

2. The number of securities available for future issuance in column (c) were: 2,391,785 shares under the 1999 Stock Option Plan and 2,843,953 shares under the 2003 Restricted Stock Plan.

3. Reflects options to purchase shares of the Company’s common stock issued to a non-management employee. This was a one time grant of options.

Employment Agreements and Other Arrangements

Edgardo A. Mercadante—On November 12, 2004, FMG merged with and into the Company, and in connection therewith Mr. Mercadante became the Co-Chairman of the Board and Chief Executive Officer of the Company. On June 7, 2005, the Company entered into a new employment agreement with Mr. Mercadante. The initial term of Mr. Mercadante’s agreement terminates on November 30, 2005, and is subject to successive, automatic one-year renewals, unless one party notifies the other of its desire not to renew the agreement. The agreement provides for an initial annual base salary of $346,466.12, plus bonuses as determined by the board of directors. The agreement also contains standard termination provisions for disability, for cause, and for good reason, and it also contains confidentiality and non-competition provisions that prohibit Mr. Mercadante from disclosing certain information belonging to the Company and from competing against the Company. If the employment agreement is terminated other than for cause prior to November 30, 2007, or if the Company fails to renew the agreement at least through November 30, 2007, the Company is required to continue to pay to Mr. Mercadante (or to his estate in the event of termination due to his death) his compensation and other benefits until November 30, 2007, subject to the terms of the agreement.

Jugal K. Taneja—Mr. Taneja is the Company’s Co-Chairman of the Board. On June 7, 2005, the Company entered into a new employment agreement with Mr. Taneja. The initial term of Mr. Taneja’s agreement terminates on November 30, 2005, and is subject to successive, automatic one-year renewals, unless one party notifies the other of its desire not to renew the agreement. The agreement provides for an initial annual base salary of $346,466.12, plus bonuses as determined by the board of directors. The agreement also contains standard termination provisions for disability, for cause, and for good reason, and it also contains confidentiality and non-competition provisions that prohibit Mr. Taneja from disclosing certain information belonging to the Company and from competing against the Company. If the employment agreement is terminated other than for cause prior to November 30, 2007, or if the Company fails to renew the agreement at least through November 30, 2007, the Company is required to continue to pay to Mr. Taneja (or to his estate in the event of termination due to his death) his compensation and other benefits until November 30, 2007, subject to the terms of the agreement.

Dale J. Ribaudo—On November 12, 2004, FMG merged with and into the Company, and in connection therewith Mr. Ribaudo became the Company’s Chief Financial Officer. Mr. Ribaudo entered into his employment agreement with Familymeds, Inc. in November 2000, as amended August 8, 2002 and August 13, 2004. The amended agreement provides for a two-year term, and a minimum annual base salary of $232,399, plus bonuses and stock options as determined by the board of directors. Mr. Ribaudo’s employment agreement contains standard termination provisions for disability, for cause, and for good reason, and it also contains confidentiality provisions that prohibit him from disclosing certain information belonging to the Company. On May 23, 2005, Mr. Ribaudo announced his resignation and on June 3, 2005, he left the Company.

44

James E. Searson—On May 23, 2005, Mr. Searson became the Company’s Chief Financial Officer. On June 7, 2005, the Company entered into a new employment agreement with Mr. Searson. The initial term of Mr. Searson’s agreement terminates on May 23, 2006, and is subject to successive, automatic one-year renewals, provided that either party may terminate the agreement at any time by providing 90-days prior written notice. The agreement provides for an initial annual base salary of $250,000, plus bonuses as determined by the board of directors of up to 45% of his annual base compensation. The agreement also contains standard termination provisions for disability, for cause, and for good reason, and it also contains confidentiality provisions that prohibit Mr. Searson from disclosing certain information belonging to the Company. If the Company terminates the employment agreement other than for cause, death or disability prior to May 23, 2006, the Company is required to pay to Mr. Searson an amount equal to the monthly portion of his annual base compensation multiplied by the greater of 12 months or the number of months remaining in the term of the agreement.

William L. LaGamba—Mr. LaGamba was the Company’s former President and Chief Operating Officer. In April 2003, the Company entered into a new employment agreement with Mr. LaGamba for an initial three-year term and an initial annual base salary of $175,000, plus bonuses and stock options as determined by the board of directors in its sole discretion. Mr. LaGamba’s employment agreement contains standard termination provisions for disability, for cause, and for good reason, and it also contains confidentiality provisions that prohibit him from disclosing certain information belonging to the Company. If the employment agreement is terminated other than for good reason or cause, Mr. LaGamba is entitled to receive his base salary through the date of termination and for one year thereafter. On August 12, 2005, Mr. LaGamba resigned from his position with the Company.

James S. Beaumariage—Mr. Beaumariage is the Senior Vice President of Operations for Familymeds, Inc. (a wholly-owned subsidiary). In May 1998, Familymeds, Inc. entered into an employment agreement with Mr. Beaumariage which was amended August 8, 2002 and August 13, 2004. The amended agreement provides for a two-year term, and a minimum annual base salary of $191,889, plus bonuses and stock options as determined by the board of directors. Mr. Beaumariage’s employment agreement contains standard termination provisions for disability, for cause, and for good reason, and it also contains non-compete and confidentiality provisions that prohibit him from disclosing certain information belonging to the Company.

45

 

Share Ownership of Directors, Certain Executive Officers and Principal Stockholders

To the best of the Company’s knowledge, the following table sets forth, as of October 31, 2005, information as to the beneficial ownership of the Company’s voting securities by (i) each person known to the Company as having beneficial ownership of more than 5% of the Company’s voting securities, (ii) each person serving the Company as a director on such date, (iii) each person serving the Company as an executive officer on such date who qualifies as a Named Executive Officer, as defined in Item 403(a)(3) of Regulation S-K under the Securities Exchange Act of 1934, and (iv) all of the directors and executive officers of the Company as a group.

Name and Address of Beneficial Owner(1)	Amount and Nature of Beneficial Ownership		Percent of Class(2)
MEDCAP MANAGEMENT & RESEARCH LLC, 500 Third Street, Suite 535, San Francisco, CA 94107 (3)		9,298,501		14.19	%
C. Fred Toney, 500 Third Street, Suite 535, San Francisco, CA 94107 (3)		9,298,501		14.19	%
MEDCAP PARTNERS, LP, 500 Third Street, Suite 535, San Francisco, CA 94107 (3)		7,809,111		11.91	%
JANUS VENTURE FUND, 151 Detroit Street, Denver CO 80206 (4)		6,100,000		9.31	%
ABS CAPITAL PARTNERS III, LP, 400 East Pratt St Ste 910, Baltimore MD 21202 (5)		6,183,444		9.21	%
BTG INVESTMENTS, LLC, 24 Corporate Plaza, Newport Beach, CA, 94108(6)		3,470,716		5.30	%
AMERISOURCEBERGEN DRUG CORPORATION, 1300 Morris Drive, Chesterbrook, PA		3,453,178		5.00	%
Laura L. Witt(7)		6,236,444		9.29	%
Peter J. Grua (8)		1,616,615		2.45	%
Jugal K. Taneja (9)		1,755,207		2.67	%
Edgardo A. Mercadante (10)		506,175		*
James E. Searson (11)		250,500		*
James S. Beaumariage (12)		50,000		*
Philip P. Gerbino		58,000		*
Mark T. Majeske		40,000		*
Rakesh K. Sharma		40,000		*
All Directors and Executive Officers as a group		10,552,941		15.52	%

46

* Less than 1%

(1) Unless otherwise indicated, the address of each of the beneficial owners identified is 312 Farmington Avenue, Farmington, CT, 06032-1968.

(2) Based on 65,545,415 shares of common stock and no shares of preferred stock outstanding plus any vested warrants or options for each beneficial owner. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Pursuant to the rules of the Securities Exchange Commission, certain shares of common stock which a person has the right to acquire within 60 days of the date hereof pursuant to the exercise of stock options or warrants are deemed to be outstanding for the purpose of computing the percentage ownership of such person but are not deemed outstanding for the purpose of computing the percentage ownership of any other person. To the Company’s knowledge, the persons named in this table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them, subject to community property laws where applicable and except as indicated in the other footnotes to this table.

(3) Excludes 3,904,555 warrants, as these warrants are not exercisable within 60 days. MedCap Partners LP is the beneficial owner of 7,809,111 shares of common stock. MedCap Management & Research, LLC (“MMR”) as general partner and investment manager of MedCap Partners LP, and MedCap Master Fund LP, and Mr. C Fred Toney as managing member of MMR may be deemed to beneficially own the securities owned by MedCap Partners L.P. and MedCap Master Fund, L.P., in that they may be deemed to have the power to direct the voting or disposition of the securities. Both MMR and Mr. Toney disclaim beneficial ownership of the securities, except to the extent of their respective pecuniary interests therein.

(4) Excludes 3,050,000 warrants, as these warrants are not exercisable within 60 days. Janus Capital Management LLC is the investment advisor to Janus Venture Fund, a registered investment company comprised of a series of funds under the Investment Company Act of 1940, which are the beneficial owners of the shares owned by such entity.

(5) Includes 1,561,791 shares issuable upon the exercise of warrants to acquire common stock that are currently exercisable.

(6) Excludes 1,735,358 warrants, as these warrants are not exercisable within 60 days. Gordon J. Roth is the natural control person of BTG Investments, LLC and has investment power and voting control over these securities, but disclaims beneficial ownership of these securities.

(7) Includes 4,621,653 common shares and 1,561,791 warrants held by ABS Capital Partners III, LP. Ms. Witt is a general partner of ABS Capital Partners III, LP. She disclaims beneficial ownership of all such securities held by ABS Capital Partners III, L.P., except to the extent of her proportionate pecuniary interests therein.

(8) Includes the following shares beneficially owned by: HLM/CB Fund LP, 241,802 common shares and 81,712 warrants; HLM/UH Fund LP, 331,796 common shares and 112,123 warrants; and Validus LP, 602,560 common shares and 203,622 warrants. Excludes 5,252 options issued to Peter Grua, as these options are not exercisable within 60 days. Mr. Grua is a general partner of all such limited partnerships. He disclaims beneficial ownership of all such securities held by all of such limited partnerships, except to the extent of his proportionate pecuniary interests therein.

(9) Includes the following shares and options beneficially owned: 21^st Century Healthcare Fund LLC, 300,000; Carnegie Capital, 422,555; Dynamic Health Products, 122,462; First Delhi Trust, 48,378; Manju Taneja, his spouse, 469,510 and exercisable stock options, 242,500. Mr. Taneja disclaims beneficial ownership of all such securities held by his wife.

(10) Excludes 1,621,672 stock options, as these options are not exercisable within 60 days.

(11) Excludes 262,500 stock options, as these options are not exercisable within 60 days.

(12) Excludes 268,314 stock options, as these options are not exercisable within 60 days.

Shares of the common stock of the Company are listed and traded on the Nasdaq Capital Market (“Nasdaq”) under the symbol “DMAX.”

47

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information set forth herein briefly describes certain relationships and related transactions during the last three fiscal years between the Company and its Directors, officers and stockholders owning 5% or more of the Company’s Common Stock. These relationships and transactions have been and will continue to be reviewed and approved by a majority of the Company’s independent Directors and the Audit Committee.

River Road Real Estate—In October 2001, prior to the Merger, the Company executed a commercial lease agreement with River Road Real Estate, LLC, an entity controlled by a current director and other directors and officers of the Company at the time the lease was executed, to house the operations of Valley Drug Company South, the Company’s subsidiary in St. Rose, Louisiana. The lease is for an initial period of five years with a base monthly lease payment of $15,000, and an initial deposit of $15,000. During the period from November 12, 2004 to January 1, 2005, the Company recorded rent expense of $28,183 related to the lease. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

Becan Development LLC—In January 2004, prior to the Merger, the Company executed a second commercial lease agreement (the “Second Lease”) with Becan Development, LLC, an entity controlled by a current director and other directors and officers of the Company at the time the lease was executed.. The Second Lease is for an initial period of fifteen years with a base monthly lease payment of $17,000. During the period from November 12, 2004 to January 1, 2005, the Company recorded rent expense of $25,500 related to the Second Lease. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

48

INDEX TO FINANCIAL STATEMENTS

OF DRUGMAX, INC. AND SUBSIDIARIES

(formerly, Familymeds Group, Inc. and Subsidiaries)

	Page
Audited Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm	F-2
Consolidated Balance Sheets as of January 1, 2005 and December 27, 2003	F-3
Consolidated Statements of Operations for the Fiscal Years Ended January 1, 2005, December 27, 2003 and December 28, 2002	F-4
Consolidated Statements of Shareholders’ Equity (Deficit) for the Fiscal Years Ended January 1, 2005, December 27, 2003 and December 28, 2002	F-5
Consolidated Statements of Cash Flows for the Fiscal Years Ended January 1, 2005, December 27, 2003 and December 28, 2002	F-6
Notes to Consolidated Financial Statements	F-7
Schedule II—Valuation and Qualifying Accounts for the Fiscal Years Ended January 1, 2005, December 27, 2003 and December 28, 2002	F-28
Unaudited Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of July 2, 2005 and January 1, 2005 (unaudited)	F-29
Condensed Consolidated Statements of Operations for the Three and Six Months Ended July 2, 2005 and June 26, 2004 (unaudited)	F-30
Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 2, 2005 and June 26, 2004 (unaudited)	F-31
Notes to Condensed Consolidated Financial Statements	F-32

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

DrugMax, Inc.

Farmington, Connecticut

We have audited the accompanying consolidated balance sheets of DrugMax, Inc. (formerly, Familymeds Group, Inc.) and subsidiaries (collectively, the “Company”) as of January 1,2005 and December 28, 2003, and the related consolidated statements of operations, changes in stockholders’ equity (deficit) and cash flows for each of the three years in the period ended January 1, 2005. Our audits also included the financial statement schedule included on page F-27. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of DrugMax, Inc.and subsidiaries as of January 1, 2005 and December 27, 2003, and the results of their operations and their cash flows for each of the three years in the period ended January 1, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, as of January 1, 2005 the Company was in violation of certain financial and other covenants on its Senior Credit Facility and the lender can demand repayment of the $32.9 million outstanding as of such date and could foreclose upon all or substantially all of the Company’s assets and the assets of its subsidiaries. Additionally, the Company has a history of operating losses. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans concerning these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from these uncertainties.

Effective December 30, 2001, the Company changed its methods of accounting for negative goodwill and goodwill to conform with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.

/s/ Deloitte & Touche LLP

Hartford, Connecticut

April 15, 2005, except with respect to the matters discussed in Note 17, as to which the date is November 1, 2005

F-2

DRUGMAX, INC. AND SUBSIDIARIES

(formerly, Familymeds Group, Inc. and Subsidiaries)

CONSOLIDATED BALANCE SHEETS

JANUARY 1, 2005 AND DECEMBER 27, 2003

	2004			2003
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	2,331,552		$	1,307,094
Trade receivables, net of allowance for doubtful accounts of approximately $3,897,000 and $1,718,000 in 2004 and 2003, respectively		20,570,053			9,864,996
Inventories		34,525,247			18,874,602
Prepaid expenses and other current assets		1,965,515			876,631
Total current assets		59,392,367			30,923,323
PROPERTY AND EQUIPMENT—Net of accumulated depreciation and amortization of approximately $11,707,000 and $9,640,000 in 2004 and 2003, respectively		5,250,684			4,788,732
GOODWILL		19,813,080			—
OTHER INTANGIBLE ASSETS—Net of accumulated amortization of approximately $15,350,000 and $15,071,000 in 2004 and 2003, respectively		10,570,061			7,537,397
OTHER NONCURRENT ASSETS		571,874			903,325
TOTAL	$	95,598,066		$	44,152,777
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
CURRENT LIABILITIES:
Revolving credit facility	$	32,870,787		$	25,077,638
Current portion of long-term debt		2,284,212			12,618,690
Current portion of obligations under capital leases		30,092			40,456
Accounts payable		26,132,491			21,336,404
Accrued expenses		5,949,342			9,453,780
Total current liabilities		67,266,924			68,526,968
LONG-TERM ACCOUNTS PAYABLE		22,425,000			—
OBLIGATIONS UNDER CAPITAL LEASES—Less current portion		—			33,687
OTHER LONG-TERM LIABILITIES		50,854			155,310
FMG REDEEMABLE PREFERRED STOCK:
FMG Series A Redeemable Convertible Preferred Stock, $0.01 par value, no and 1,317,391 shares authorized for 2004 and 2003, respectively; no and 1,317,391 shares issued and outstanding for 2004 and 2003, respectively (involuntary liquidation value $0 and $7,809,217 for 2004 and 2003, respectively)		—			7,800,660
FMG Series B Redeemable Convertible Preferred Stock, $0.01 par value, no and 2,042,105 shares authorized for 2004 and 2003, respectively; no and 1,858,239 shares issued and outstanding for 2004 and 2003, respectively (involuntary liquidation value $0 and $14,008,967 for 2004 and 2003, respectively)		—			13,954,108
FMG Series C Redeemable Convertible Preferred Stock, $0.01 par value, no and 2,564,102 shares authorized for 2004 and 2003, respectively; no and 2,564,102 shares issued and outstanding for 2004 and 2003, respectively (involuntary liquidation value $0 and $24,999,995 for 2004 and 2003, respectively)		—			24,655,525
FMG Series D Redeemable Convertible Preferred Stock, $0.01 par value, no and 4,000,000 shares authorized for 2004 and 2003, respectively; no and 2,217,769 shares issued and outstanding for 2004 and 2003, respectively (involuntary liquidation value $0 and $51,766,960 for 2004 and 2003, respectively)		—			51,277,856
FMG Series E Redeemable Convertible Preferred Stock, $0.01 par value, no and 1,519,757 shares authorized for 2004 and 2003, respectively; no and 988,441 shares issued and outstanding for 2004 and 2003, respectively (involuntary liquidation value $0 and $21,473,849 for 2004 and 2003, respectively)		—			11,636,924
Total FMG redeemable preferred stock		—			109,325,073
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY (DEFICIT):
Common stock, $.001 par value, 45,000,000 and 24,000,000 shares authorized for 2004 and 2003, respectively; 19,483,674 and 1,288,909 shares issued and outstanding for 2004 and 2003, respectively		19,484			1,289
Additional paid in capital		175,499,012			15,283,979
DrugMax Series A Convertible Preferred Stock, $1,000 par value, 17,000 and no shares issued and outstanding for 2004 and 2003, respectively; 5,000,000 and 2,000,000 shares authorized in 2004 and 2003, respectively (involuntary liquidation value $17,000,000 and $0 for 2004 and 2003, respectively)		14,026,902			—
Accumulated deficit		(177,841,211	)		(149,173,529	)
Unearned compensation		(5,848,899	)		—
Total stockholders’ equity (deficit)		5,855,288			(133,888,261	)
TOTAL	$	95,598,066		$	44,152,777

See notes to consolidated financial statements.

F-3

DRUGMAX, INC. AND SUBSIDIARIES

(formerly, Familymeds Group, Inc. and Subsidiaries)

CONSOLIDATED STATEMENTS OF OPERATIONS

FISCAL YEARS ENDED JANUARY 1, 2005, DECEMBER 27, 2003 and DECEMBER 28, 2002

	2004			2003			2002
NET REVENUES	$	239,231,108		$	218,015,047		$	223,512,843
COST OF SALES		192,386,725			170,597,432			177,491,050
Gross margin		46,844,383			47,417,615			46,021,793
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		46,681,200			47,492,008			47,798,688
DEPRECIATION AND AMORTIZATION EXPENSE		4,773,016			5,297,625			5,075,883
IMPAIRMENTS OF LONG-LIVED ASSETS		31,259,794			791,653			592,610
GAIN ON DISPOSAL OF FIXED ASSETS AND INTANGIBLE ASSETS		(1,026,814	)		(365,382	)		(609,956	)
OPERATING LOSS		(34,842,813	)		(5,798,289	)		(6,835,432	)
OTHER INCOME (EXPENSE):
Interest expense		(5,653,602	)		(7,199,746	)		(4,025,584	)
Interest income		45,852			69,966			12,618
Other income		606,485			753,954			1,442,899
Total other expense, net		(5,001,265	)		(6,375,826	)		(2,570,067	)
LOSS BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES		(39,844,078	)		(12,174,115	)		(9,405,499	)
CUMULATIVE EFFECT OF ADOPTION OF SFAS No. 141 (Note 2)		—			—			209,870
CUMULATIVE EFFECT OF ADOPTION OF SFAS No. 142 (Note 2)		—			—			(920,028	)
NET LOSS		(39,844,078	)		(12,174,115	)		(10,115,657	)
FMG Redeemable Preferred Stock Dividends		(10,665,274	)		(5,657,232	)		(5,657,227	)
DrugMax Preferred Stock Dividends		(130,375	)		—			—
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS	$	(50,639,727	)	$	(17,831,347	)	$	(15,772,884	)
BASIC AND DILUTED LOSS PER SHARE:
Loss available to common stockholders before cumulative changes in accounting principles	$	(13.57	)	$	(13.83	)	$	(11.69	)
Adoption of SFAS No. 141		—			—			0.16
Adoption of SFAS No. 142		—			—			(0.71	)
Net loss available to common stockholders	$	(13.57	)	$	(13.83	)	$	(12.24	)
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic and Diluted Shares		3,731,494			1,288,909			1,288,909

See notes to consolidated financial statements.

F-4

DRUGMAX, INC. AND SUBSIDIARIES

(formerly, Familymeds Group, Inc. and Subsidiaries)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

FISCAL YEARS ENDED JANUARY 1, 2005, DECEMBER 27, 2003 AND DECEMBER 28, 2002

	Common Stock									DrugMax Series A Convertible Preferred Stock					Accumulated Deficit			Unearned Compensation			Total Stockholders’ Equity (Deficit )
	Shares			Amount			Additional Paid in Capital			Shares		Amount
BALANCE—December 29, 2001		1,286,910		$	1,287		$	14,911,067			—	$	—		$	(115,623,652	)	$	—		$	(100,711,298	)
Net loss		—			—			—			—		—			(10,115,657	)		—			(10,115,657	)
Issuance of warrant		—			—			—			—		—			54,354			—			54,354
Exercise of stock options		1,999			2			2,998			—		—			—			—			3,000
Dividends accrued and accretion of issuance costs on Series A, B, D and E Redeemable Convertible Preferred Stock		—			—			—			—		—			(5,657,227	)		—			(5,657,227	)
Stock compensation		—			—			193,000			—		—			—			—			193,000
BALANCE—December 28, 2002		1,288,909			1,289			15,107,065			—		—			(131,342,182	)		—			(116,233,828	)
Net loss		—			—			—			—		—			(12,174,115	)		—			(12,174,115	)
Dividends accrued and accretion of issuance costs on Series A, B, D and E Redeemable Convertible Preferred Stock		—			—			—			—		—			(5,657,232	)		—			(5,657,232	)
Stock compensation		—			—			176,914			—		—			—			—			176,914
BALANCE—December 27, 2003		1,288,909			1,289			15,283,979			—		—			(149,173,529	)		—			(133,888,261	)
Net loss		—			—			—			—		—			(39,844,078	)		—			(39,844,078	)
Dividends accrued and accretion of issuance costs on FMG Series A, B, D and E Redeemable Convertible Preferred Stock through Merger date		—			—			—			—		—			(5,185,796	)		—			(5,185,796	)
Stock compensation related to vesting and exercise of FMG stock options		524,652			525			7,347			—		—			—			—			7,872
Dilution of common shares		(1,813,559	)		(1,814	)		(15,291,326	)		—		—			—			—			(15,293,140	)
Conversion of FMG notes payable, including accrued interest, into DrugMax common stock		2,106,982			2,107			7,997,893			—		—			(54,357	)		—			7,945,643
Conversion of certain FMG Redeemable Preferred Stock to DrugMax common stock and reversal of accrued dividends not converted		8,363,525			8,364			106,291,222			—		—			22,026,402			—			128,325,988
Issuance of warrants to note holders in connection with the Merger		—			—			1,655,289			—		—			—			—			1,655,289
Dividends related to warrants issued to former FMG preferred shareholders in connection with the Merger		—			—			5,479,478			—		—			(5,479,478	)		—			—
Issuance of common stock in connection with the Merger		8,196,652			8,197			44,549,858			—		—			—			—			44,558,055
Granting of restricted stock and stock options in connection with the Merger		656,047			656			7,186,199			—		—			—			(7,186,855	)		—
Exercise of stock options		160,466			160			295,642			—		—			—			—			295,802
Other stock compensation		—			—			—			—		—			—			1,337,956			1,337,956
Issuance of warrants in connection with promissory notes		—			—			170,973			—		—			—			—			170,973
Issuance of Series A Convertible Preferred Stock		—			—			—			17,000		15,868,152			—			—			15,868,152
Issuance of warrants in connection with Series A Convertible Preferred Stock		—			—			1,872,458			—		(1,872,458	)		—			—			—
Dividends accrued on DrugMax Series A Convertible Preferred Stock		—			—			—			—		31,208			(130,375	)		—			(99,167	)
BALANCE—January 1, 2005		19,483,674		$	19,484		$	175,499,012			17,000	$	14,026,902		$	(177,841,211	)	$	(5,848,899	)	$	5,855,288

See notes to consolidated financial statements.

F-5

DRUGMAX, INC. AND SUBSIDIARIES

(formerly, Familymeds Group, Inc. and Subsidiaries)

CONSOLIDATED STATEMENTS OF CASH FLOWS

FISCAL YEARS ENDED JANUARY 1, 2005, DECEMBER 27, 2003 AND DECEMBER 28, 2002

	2004			2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(39,844,078	)	$	(12,174,115	)	$	(10,115,657	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		4,773,016			5,297,625			5,075,883
Stock compensation expense		1,345,828			176,914			193,000
Noncash interest expense		1,664,788			4,280,000			204,780
Impairments of long-lived assets		31,259,794			791,653			592,610
Amortization of deferred financing costs		288,000			377,796			459,121
Provision for doubtful accounts		341,995			615,465			4,105,776
Gain on disposal of fixed assets and intangible assets		(1,026,814	)		(365,382	)		(609,956	)
Cumulative effect of adoption of SFAS No. 142		—			—			920,028
Effect of changes in operating assets and liabilities:
Trade receivables		(241,373	)		(318,883	)		(488,083	)
Inventories		(2,099,728	)		188,046			3,492,304
Prepaid expenses and other current assets		(1,969,768	)		(118,788	)		(156,132	)
Accounts payable		3,528,796			404,826			(3,518,107	)
Accrued expenses		1,984,111			(500,126	)		(1,306,800	)
Other		388,469			615,977			(304,522	)
Net cash provided by (used in) operating activities		393,036			(728,992	)		(1,455,755	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net		(1,135,588	)		(1,336,906	)		(1,158,657	)
Proceeds from sale of prescription files, net		1,103,487			420,361			429,674
Payments for intangible assets		—			(213,161	)		(109,000	)
Net cash used in investing activities		(32,101	)		(1,129,706	)		(837,983	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from Series A Convertible Preferred Stock		15,868,152			—			—
(Repayment) proceeds from term loan		(4,000,000	)		—			4,000,000
Proceeds from convertible subordinated notes		—			4,000,000			—
Repayment of amounts outstanding on revolving credit facilities, net		(8,530,048	)		(995,306	)		(723,823	)
Repayment of promissory notes		(2,334,478	)		(181,310	)		—
Repayment of obligations under capital leases		(44,051	)		(193,720	)		(712,612	)
Payment of deferred financing costs		(591,854	)		(96,401	)		(587,911	)
Proceeds from exercise of stock options		295,802			—			3,000
Net cash provided by financing activities		663,523			2,533,263			1,978,654
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		1,024,458			674,565			(315,084	)
CASH AND CASH EQUIVALENTS—Beginning of fiscal year		1,307,094			632,529			947,613
CASH AND CASH EQUIVALENTS—End of fiscal year	$	2,331,552		$	1,307,094		$	632,529
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest	$	3,700,814		$	2,541,950		$	3,827,475
Noncash transactions—
Conversion of notes payable and accrued interest into DrugMax Common Stock	$	7,945,643		$	—		$	—
Exercise of FMG Series E Preferred Stock warrants into FMG Series E Preferred Stock	$	4,000,000		$	—		$	—
Issuance of DrugMax common shares in connection with Merger	$	44,558,055		$	—		$	—
Dividends relating to warrants issued to FMG preferred shareholders	$	5,479,478		$	—		$	—
Interest expense relating to warrants issued to note holders	$	1,655,289		$	—		$	—
Issuance of warrants to promissory note holders	$	170,973		$	—		$	—
Issuance of warrants to Series A Convertible Preferred Stockholders	$	1,872,458		$	—		$	—

See notes to consolidated financial statements.

F-6

DRUGMAX, INC. AND SUBSIDIARIES

(formerly, Familymeds Group, Inc. and Subsidiaries)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FISCAL YEARS ENDED JANUARY 1, 2005, DECEMBER 27, 2003 AND DECEMBER 28, 2002

1. MERGER, BUSINESS AND GOING CONCERN

Merger —On March 19, 2004, Familymeds Group, Inc. (“FMG”) entered into an Agreement and Plan of Merger which was amended on July 1, 2004 and also on October 11, 2004 (as amended, the “Merger Agreement”) with DrugMax, Inc. (“DrugMax”). Under the terms of the Merger Agreement, on November 12, 2004, FMG merged into DrugMax, and DrugMax became the surviving corporation in the Merger (the “Merger”). The separate existence of FMG ceased and the name of the surviving corporation is DrugMax. DrugMax issued 10,470,507 shares of DrugMax common stock to certain FMG preferred shareholders and FMG note holders in connection with the Merger. The FMG note holders received 2,106,982 DrugMax shares in exchange for their notes and the remaining 8,363,525 DrugMax shares were allocated to FMG’s preferred shareholders based on liquidation preferences. FMG’s common shareholders received no consideration in the Merger. In addition, DrugMax issued 656,047 shares of DrugMax restricted common stock and options to purchase 1,574,369 shares of DrugMax common stock at $0.57 per share to certain employees and directors of FMG that remained employees and directors of DrugMax after the Merger. Additionally, DrugMax issued warrants to purchase 3,500,090 shares of DrugMax common stock at $2.61 per share to the former FMG stockholders, warrant holders and note holders. The warrants were allocated among the FMG stockholders, warrant holders and note holders in the same manner as the DrugMax common stock. Immediately after the Merger, DrugMax’s pre-Merger stockholders, as a group, owned approximately 40%, and the FMG stockholders, employees and directors, as a group, owned approximately 60%, of the issued and outstanding shares of common stock, assuming the exercise of all stock options and warrants outstanding.

The Merger was treated as a purchase of DrugMax by FMG for accounting purposes. Accordingly, for periods prior to the Merger, the information herein is historical information of FMG. The purchase price of approximately $44.6 million represents the sum of (i) the fair value ($37.8 million) of the 8,196,652 shares of DrugMax common stock, $.001 par value, retained by the existing common stockholders of DrugMax, Inc. (the fair value of the shares of DrugMax common stock is based on the average closing price of DrugMax common stock of $4.61 per share for the five-day period from March 18, 2004 to March 24, 2004, which includes two business days before and after the announcement of the Merger), (ii) $5.2 million based on a Black Scholes valuation for 2.2 million outstanding DrugMax options, all of which vested in connection with the Merger, and (iii) FMG Merger costs of approximately $1.6 million.

The assets acquired and liabilities assumed of DrugMax were recorded based upon their estimated fair values at the acquisition date. In order to record amounts at fair value, historical carrying amounts for accounts receivable, inventories, accounts payable and other amounts were adjusted to reflect estimated realizable amounts as of the acquisition date. Additionally, $1.6 million of outstanding checks not previously recorded by DrugMax in error were recorded primarily via a charge to cost of sales. The effect of these adjustments is reflected in the pro forma amounts below for the year ended January 1, 2005. The results of operations of DrugMax have been included in the Company’s consolidated statements of operations since the date of acquisition. The excess of the purchase price over the estimated fair values of the underlying assets acquired and liabilities assumed was allocated to goodwill. The allocation of the purchase price is based upon preliminary estimates and assumptions. Accordingly, the allocation is subject to revision when the Company receives final information, including appraisals and other analyses. Revisions to the fair values, which may be significant, will be recorded by the Company as further adjustments to the purchase price allocations. The Company is also in the process of integrating the operations of all its acquired businesses and expects to incur costs relating to such integrations. These costs may result from integrating operating systems, relocating employees, closing facilities, reducing duplicative efforts and exiting and consolidating other activities. These costs will be recorded on the Company’s consolidated balance sheets as adjustments to the purchase price or on the Company’s consolidated statements of operations as expenses, as appropriate.

F-7

Following is a summary of the preliminary purchase price allocation (in thousands):

Cash and cash equivalents	$	346
Accounts receivable		11,321
Inventories		13,551
Prepaid expenses and other current assets		501
Property and equipment		1,565
Goodwill		50,813
Identified intangibles		5,600
Debt		(12,323	)
Accounts payable		(23,692	)
Accrued expenses		(3,124	)
Purchase price	$	44,558

The fair value adjustments included in the preliminary allocation of purchase price above, primarily consisted of (i) $1.8 million to DrugMax’s authorized distributor licenses with an estimated life of 15 years, (ii) $3.2 million to trademarks and copyrights with an estimated life of 15 years and (iii) $0.6 million to customer lists with an estimated life of 5 years. The purchase price is based on certain preliminary estimates and subject to change as more information is available.

In connection with the Merger, the Company terminated certain DrugMax employees. Total severance obligations to these employees are approximately $966,000, none of which had been paid as of January 1, 2005 and all of which are expected to be paid during fiscal 2005. The severance obligation was reflected as an accrued expense as of the Merger date. Additionally, an accrued lease liability of $85,000 was recorded related to an office location that will no longer be used.

The accompanying consolidated financial statements include the results of operations of FMG for all periods presented and the results of operations of DrugMax subsequent to November 12, 2004. Pro forma information as if the Merger had occurred as of the beginning of the fiscal years presented is as follows (in thousands, except per share information):

		Fiscal Years Ended
		January 1, 2005			December 27, 2003
		(Unaudited)
Net revenues	$	380,549		$	458,786
Net loss		(60,749	)		(16,105	)
Net loss per share		(3.14	)		(0.83	)
Weighted average common shares outstanding—basic and diluted		19,344,750			19,323,208

Business —The Company’s operations include specialty pharmacy and drug distribution. The specialty pharmacy operations represent the former FMG operations. The drug distribution operations represent the former DrugMax operations doing business as Valley Drug Company and Valley Drug South.

As of January 1, 2005, the Company owned or franchised pharmacy locations in 13 states. As of January 1, 2005 and December 27, 2003 there were 77 and 82 owned locations, respectively, and eight franchised pharmacy locations. The Company is not actively seeking to franchise additional locations. The drug distribution operations distribute their products to independent pharmacies in the continental United States, as well as to the Company’s specialty pharmacies, other small and medium-sized pharmacy chains, alternative care facilities and other wholesalers. The Company offers branded and generic prescription and non-prescription pharmaceuticals, specialty injectables, generic biologics, compounded medicines, healthcare-related products and diagnostic products.

Going Concern —The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As of January 1, 2005 the Company was in violation of certain financial and other covenants on its Senior Credit Facility and the lender can demand repayment of the $32.9 million outstanding as of such date and could foreclose upon all or substantially all of the Company’s assets and the assets of its subsidiaries. Additionally, the Company has a history of operating losses. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management believes that with the purchasing synergies from the Merger and the effect of the reduction in costs associated with the elimination of certain redundant positions as a result of the Merger that the Company will continue as a going concern. Additionally, the Company expects to receive an amendment to the Senior Credit Facility during the second quarter of 2005 to waive existing covenant violations and amend covenant requirements going forward. However, there is no assurance that the lender will waive the violations and the lender could demand repayment of the $32.9 million outstanding as of January 1, 2005 and could foreclose upon all or substantially all of our assets and the assets of our subsidiaries.

F-8

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Fiscal Periods —The Company reports on a 52-53 week fiscal year. Fiscal year 2004 includes 53 weeks, while fiscal years 2003 and 2002 each include 52 weeks.

Principles of Consolidation —The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Use of Estimates —The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. Management’s estimates relate primarily to assigning values and lives to intangible assets acquired in connection with the Merger, estimating impairments of long-lived assets and estimating the allowance for doubtful accounts and inventory reserves.

Revenue Recognition —Revenues from pharmacy operations are comprised of both specialty pharmacy sales in Company-owned locations and royalty revenues from franchised pharmacies. Revenues from pharmacy sales, net of contractual allowances from third-party payors, are recognized at the time of sale. The Company participates in various third-party provider networks and state Medicaid programs. Under a majority of these networks, revenue is adjudicated at the time of sale. However, for certain third-party providers and state Medicaid programs, revenue is reported at the net realizable amount and adjusted in future periods as final settlements are determined. Revenues from franchised pharmacies are based on a flat fee per location or a percentage of the revenues of the franchised pharmacy and are recognized in the period in which revenues are earned. The Company recognizes revenues from the mail order and e-commerce operations when products are shipped to customers, net of discounts. Royalty revenues for the drug distribution operations are recognized when goods are shipped and title or risk of loss resides with unaffiliated customers or when services are provided. The Company has no sales incentive or rebate programs with its customers. Revenue is recorded net of sales returns and allowances.

Vendor Rebates, Allowances and Chargebacks—Rebates and allowances are recorded as a component of cost of goods sold in the period they are received from the vendor or manufacturer unless such rebates and allowances are reasonably estimable at the end of a reporting period. The Company records chargeback credits due from its vendors in the period when the sale is made to the customer which is eligible for contract pricing from the manufacturer.

Cash and Cash Equivalents —The Company considers investments with original maturities of three months or less to be cash equivalents.

Inventories —Inventories consists of pharmaceuticals and other retail merchandise. Inventories are stated at the lower of cost (first-in, first-out method for pharmaceutical inventory and retail method for retail merchandise inventory) or market. Inventories are monitored for out of date or damaged products. Inventories are recorded net of a reserve for obsolescence of approximately $902,000 and $1,046,000 at January 1, 2005 and December 27, 2003, respectively. The drug distribution operations accepts return of product from its customers for product which is saleable, in unopened containers and expires six months or more from the return date.

Property and Equipment —Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the useful lives of the assets with a mid-month convention being applied to the first year assets are placed into service. Furniture and fixtures, computer equipment and software, excluding website software costs, are depreciated over useful lives of five years. Capitalized website software costs are amortized over three years. Leasehold improvements and equipment purchased under capital leases are amortized over the shorter of the useful life of the asset or the lease term. When fixed assets are retired or sold, the asset cost and related accumulated depreciation and amortization are eliminated and any resulting gain or loss is included in the consolidated statements of operations.

Leases and Deferred Rent Payable —The Company leases pharmacy, distribution, administrative, marketing and customer service facilities. Leases are accounted for under the provisions of SFAS No. 13, Accounting for Leases, as amended, which requires that leases be evaluated and classified as operating or capital leases for financial reporting purposes. The lease term used for lease evaluation includes option periods only in instances in which the exercise of the option period can be reasonably assured and failure to exercise such options would result in an economic penalty.

For leases that contain rent escalations, the Company records the total rent payable during the lease term, as determined above, on a straight-line basis over the term of the lease and records the difference between the rents paid and the straight-line rent as a deferred rent payable. As of both January 1, 2005 and December 27, 2003, a liability of $0.1 million was recorded related to deferred rent payable.

Goodwill —Goodwill represents the excess of acquisition cost over the fair value of the net assets acquired as a result of the Merger. Goodwill is not amortized, but is subject to impairment testing annually, or more frequently if events and circumstances indicate there may be impairment. The Company measures impairment based on a discounted cash flow method and a discount rate determined by management to be commensurate with the reporting unit risk. The Company completed an impairment test for goodwill related to the drug distribution reporting unit as of January 1, 2005 and recorded a write-down of approximately $31.0 million (see Note 6).

F-9

Other Intangible Assets —Prescription file intangible assets were recorded at fair value in connection with store acquisitions. The Company amortizes prescription files on a straight-line basis over an estimated useful life of seven years.

Authorized distributor licenses, trademarks and patents and a customer list were recorded in connection with the Merger. Authorized distributor licenses relate to contractual and non-contractual relationships with pharmaceutical manufacturers allowing direct access to purchase their products. These contracts are amortized on a straight-line basis over an estimated life of 15 years. Trademarks and patents are amortized on a straight-line basis over their estimated life of 15 years. The customer list is amortized on a straight-line basis over an estimated life of five years.

Noncompete agreements relate to agreements with former storeowners who sold their pharmacies to the Company. These agreements are amortized on a straight-line basis over the lives of the agreements, generally two to five years.

Royalty rights relate to the purchase of certain franchise license agreements and are amortized on a straight-line basis over an estimated life of 20 years.

Deferred financing costs are being amortized as interest expense on an effective yield basis over the terms of the related debt. Amortization of approximately $288,000, $378,000 and $459,000 for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively, was recorded as interest expense in the accompanying consolidated statements of operations.

Impairment of Long-Lived Assets —The Company reviews long-lived assets, including property plant and equipment and intangible assets, to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the undiscounted expected future cash flows is less than the carrying amount of the related assets, the Company recognizes an impairment loss. Impairment losses are measured as the amount by which the carrying amount of the assets, including related intangible assets, exceeds the fair value of assets. For purposes of recognizing and measuring impairment of long-lived assets, the Company evaluates assets at the store level for specialty pharmacy operations. For purposes of measuring goodwill impairment, the drug distribution operations and specialty pharmacy operations are considered separate reporting units.

Store Opening and Closing Costs —Store opening costs are charged directly to expense when incurred, including rent expense during construction periods. When the Company makes a decision to close a store, the unrecoverable costs, including remaining lease obligations (net of estimated sublease rental income commencing in fiscal 2003 upon adoption of SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities ), are charged to expense.

SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was adopted by the Company in fiscal 2003. SFAS No. 144 requires the results of operations of a component entity that is classified as held for sale or that has been disposed of to be reported as discontinued operations in the statement of operations if certain conditions are met. These conditions include commitment to a plan of disposal after the effective date of this statement, elimination of the operations and cash flows of the component entity from the ongoing operations of the company and no significant continuing involvement in the operations of the component entity after the disposal transaction. The stores closed in fiscal 2004 and 2003 did not meet the criteria to be classified as discontinued operations under SFAS No. 144.

Concentration of Credit Risk —The Company’s receivables for the specialty pharmacy operations are principally from third-party insurance plans and state Medicaid programs (collectively, “Third-Party Customers”). The largest individual Third-Party Customer accounted for approximately 12%, 13% and 11% of the Company’s net revenues for the years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively. There is no other customer that represents over 10% of the Company’s net revenues for these periods. Total gross trade receivables for this customer were $652,000, $1,814,000 and $1,839,000 as of January 1, 2005, December 27, 2003 and December 28, 2002, respectively.

Advertising —Advertising costs are charged to expense as incurred and were approximately $1,345,000, $1,892,000, and $1,861,000 for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002 respectively.

Shipping and Handling Costs —Outbound shipping and handling costs are included in selling, general and administrative expenses in the accompanying consolidated statements of operations. Shipping and handling costs were approximately $1,341,000, $1,095,000 and $1,087,000 for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively.

Income Taxes —The Company accounts for income taxes according to the provisions of SFAS No. 109, Accounting for Income Taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax effects attributable to operating loss carryforwards and to differences between the financial statement and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be reversed. Valuation allowances are established for deferred tax assets when realization is not likely.

F-10

Per Share Information —For periods prior to the Merger, the weighted average shares outstanding have been computed based on the number of shares that former FMG common shareholders would have received in the transaction, on an as-if converted basis (i.e., if the preferred shareholders were converted to common prior to the Merger), had the Merger consideration not be distributed to the preferred shareholders based on liquidation values. Based on the exchange ratio, the FMG common shareholders would have received 1,288,909 shares of common stock. For the periods subsequent to the Merger, the total outstanding shares include: (i) the 1,288,909 shares assumed outstanding prior to the Merger, (ii) the 8,363,525 shares issued to the former FMG preferred shareholders based on their liquidation value in connection with the Merger, (iii) 8,196,652 shares held by the former DrugMax shareholders, (iv) the 2,106,982 shares issued to the note holders for the extinguishment of those notes in connection with the Merger, (v) 656,047 of vested restricted shares granted to management, and (vi) 160,466 shares issued post Merger related to option exercises. Potentially dilutive securities were not considered in any period presented since the effect would be anti-dilutive. Accordingly all per share information herein has been restated from the amounts previously reported by FMG.

Segment —The Company operated as one business segment for all periods presented. This segment includes two reporting units: specialty pharmacy operations and drug distribution operations.

Reclassifications —Certain prior period amounts have been reclassified to conform with the current year classification.

Stock-Based Compensation —The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“Opinion 25”), and its related interpretations in accounting for employee stock compensation and Emerging Issues Task Force (“EITF”) 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, to account for options issued to nonemployees. Forfeitures are accounted for in the period the options are actually forfeited. Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, Accounting for Stock-Based Compensation, the Company’s net loss would have decreased (increased) to the pro forma amounts indicated below:

	Fiscal Year Ended
	January 1, 2005			December 27, 2003			December 28, 2002
Net loss available to common shareholders, as reported	$	(50,639,727	)	$	(17,831,347	)	$	(15,772,884	)
Effect of stock-based employee compensation expense determined under fair method valuation for all awards		313,198			44,676			(3,334	)
Pro forma net loss available to common shareholders	$	(50,326,529	)	$	(17,786,671	)	$	(15,776,218	)
Basic and diluted net loss per share:
Net loss available to common shareholders, as reported	$	(13.57	)	$	(13.83	)	$	(12.24	)
Pro forma net loss available to common shareholders	$	(13.49	)	$	(13.80	)	$	(12.24	)
Shares used in basic and diluted net loss per share		3,731,494			1,288,909			1,288,909

The fair value of each option grant has been for SFAS No. 123 purposes on the date of grant using the Black Scholes pricing model with the following assumptions:

	Fiscal Year Ended
	January 1, 2005	December 27, 2003	December 28, 2002
Risk-free interest rate	3.54% - 4.22%	2.62% - 5.71%	3.63% - 5.71%
Expected life	3 years	3 years	3 years
Volatility	48%	—  %	—  %
Dividend yield	—  %	—  %	—  %
Weighted average fair value of each option granted	$3.50	$0.67	$0.67

F-11

3. NEW ACCOUNTING PRONOUNCEMENTS

In December 2004 the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment, which requires that the cost resulting for all share-based payment transactions be recognized in the financial statements. This statement is effective for the Company for the first fiscal year beginning after June 15, 2005 (as a result of the deferral of the effective date in April 2005) and applies to all awards granted in periods after the effective date and unvested awards as of the effective date. The Company is in the process of evaluating the method of adoption and the resulting impact of SFAS No. 123R on the Company upon adoption.

In November 2004 the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS No. 151 is effective for inventory costs incurred after October 31, 2005. The Company does not believe SFAS No. 151 will have a material impact on its consolidated financial statements.

4. IMPAIRMENTS OF LONG-LIVED ASSETS

During the year ended January 1, 2005, the Company recorded a goodwill impairment charge of $31.0 million (see Note 6).

During the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, the Company approved the closure of seven, five and 16 underperforming stores, respectively. As a result, the Company recorded impairments of long-lived assets of approximately $0, $182,000 and $170,000 in the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively, primarily related to the prescription file intangible assets and equipment for these locations. Additionally, net lease obligations related to these stores of approximately $179,000, $180,000 and $348,000 were accrued during the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively and are included in write-downs of long-lived assets. During the fiscal years ended January 1, 2005 and December 27, 2003, the Company had favorable settlements on lease obligations of approximately $87,000 and $206,000, respectively. Revenues for stores closed were $2.8 million, $1.7 million and $11.8 million for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively. The operating loss for the stores closed was $0.4 million, $0 and $0.4 million for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively.

The Company incurred impairment charges for prescription file intangible assets and property and equipment of approximately $260,000, $635,000, and $75,000 relating to underperforming and relocated stores during the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively.

5. PROPERTY AND EQUIPMENT

Property and equipment consists of:

	January 1, 2005			December 27, 2003
Computer equipment and software	$	9,015,941		$	7,848,973
Furniture, fixtures and equipment		5,073,425			4,119,995
Leasehold improvements		2,692,100			2,282,819
Equipment under capital lease obligations		176,651			176,651
Total		16,958,117			14,428,438
Less accumulated depreciation and amortization		(11,707,433	)		(9,639,706
Property and equipment, net	$	5,250,684		$	4,788,732

Depreciation and amortization expense of the Company’s property and equipment was approximately $2,203,000, $2,270,000, and $2,182,000 for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively.

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6. GOODWILL

Goodwill at January 1, 2005 is attributable to the drug distribution reporting unit and resulted from the Merger. The changes in the net carrying value of goodwill for the fiscal year ended January 1, 2005 are as follows:

	Fiscal Year Ended January 1, 2005
Goodwill, beginning of fiscal year	$	—
Goodwill associated with Merger		50,813,095
Impairment loss		(31,000,015	)
Goodwill, end of fiscal year	$	19,813,080

Goodwill was tested for impairment as of January 1, 2005. The fair value of the reporting unit was estimated using future cash flows, and a non-cash impairment charge of $31.0 million was recognized. The impairment of the drug distribution reporting unit is a result of lower revenues and profitability since the Merger terms were announced on March 20, 2004 and a decline in the fair value of the Company. Since the Merger terms were announced and the purchase price was determined, the drug distribution operations have experienced declining profitability as opportunities for forward buying and increased competition have negatively impacted estimated future cash flows. Additionally, the Company’s stock price decreased from $4.61 for the five-day period from the Merger announcement date to $3.28 as of January 1, 2005 which also negatively impacted the fair value of the reporting unit.

7. OTHER INTANGIBLE ASSETS

Other intangible assets consist of:

	January 1, 2005					December 27, 2003
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Prescription files	$	18,135,217	$	(14,124,284	)	$	19,025,178	$	(12,262,725	)
Trademarks and copyrights		3,518,127		(102,438	)		318,127		(59,865	)
Wholesale distributor contracts		1,800,000		(15,000	)		—		—
Noncompete agreements		883,867		(874,557	)		899,131		(868,399	)
Customer list		600,000		(15,000	)		—		—
Royalty rights		513,500		(205,400	)		513,500		(179,725	)
Other		469,058		(13,029	)		1,852,185		(1,700,010	)
	$	25,919,769	$	(15,349,708	)	$	22,608,121	$	(15,070,724	)

The weighted average amortization period for intangible assets is approximately 7.3 years. Amortization expense related to other intangible assets was approximately $2,570,000, $3,027,000 and $2,894,000 for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively.

Estimated future amortization expense for the succeeding five years is as follows:

Fiscal Year Ending	Amount
2005	$	3,004,414
2006		2,002,344
2007		883,943
2008		647,058
2009		555,450

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8. DEBT

Debt at January 1, 2005 and December 27, 2003 consisted of the following:

	January 1, 2005		December 27, 2003
Revolving credit facility	$	32,870,787	$	25,077,638
Term loan		—		4,000,000
12% convertible subordinated notes		—		4,000,000
Promissory notes payable		2,284,212		4,618,690
Total	$	35,154,999	$	37,696,328

The Company believes the carrying values of the revolving credit facility, term loan and promissory notes payable at January 1, 2005 and December 27, 2003 approximated the respective fair values as of such dates since the revolving credit facility and term loan had variable market rates of interest. The promissory notes payable have a fixed interest rate which management believes approximated market as of January 1, 2005 and December 27, 2003. The convertible subordinated notes and related accrued interest were converted in common stock equal to such amount in connection with the Merger.

Senior Collateralized Revolving Credit Facility and Term Loan —On July 2, 1999, FMG entered into a $25,000,000 senior collateralized revolving credit facility (the “GECC Agreement”) with General Electric Capital Corporation (“GECC”). In November 2000, the facility was increased to $31,000,000.

In June 2001, the agreement was amended (the “June 2001 Waiver and Amendment Agreement”) The June 2001 Waiver and Amendment Agreement established a $4 million reserve against the borrowing availability (reducing the maximum availability on the revolver to $27,000,000) and new minimum EBITDA financial covenants beginning with the fiscal month of June 2001 and for each fiscal month through December 2001. The Company violated the EBITDA financial covenant requirements under the June 2001 Waiver and Amendment Agreement. On January 22, 2002, the Company obtained a waiver and amendment from GECC (the “January 2002 Waiver and Amendment”), which waived these violations and amended the GECC Agreement. The January 2002 Waiver and Amendment also provided for a minimum EBITDA financial covenant measured monthly and a term loan of $4,000,000. Interest on the term loan was payable monthly and was calculated as an adjusted monthly LIBOR index rate (as defined) plus an applicable LIBOR margin (as defined). Additional paid-in-kind interest at 7.00% per annum accrued on the term loan.

On August 19, 2002, the Company entered into an Amended and Restated Credit Agreement (the “August 2002 Amendment”) with GECC. The August 2002 Amendment increased the borrowing base by $5,100,000. There was no impact on the maximum availability on the revolver, which remained at $27,000,000. This amendment extended the maturity date of the revolver and the term loan to August 19, 2003. On August 14, 2003, the maturity date of the revolver and term loan was extended to August 20, 2003. Later, the maturity date was further extended to September 26, 2003.

On September 24, 2003, the Company entered into a Waiver and First Amendment to the Amended and Restated Credit Agreement (the “September 2003 Amendment”), which extended the maturity date of the revolver and term loan to April 21, 2004. The September 2003 Amendment also waived the violation of certain financial covenants in February 2003 and April through August 2003 as well as other events of default, changed covenant requirements through the maturity date of the agreement, and increased the interest rates on amounts outstanding by 25 basis points. Under the terms of the September 2003 Amendment, the Company was required to have a letter of intent(s) providing for new capital of not less than $11 million by January 31, 2004. Since a letter of intent was not obtained prior to January 31, 2004, the maximum availability of the revolver was reduced by $1,000,000 to $26,000,000. On October 24, 2003, the Company entered into the Second Amendment (the “October 2003 Amendment”) to the Amended and Restated Credit Agreement, which placed GECC approval requirements on future compensation increases to certain members of senior management.

On April 16, 2004, the Company entered into a Third Amendment to the Amended and Restated Credit Agreement (the “April 2004 Amendment”), which extended the maturity date of the revolver and term loan to August 31, 2004. The April 2004 Amendment also waived the violation of certain financial covenants in fiscal 2003 and January and February 2004 and established new EBITDA covenants commencing in March 2004.

On December 9, 2004, the Company entered into the Second Amended and Restated Credit Agreement (the “Senior Credit Facility”) with GECC, which increased the facility from $31 million to $65 million. The $65 million of maximum availability was reduced by $5.5 million of permanent availability, until the March 2005 Amendment discussed below, which increased the permanent availability reduction to $7.5 million. In conjunction with entering into the Senior Credit Facility, the $4 million term loan and related interest of $0.8 million were repaid to GECC. In addition, DrugMax’s credit facility in existence at the time of the Merger was terminated and the $11.9 million balance then outstanding was repaid to the lender. The Senior Credit Facility matures on December 9, 2007. The Senior Credit Facility includes a prepayment penalty of $1,300,000 if paid in full before December 9, 2005, $975,000 if paid in full after December 9, 2005 but before December 9, 2006 and $650,000 if paid after December 9, 2006. The Senior Credit Facility is secured by substantially all assets of the Company. As of January 1, 2005, $32.9 million was outstanding under the Senior Credit Facility and $2.9 million was available for additional borrowings, based on eligible receivables and inventory.

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Interest on the revolving credit facility is calculated at either the index rate (as defined) plus an applicable index margin (as defined) or, at the option of the Company, at an adjusted monthly LIBOR index rate plus an applicable LIBOR margin (as defined). The applicable index margin as of January 1, 2005 and December 27, 2003 was 0.5% and 3.25%, respectively. The interest rates, including applicable margin, that were used to calculate accrued interest were 5.75%, 5.56% and 5.81% as of January 1, 2005, December 27, 2003 and December 28, 2002, respectively. Interest is payable monthly.

On March 22, 2005, the Company entered into the First Amendment to the Senior Credit Facility (the “March 2005 Amendment”). The March 2005 Amendment provided for an increase in the reduction of permanent availability from $5.5 million to $7.5 million and allowed the Company to convert the $23 million of accounts payable (after consideration of a $6 million payment in March 2005) to AmerisourceBergen Drug Corporation (“ABDC”) into a subordinated convertible debenture in the original principal amount of $11,500,000 (the “Subordinated Debenture”) and a subordinated promissory note in the original principal amount of $11,500,000 (the “Subordinated Note”).

The Senior Credit Facility requires compliance with certain restrictive covenants including, but not limited to, minimum EBITDA, maximum capital expenditures, maximum fixed charge coverage ratio, minimum net worth, minimum inventory turnover, maximum trade receivable days sales outstanding, maximum accounts payable days outstanding and maximum ratio of non-pharmaceutical inventory to total inventory. The Company violated certain of these covenants as of January 1, 2005, including the EBITDA and net worth financial covenants, and other covenants, and as of such date was in default on this obligation. As of April 15, 2005, the Company had not yet received an amendment waiving covenant violations. The Company expects to receive an amendment during the second quarter of 2005. However, there is no assurance that the lender will waive the violation and the lender could demand repayment of the $32.9 million outstanding as of January 1, 2005 and could foreclose upon all or substantially all of our assets and the assets of our subsidiaries.

Convertible Subordinated Notes Payable and Guarantee —On August 19, 2002, FMG entered into a Capital Support and Subscription Agreement (the “Support Agreement”) with existing investors. Under the terms of the limited guarantee agreements, certain investors guaranteed $6 million of FMG’s indebtedness under the GECC Agreement (the “Guarantees”). Certain investors also committed to make $4 million available to FMG for working capital purposes. In exchange for the commitment and Guarantees, FMG issued warrants to purchase 438,249 shares of Series E Preferred Stock at an exercise price of $9.87 per share.

On January 23, 2003, FMG utilized the commitment and $4 million of 12% convertible subordinated promissory notes (the “Notes”) were issued by FMG. While these Notes accrued interest at a rate of 12% per annum, the Notes provided for aggregate interest of $4 million at maturity during fiscal 2003. Accordingly interest of $4 million was accrued through the original note maturity date during fiscal 2003.

Prior to the Merger, the warrants to purchase FMG Series E Preferred Stock were exercised into 438,249 shares of FMG Series E Preferred Stock in a cashless exercise. In connection with the Merger, Series E Preferred Stock was converted into DrugMax common stock based on its liquidation preference. The Notes and accrued interest payable aggregating $8 million were paid in full by the issuance of 2,106,982 shares of DrugMax common stock. The Company recorded noncash interest expense of approximately $1,655,000 that relates to the allocation of the warrants to the former FMG note holders, which was based on a Black Scholes valuation.

Convertible Subordinated Debentures —On October 29, 1999, FMG issued $4,800,000 of 7% subordinated convertible debentures in connection with an acquisition. The entire principal amount of the debentures was originally due in full on October 29, 2003. In September 2003, FMG entered into the First Amendment to the Convertible Subordinated Debentures (the “Promissory Notes”) of the same principal amount. The Promissory Notes bore interest at 9% per annum and were payable in equal monthly installments of principal and interest of approximately $219,000 until October 30, 2004. The Promissory Notes contained certain covenants, none of which were more restrictive than those contained in the GECC Agreement. In consideration of the note holders signing the Promissory Notes, FMG issued the holders warrants to purchase 328,122 shares of FMG’s nonvoting common stock at an exercise price of $14.63 per share. The warrants were ascribed no value, were not exercised and were canceled in connection with the Merger.

On November 1, 2004, the Promissory Notes were exchanged for new promissory notes (the “New Promissory Notes”), which bear interest at 9% per annum. Of the New Promissory Notes, $1,412,306 are payable in equal monthly installments of principal and interest of approximately $124,000 until October 30, 2005. The remaining $1,098,460 of New Promissory Notes are payable in full on October 30, 2005 with interest payable monthly. The New Promissory Notes contain certain covenants, none of which are more restrictive than those contained in the Senior Credit Facility. In consideration of the note holders agreeing to the exchange, the Company issued the holders warrants to purchase 492,306 shares of DrugMax common stock at an exercise price of $9.75 per share. Using the Black-Scholes model, these warrants were valued at $170,973, of which $9,498 was amortized as additional interest expense during the year ended January 1, 2005. As of January 1, 2005, the warrants have not been exercised.

F-15

9. CAPITAL STOCK

DrugMax Common Stock —Authorized common stock consists of 45 million shares of common stock, $.001 par value as of January 1. 2005. The number of authorized shares of common stock was increased from 24 million to 45 million shares on November 12, 2004. In connection with the Merger, the shareholders of FMG (along with certain FMG warrant holders and note holders) received an aggregate of 10,470,507 shares of DrugMax common stock.

On August 27, 2003, DrugMax adopted the DrugMax, Inc. 2003 Restricted Stock Plan (“the Restricted Stock Plan”). Prior to the Merger, DrugMax had not issued any restricted shares under the Restricted Stock Plan. On November, 12, 2004, the number of shares authorized under the Restricted Stock Plan was increased from 1.5 million shares to 3.5 million shares. In connection with the Merger, DrugMax issued an aggregate of 656,047 shares of restricted DrugMax common stock to certain employees and directors of FMG. The restricted stock was scheduled to vest on March 25, 2005 or upon such time as a registration statement is declared effective. On March 23, 2005, certain of the restricted stock agreements were amended to change the vesting to June 15, 2005 or upon such time as a registration statement is declared effective by the SEC. The compensation charge recorded during the year ended January 1, 2005 relating to the restricted stock was $809,125 which was based on the vesting provisions of the original restricted stock agreements. The effect of the March 2005 modification will be accounted for prospectively as of March 23, 2005.

In connection with the Merger, a proposal to approve a reverse stock split of DrugMax’s common stock at a ratio of between four-for-five and one-for-two, to be implemented immediately before the Merger, at the discretion of DrugMax’s board of directors was approved by the Company’s stockholders. Although the Company’s stockholders approved the foregoing reverse stock split, the Company’s Board of Directors, at a meeting held November 12, 2004, determined that it was not in the best interest of the Company’s stockholders to affect a reverse stock split at that time and a reverse stock split did not occur.

DrugMax Preferred Stock —The number of authorized shares was increased from two million to five million preferred shares at the annual meeting on November 12, 2004, of 5,000,000 shares of which 17,000 shares have been designated as Series A Convertible Preferred Stock. On December 2, 2004, the Company sold 17,000 shares of Series A Convertible Preferred Stock (the “DrugMax Preferred Stock”) to certain qualified institutional buyers and accredited investors for net proceeds of $15,868,000, after expenses of approximately $1,132,000. Holders of the DrugMax Preferred Stock are entitled to receive cumulative dividends, before any dividends are paid to the common stockholders, at the rate per share of 7% per annum until the fourth anniversary, 9% per annum from the fourth anniversary until the fifth anniversary, 11% per annum from the fifth anniversary until the sixth anniversary and 14% per annum thereafter. The dividends are being recorded on a straight line basis using an estimated life of 10 years. Except as provided in the certificate of designation filed with the SEC on January 21, 2005, the shares of DrugMax Preferred Stock do not have any voting rights. The holders may at their option convert their shares into shares of DrugMax common stock. The DrugMax Preferred Stock is convertible into an aggregate of 4,594,591 shares of DrugMax common stock, based upon an initial conversion price of $3.70 per share. The initial conversion is not deemed to be a beneficial conversion feature. The conversion price is subject to an anti-dilution adjustment. Further, if the Company meets certain equity conditions, the Company may at its option force the holders to convert their DrugMax Preferred Stock into common stock at the then applicable conversion price. Furthermore, after the fourth anniversary, provided the Company has satisfied certain equity conditions, the Company may at its option redeem the DrugMax Preferred Stock.

If the redemption date occurs following the fourth anniversary but prior to the fifth anniversary, the redemption price shall be $1,200 per share, if the redemption date occurs on or following the fifth anniversary, but prior to the sixth anniversary, the redemption price shall be $1,100 per share, if the redemption date occurs on or following the sixth anniversary, the redemption price shall be $1,050, plus all accrued but unpaid dividends. Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, the DrugMax preferred stockholders shall be entitled to receive out of the assets of the Company, $1,000 for each share plus any accrued and unpaid dividends thereon and any other fees or liquidated damages owing thereon before any distribution or payment shall be made to the holders of any junior securities, including common stock.

The preferred stock investors received warrants to purchase 1,378,374 shares of DrugMax common stock at an exercise price of $4.25 per share. The warrants expire on December 1, 2010. As of January 1, 2005, no warrants had been exercised. The fair value of the warrants of $1,872,458, based on a Black Scholes valuation is being recorded as additional preferred stock dividends over the ten-year estimated life of the DrugMax series A convertible preferred stock.

FMG Redeemable Convertible Preferred Stock —Prior to the Merger, FMG had outstanding Series A, B, C, D and E Preferred Stock. In connection with the Merger, DrugMax issued 8,363,525 shares of DrugMax common stock to certain FMG preferred shareholders which were allocated to FMG’s preferred shareholders based on liquidation preferences. Based on the ten-day-weighted stock price of $3.7969 as of November 12, 2004, the FMG Series E shareholders received DrugMax stock equal to their full liquidation preference, the FMG Series C preferred shareholders and FMG Series D preferred shareholders received DrugMax stock equal to approximately 7% of their liquidation preferences and the FMG Series A preferred shareholders, FMG Series B preferred shareholders and FMG common shareholders received no consideration for their shares.

DrugMax also issued warrants to purchase 3,500,090 shares of DrugMax common stock at $2.61 per share to the former FMG stockholders and note holders. The warrants were allocated among the FMG stockholders, note holders in the same manner as the DrugMax common stock and warrants to purchase 1,950,692 shares were allocated to former FMG preferred stockholders. The fair value of the warrants issued to the former FMG preferred shareholders of $5,479,478 based on a Black Scholes valuation was recorded as a preferred stock dividend prior to the Merger.

F-16

Following is a summary of FMG liquidation preferences and the shares received by FMG note holders and preferred stockholders in the Merger:

	DrugMax Common Shares Received		Liquidation Value as of Merger Date		Carrying Value as of Merger Date
Noteholders, including accrued interest		2,106,982	$	8,000,000	$	8,000,000
Series E Preferred Stockholders, after warrant exercise		6,974,711		26,482,280		17,860,084
Series D Preferred Stockholders		952,732		3,617,426		54,618,760
Series C Preferred Stockholders		436,082		1,655,762		24,999,995
Series B Preferred Stockholders		—		—		14,687,967
Series A Preferred Stockholders		—		—		8,159,182
Total		10,470,507	$	39,755,468	$	128,325,988

Dividends on FMG preferred stock were accrued through the Merger date. Following is a summary of the terms and conditions of the FMG preferred stock prior to the Merger:

FMG Series E Redeemable Convertible Preferred Stock—On June 22, 2001, FMG issued to existing investors 988,441 shares of Series E Redeemable Convertible Preferred Stock (“FMG Series E Preferred Stock”) at a purchase price of $9.87 per share for aggregate proceeds of $9,755,913. In connection with this transaction, FMG incurred $180,924 of professional fees and closing costs, which were offset against the proceeds. The carrying amount of the FMG Series E Preferred Stock was increased by periodic accretion, using the effective interest method, with charges to accumulated deficit. For the fiscal years ended January 1, 2005, December 27, 2003, and December 28, 2002, $40,616, $44,308 and $44,308, respectively, of expenses were accreted. The Series E Preferred Stock accrued dividends at 8% per annum, was senior to all other classes of stock, had certain special voting rights and had an initial liquidation value of $9.87 per share.

In exchange for the commitment and funding of the Notes (see Note 7), FMG issued certain note holders warrants to purchase 438,249 shares of FMG Series E Preferred Stock at an exercise price of $9.87 per share. The fair value of the warrants as of the date of issuance was $54,354 using the Black-Scholes model. These warrants were exercised into 438,249 shares of FMG Series E Preferred Stock on a cashless basis prior to the Merger.

FMG Series E Preferred Stock was senior to all other series of preferred stock and had to have 100% of their liquidation preference satisfied prior to distribution to the other series of preferred stock. As of the Merger, November 12, 2004, Series E was convertible into common stock at $14.81 per share. The Series E Preferred Stock accrued dividends at 8% per annum, and had certain special voting rights. Upon a liquidation event, Series E preferred shareholders were entitled to receive the greater of the value of two times the liquidated value plus accrued dividends or the amount received on an “as converted” basis. The holders had the right to require the Company to redeem the Series E Preferred Stock in August 2005.

FMG Series D Redeemable Convertible Preferred Stock—In July 2000, FMG issued to an investor group1,542,188 shares of Series D Redeemable Convertible Preferred Stock (“FMG Series D Preferred Stock”), with a par value of $0.01 at a purchase price of $18.37 per share for gross proceeds of $28,330,000. In connection with this transaction, FMG incurred approximately $1,843,000 of professional fees and closing costs, which were offset against the proceeds. The carrying amount of the FMG Series D Preferred Stock was increased by periodic accretion, using the effective interest method, with charges to accumulated deficit. For the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, $333,898, $364,252, and $364,252 of expenses were accreted, respectively.

In connection with the FMG Series D Preferred Stock issuance, $10,000,000 of convertible promissory notes issued in March 2000 were converted into FMG Series D Preferred Stock in fiscal 2000 at $17.45 per share. Upon conversion, the note holders received 573,017 shares of FMG Series D Preferred Stock and exercised the nondetachable warrants for an additional 102,564 shares of FMG Series D Preferred Stock at a price of $9.75 per share for $1,000,000.

The Series D Preferred Stock was convertible into common stock at any time and would automatically convert into common stock upon the closing of an initial public offering with gross proceeds of at least $30,000,000. The FMG Series D Preferred Stock accrued dividends at 8% per annum, had certain special voting rights and had an initial liquidation value of $18.37 per share. Due to the absence of certain events, including an underwritten public offering of FMG’s stock, not occurring within 18 months, the FMG Series D Preferred Stock shareholders’ conversion price was adjusted. The adjusted conversion price entitled such shareholder to the number of common shares issuable upon conversion of the Series D. The change in the conversion ratio had no accounting implications since the conversion terms did not represent a beneficial conversion feature. Additionally, in the event of an underwritten public offering, dividends would become payable in cash. Upon liquidation or redemption, the Series D Preferred Stock shareholders were entitled to the liquidation value, including any unpaid dividends. The holders of FMG Series D Preferred Stock had the right to require the Company to redeem the stock in August 2005.

FMG Series D and C Preferred Stock were senior to FMG Series B and A Preferred Stock, but were subordinate to FMG Series E Preferred Stock. Series D and C shared pari passu after satisfaction of the Series E in connection with the Merger.

F-17

FMG Series C Convertible Preferred Stock—On May 14, 1999, FMG issued to an investor group 2,564,102 shares of Series C Convertible Preferred Stock (“FMG Series C Preferred Stock”), with a par value of $0.01 at a purchase price of $9.75 per share for aggregate proceeds of $25,000,000. In connection with this transaction FMG incurred $344,475 of professional fees and closing costs, which were offset against the proceeds. The FMG Series C Preferred Stock shareholders were entitled to convert each share of FMG Series C Preferred Stock into that number of fully paid and nonassessable shares of common stock as is determined by dividing the initial conversion price of $14.63 by the conversion price in effect at the time of conversion. The conversion rate was subject to adjustment for the effects of dilution. The FMG Series C Preferred Stock shareholders were entitled to certain special voting rights, preferential liquidation rights (initial liquidation value of $9.75 per share) and anti-dilutive provisions. Dividends did not accrue on the Series C Preferred Stock.

Additionally, the Series C Preferred Stock was convertible into common stock at any time and would automatically convert into common stock upon the occurrence of an initial public offering at a price per share that implies that the Company has a pre-money value of at least $100,000,000 and where the aggregate proceeds to the Company are at least $30,000,000.

FMG Series B Redeemable Convertible Preferred Stock—On June 8, 1998, FMG issued to an investor group 2,042,105 shares of Series B Redeemable Convertible Preferred Stock (“FMG Series B Preferred Stock”), with a par value of $0.01 at a purchase price of $4.75 per share for aggregate proceeds of $9,700,000. In connection with this transaction, FMG incurred approximately $225,000 of professional fees and closing costs, which were offset against the proceeds. The carrying amount of the FMG Series B Preferred Stock was increased by periodic accretion, using the effective interest method, with charges to accumulated deficit. For the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, $30,266, $33,017 and $33,017 of expenses were accreted. The FMG Series B Preferred Stock accrued dividends at an annual rate of 8% of liquidation value, as defined, with an initial liquidation value of $4.75 per share. Concurrent with the FMG Series C Convertible Preferred Stock issuance, the conversion price of the FMG Series B Preferred Stock was adjusted to $7.83 per share and the existing 2,042,105 FMG Series B Preferred Stock shares were exchanged for 1,858,239 shares of FMG Series B Preferred Stock with a liquidation value of $5.22 per share, plus unpaid dividends. Upon liquidation or redemption, the Series B Preferred Stock shareholders are entitled to the liquidation value, plus accrued but unpaid dividends. Under certain liquidation circumstances, the cumulative unpaid dividend is increased to a rate of 12% of liquidation value.

The FMG Series B Preferred Stock shareholders were entitled to convert each share of FMG Series B Preferred Stock into that number of fully-paid and nonassessable shares of common stock determined by dividing the initial conversion price of $7.83 by the conversion price in effect at the time of conversion. The conversion rate was subject to adjustment for the effects of dilution. Additionally, the Company had the option to convert each share of Series B Preferred Stock into common stock upon the occurrence of an initial public offering with aggregate gross proceeds to the Company of at least $15,000,000 and at a price per share of at least three times the then conversion price. Upon such conversion, all accrued dividends will be canceled. The holders of Series B Preferred Stock, subject to the consent of both the Series C and Series D Preferred Stock shareholders, also have the right to require the Company to redeem 25% of the Series B Preferred Stock outstanding immediately prior to the fifth anniversary of the Series B Preferred Stock issuance and on the sixth, seventh and eighth anniversaries. The Series B Preferred Stock shareholders were entitled to certain special voting rights, registration rights and anti-dilutive provisions.

FMG Series B and A were subordinate to all other series of FMG preferred stock. If a liquidation amount remained after all other FMG preferred shareholders were 100% satisfied, Series B and A would have shared pari passu up to the amount of their respective liquidation preferences.

FMG Series A Redeemable Convertible Preferred Stock—On December 18, 1996, FMG issued to an investor group 900,000 shares of Series A Redeemable Convertible Preferred Stock (“FMG Series A Preferred Stock”) with a par value of $0.01 at a purchase price of $5.55 per share for aggregate proceeds of approximately $5,000,000. In connection with this transaction, FMG incurred approximately $189,000 of professional fees and closing costs, which were offset against the proceeds. The carrying amount of the FMG Series A Preferred Stock was increased by periodic accretion, using the effective interest method, with charges to accumulated deficit. Conversion and dividend features are calculated for FMG Series A Preferred Stock in the same manner as the FMG Series B Preferred Stock with the exception of the following:

• FMG Series A Preferred Stock initial conversion price was $8.33 per share; and

• FMG Series A Preferred Stock liquidation value was adjusted from $5.55 per share to $5.69 per share in conjunction with the FMG Series B Preferred Stock issuance.

To redeem a FMG Series A Preferred Stock shareholder in 1998, the Company purchased 468,406 shares of FMG Series A Preferred Stock for $1,749,337. Voting rights, redemption rights, registration rights and anti-dilutive provisions were identical to Series B Preferred Stock shares.

FMG Common Stock —Immediately prior to the Merger there were 2,485,653 voting and non-voting common shares of FMG issued and outstanding. In July 2000, the Company entered into a five-year Strategic Alliance Agreement with an investor (“Investor”). Concurrently, the Investor purchased 653,239 shares of FMG Series D Preferred Stock of the 1,542,188 shares sold to an investor group as described above. Terms of the Strategic Alliance Agreement provided for the establishment of an internet pharmacy, maintained and endorsed by the Investor. The Company developed over-the-counter (“OTC”) pharmacy content, which was embedded into the website, and acted as the preferred OTC pharmacy fulfillment vendor for the Investor. In accordance with the Strategic Alliance Agreement, the Company issued 520,820 shares of its common stock at $27.56 per share to the Investor upon execution of the Strategic Alliance Agreement. The $14,354,777 was recorded as an intangible asset and was being amortized over a five-year period using the straight-line method. During 2001, the Company determined that the intangible asset was not realizable and wrote-off the remaining unamortized asset of $10,407,000. In addition, the Company placed in escrow 1,410,173 shares of its common stock, of which 1,088,460 of such shares were to be released from escrow to the Investor upon achievement of certain performance criteria. Prior to the Merger, 2,330 performance shares had been earned, but had not been issued. As a result of the Merger, all common shareholders, including the Investor performance shares, received no consideration for the liquidation of their shares.

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10. EMPLOYEE BENEFITS

The Company has three 401(k) defined contribution plans that cover eligible full-time employees, including the Familymeds 401(k) plan (the “Familymeds Plan”) and two DrugMax 401(k) Plans (the “DrugMax Plans”) that existed prior to the Merger for DrugMax employees. During fiscal 2004 and 2003, Familymeds, Inc. contributed 50% of an employee’s pre-tax contribution up to a maximum of 4% of an employee’s eligible compensation to the Familymeds Plan. During fiscal 2002, Familymeds, Inc. contributed 100% of an employee’s pre-tax contribution up to a maximum of 2% of the employee’s eligible compensation to the Familymeds Plan. During the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, the Company contributed approximately $271,000, $367,000, and $459,000, respectively, to the Familymeds Plan.

Company contributions to the primary DrugMax 401(k) Plans are discretionary. The Company made no contributions to the DrugMax 401(k) Plan for the period from November 12, 2004 to January 1, 2005.

11. INCOME TAXES

The Company incurred net operating losses for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002. Accordingly, no provision for income taxes has been recorded.

The components of deferred income taxes at January 1, 2005 and December 27, 2003 are as follows:

	January 1, 2005				December 27, 2003
	Deferred Tax				Deferred Tax
	Assets		Liabilities		Assets		Liabilities
Trade receivables	$	1,504,358	$	—	$	669,962	$	—
Inventory		1,446,565		—		407,779		—
Accrued expenses		687,986		—		623,774		—
Property and equipment		—		65,486		150,000		—
Intangible assets		230,556		—		6,997,903		—
Tax effect of net operating loss carryforwards		46,402,632		—		37,679,912		—
Other		230,463		313,090		—		—
Total	$	50,502,560	$	378,576	$	46,529,330	$	—

A valuation allowance has been established for the full amount of the net deferred tax asset as of January 1, 2005 and December 27, 2003 which, based upon available evidence, will likely not be realized.

Following is a reconciliation of the statutory income tax rate to the effective income tax rate for the fiscal years ended January 1, 2005 and December 27, 2003:

	Fiscal Year Ended
	January 1, 2005			December 27, 2003
Statutory rate		(34	)%		(34	)%
State income tax rate benefit, net of federal effect		(5	)%		(5	)%
Change in valuation allowance		39	%		39	%
Effective tax rate		—	%		—	%

At January 1, 2005, the Company had net operating loss carryforwards (“NOL’s”) for federal and state income tax purposes of approximately $119.0 million and $63.0 million, respectively, that are available, other than as described below, to offset future taxable income and expire from 2016 through 2024. As a result of changes in the Company’s ownership, usage of the Company’s NOL’s is limited. The Company is in the process of quantifying the amount of the limitation. As of January 1, 2005, approximately $117.8 million of the federal NOL carryforward is subject to a usage limitation of approximately $2.7 million per year. The amount of NOL’s that may not be available for usage due to NOL usage limitations is approximately $64 million.

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12. STOCK OPTIONS

As of January 1, 1998, FMG adopted its 1998 Non-Qualified Stock Option Plan. The plan was amended July 1, 1999, and the FMG’s 1999 Non-Qualified Stock Option Plan (“the FMG 1999 Non-Qualified Stock Option Plan”) was adopted. The majority of options issued under the FMG 1999 Non-Qualified Stock Option Plan vested evenly over a three-year period and expired after five years.

On April 25, 2000, FMG adopted its 2000 Stock Option Plan (“the FMG 2000 Plan”). Options were granted under the FMG 2000 Plan to employees, directors or consultants. Immediately prior to the Merger, FMG vested all outstanding stock options that had not terminated by their own terms prior to the Merger and issued one share of FMG non-voting common stock for each such outstanding FMG option on a one-for-one basis resulting in the issuance of 524,652 common shares. A compensation charge of $7,872 was recorded related to the exchange which represented the estimated fair value of the shares issued. Accordingly, at the time of the Merger, no options to purchase FMG common stock remained outstanding.

On August 13, 1999, DrugMax adopted its 1999 Incentive and Non-Statutory Stock Option Plan (“the DrugMax 1999 Plan”). On June 5, 2002, the first amendment to the DrugMax 1999 Plan was adopted. In connection with the Merger, on November 12, 2004 the number of shares authorized under the DrugMax 1999 Plan was increased from two to six million shares. Prior to the Merger, options were granted under the DrugMax 1999 Plan to employees and directors of DrugMax. As a result of the Merger on November 12, 2004 all of such options immediately vested.

In connection with the Merger, DrugMax issued options to purchase 1,574,369 shares of DrugMax common stock at $0.57 per share to certain employees and directors of FMG that remained employees and directors of DrugMax after the Merger. The options vested immediately, and are exercisable on January 4, 2006. A compensation charge is being recorded over the period the options become exercisable. Accordingly, $528,831 of stock compensation expense was recorded during the year ended January 1, 2005 related to the options issued in connection with the Merger that had exercise prices less than their fair value.

For the fiscal years December 27, 2003 and December 28, 2002, approximately $177,000 and $193,000 of compensation expense related to options granted in prior years at exercise prices less than the then fair value was recorded. The fair value of common stock at the time of the option issuances prior to the Merger was determined by management and based on the most recent equity transaction.

Stock option activity for the FMG plans prior to the Merger, as restated to reflect the exchange ratio for the Merger with DrugMax, is as follows:

	Number of Shares			Weighted Average Exercise Price
FMG Shares under option at December 29, 2001		913,722		$	8.82
Granted		268,600			1.50
Forfeited		(164,681	)		10.94
Cancelled		(159,960	)		14.63
Exercised		(2,000	)		1.50
FMG Shares under option at December 28, 2002		855,681			5.63
Granted		3,333			1.50
Forfeited		(41,435	)		0.63
Cancelled		(1,833	)		1.50
Expired		(127,468	)		1.50
FMG Shares under option at December 27, 2003		688,278			5.57
Forfeited		(163,626	)		8.39
Exercised		(524,652	)		4.69
FMG Shares exercisable and under option at November 12, 2004		—			—

F-20

Stock option activity for the DrugMax 1999 Plan subsequent to the Merger is as follows:

	Number of Shares			Weighted Average Exercise Price
Options outstanding as of the Merger date		2,226,412		$	3.77
Granted to FMG employees in connection with the Merger		1,574,369			0.57
Forfeited		(32,100	)		5.41
Exercised		(160,466	)		1.84
Shares under option at January 1, 2005		3,608,215
Shares exercisable at January 1, 2005		2,033,846

		Options Outstanding			Options Exercisable
Exercise Prices	Number Outstanding at January 1, 2005	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Number Exercisable at January 1, 2005
$0.57-$2.00	2,104,993	8.9	$	0.83	530,624
2.52-4.00	1,122,788	6.5		3.27	1,122,788
5.00-8.00	241,934	6.8		5.68	241,934
10.00-13.00	138,500	5.0		12.80	138,500
	3,608,215				2,033,846

The weighted average contractual life of options outstanding at January 1, 2005 was 7.8 years.

F-21

13. RELATED PARTY TRANSACTIONS

The Arrow Employee Benefit Trust (the “Trust”) was created to purchase group medical insurance for FMG, franchisees and certain affiliates. The Board of Trustees of the Trust is composed of certain officers of the Company along with certain franchisees. The Company paid approximately $1,539,779, $3,164,000 and $2,966,000 in insurance premiums and administrative fees to the Trust for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively. Use of the Trust was terminated effective May 17, 2004.

During the period from November 12, 2004 to January 1, 2005, the Company purchased $53,000 of inventory from an entity related to one of the Company’s co-chairs of the Board of Directors. The Company believes the purchases approximated fair value.

In October 2001, prior to the Merger, the Company executed a commercial lease agreement (the “Lease”) with an entity controlled by certain directors and officers of the Company at the time. The Lease is for an initial period of five years with a base monthly lease payment of $15,000, and an initial deposit of $15,000. During the period from November 12, 2004 to January 1, 2005, the Company recorded rent expense of $28,183 related to the lease. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

In January 2004, prior to the Merger, the Company executed a second commercial lease agreement (the “Second Lease”) with an entity controlled by certain directors and officers of the Company at the time. The Second Lease is for an initial period of fifteen years with a base monthly lease payment of $17,000. During the period from November 12, 2004 to January 1, 2005, the Company recorded rent expense of $25,500 related to the Second Lease. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

14. COMMITMENTS AND CONTINGENCIES

Operating Leases —The Company leases its headquarter office space under an operating lease expiring in 2007 with a renewal option through 2012. The Company also leases space for its specialty pharmacies, distribution centers, vehicles, furniture and fixtures and office equipment under various operating leases. Certain leases include renewal options. Rent expense on these operating leases was approximately $3,375,000, $3,328,000, and $3,167,000 for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002, respectively.

Minimum lease payments under these leases are as follows, excluding renewal options:

Fiscal Years
2005	$	3,786,450
2006		3,355,564
2007		2,351,634
2008		1,633,044
2009		1,164,883
Thereafter		4,709,440
Total	$	17,001,015

F-22

Legal Matters —On February 7, 2002, Messrs. Miller and Fagala filed a complaint in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, Florida, alleging, among other things, that the Company had breached an Agreement and Plan of Reorganization by and among the Company, K. Sterling Miller, Jimmy L. Fagala and HCT Capital Corp. by failing to pay 38,809 shares of the Company’s common stock to the plaintiffs. On March 11, 2002, the Company filed its answer, affirmative defenses and counterclaim against plaintiffs and HCT Capital Corp. (“HCT). In December 2003, the Company entered into a Settlement Agreement and Release with HCT whereby the Company unconditionally, fully and finally released each other from any future claims relative to the matter. HCT paid $1,000 to the Company in consideration for the release. While it is known that the plaintiffs are seeking 38,809 shares of DrugMax stock and monetary damages for breach of contract and conversion, the Company cannot reasonably estimate any possible future loss or recovery as a result of this matter. Accordingly, the Company has made no provision in the accompanying consolidated financial statements for resolution of this matter.

On November 12, 2003, Phil & Kathy’s, Inc. d/b/a Alliance Distributors (“Alliance”) served a complaint against the Company seeking to recover the non-payment of open invoices approximating $2.0 million based upon an alleged breach of contract for the sale of pharmaceuticals. On December 18, 2003, the Company filed an answer and counterclaim. The counterclaim seeks to recover lost profits and other damages relating to the sale of twenty allegedly counterfeit bottles of Lipitor by Alliance to the Company, which the Company later sold to QK Healthcare, Inc. (“QK”). Alleging that the Lipitor was counterfeit, QK later sued the Company for breach of contract, violations of the implied warranty of merchantability and fraud. Accordingly, the Company’s subsidiary, Valley, also filed a separate action against Alliance for breach of an indemnification agreement related to the sale of the twenty bottles of Lipitor that precipitated a lawsuit against Valley by QK in New York. At March 31, 2005, the amount that the Company recorded as a trade payable balance due Alliance on the above was approximately $1.5 million. Under an indemnification agreement with Alliance, pursuant to which Alliance is required to indemnify the Company for all losses, expenses and damages sustained by the Company as a result of product sold to the Company by Alliance, and the Company’s right to offset its losses, expenses and damages against any amounts due to Alliance, the Company reduced the payable to Alliance by the cost of the faulty Lipitor sold to the Company by Alliance plus the settlement and litigation expenses incurred by the Company directly as a result of the Lipitor, or an aggregate of $0.5 million. The Company has recorded the foregoing trade payable of $1.5 million as of January 1, 2005 and believes this estimate is reasonable based on the information it has at this time; however, the Company cannot reasonably estimate the total future possible loss that it will sustain as a result of the Alliance complaint or the possible recovery through its counterclaim or Valley’s consolidated action.

On May 14, 2003, prior to the Merger with FMG, Discount Rx, Inc., a Nevada corporation and one of the Company wholly-owned subsidiaries (“Discount”), acquired substantially all of Avery Pharmaceutical, Inc.’s (“Avery”) assets (“Avery Assets”) in exchange for assuming certain limited liabilities (the “Assumed Liabilities”) of Avery and issuing a promissory note to Mr. Al Sankary (“Sankary”) in the original principal amount of $318,000 (the “Sankary Note”). The Sankary Note and Avery specifically contemplated that Discount might have to pay certain unknown liabilities in connection with the acquisition in excess of the amount of Assumed Liabilities. Accordingly, the Sankary Note and the Avery Assets permit Discount to “set off” payments due under the Sankary Note against payments made in excess of the Assumed Liabilities. Discount believes the Avery obligations are well in excess of the Assumed Liabilities. On March 26, 2004, Sankary filed a lawsuit against Discount, in the 342 ^nd Judicial District Court of Tarrant County, Texas (“Sankary Suit”). The complaint in the Sankary Suit alleges that Discount defaulted under the Sankary Note as a result of Discount’s failure to make payments when due to Sankary. Discount has paid to Sankary the minimum amount due under the Sankary Note (approximately $90,000). Discount believes that the Sankary Suit is very likely to be dismissed pursuant to agreement between the parties—the parties have exchanged settlement proposals and anticipate the Sankary Suit to be dismissed in the near future. The Company believes it has adequately reserved for this matter as of January 1, 2005 based on the estimated settlement.

On February 23, 2005, a former employee of the Company, James Hostetler, filed suit in the United States District Court for the Northern District of Illinois Eastern Division claiming the Company breached a compensation agreement. Specifically, Mr. Hostetler claims he is owed a commission of an unspecified amount as a result of the sale of securities consummated on December 2, 2004. For an aggregate purchase price of $17 million, the Company sold to certain qualified institutional buyers and accredited investors an aggregate of 17,000 shares of series A convertible redeemable preferred stock. (see Note 9). The Company has not yet filed a response but intends to defend itself vigorously. Management does not believe Mr. Hostetler is entitled to any such commissions as he played no role in the sale of these securities. As a result of the early stage of this proceeding, the Company cannot currently estimate its outcome and has made no provision in the accompanying consolidated financial statements for the resolution of the matter.

F-23

15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

	Three Months Ended
Dollars in thousands, except per share amounts	March 28, 2004			June 27, 2004			September 26, 2004			January 1, 2005 (1)
Fiscal 2004:
Net revenues	$	56,219		$	55,808		$	53,449		$	73,755
Gross margin		11,716			11,672			10,893			12,563
Operating loss (2)		(291	)		(145	)		(855	)		(33,552	)
Net loss		(884	)		(865	)		(1,803	)		(36,292	)
Net loss available to common shareholders		(2,188	)		(2,389	)		(2,858	)		(43,205	)
Net loss per share available to common shareholders, basic and diluted	$	(1.70	)	$	(1.85	)	$	(2.22	)	$	(3.90	)
Shares used in basic and diluted loss per share (3)		1,289			1,289			1,289			11,086
Dividends per common share	$	—		$	—		$	—		$	—

	Three Months Ended
Fiscal 2003:	March 29, 2003			June 28, 2003			September 27, 2003			December 27, 2003
Net revenues	$	54,444		$	54,134		$	53,972		$	55,465
Gross margin		11,631			11,668			11,713			12,406
Operating loss		(1,789	)		(1,469	)		(1,719	)		(821	)
Net loss		(3,566	)		(3,489	)		(3,468	)		(1,651	)
Net loss available to common shareholders		(4,885	)		(4,778	)		(4,757	)		(3,411	)
Net loss per share available to common shareholders, basic and diluted	$	(3.79	)	$	(3.71	)	$	(3.69	)	$	(2.65	)
Shares used in basic and diluted loss per share (3)		1,289			1,289			1,289			1,289
Dividends per common share	$	—		$	—		$	—		$	—

(1) Includes drug distribution operations from November 12, 2004 to January 1, 2005

(2) Includes a goodwill impairment charge of $31.0 million for the drug distribution operations in the quarter ended January 1, 2005.

(3) The weighted average shares used in the calculation of net loss per share have been retroactively restated to give effect to the Merger of DrugMax with FMG. The transaction was accounted for as a reverse Merger, with FMG deemed the accounting acquirer. Accordingly, for periods prior to the Merger, the shares outstanding represent the number of shares that former FMG common shareholders would have received in the transaction, on an as-if converted basis, had the Merger consideration not be distributed to the preferred shareholders based on liquidation values. For periods subsequent to the Merger, shares outstanding represent actual shares outstanding.

F-24

16. SUBSEQUENT EVENTS – Subordinated Note and Debenture and Supply Agreement

On March 22, 2005, the Company entered into the First Amendment to the Senior Credit Facility (the “March 2005 Amendment”). The March 2005 Amendment provided for an increase in the reduction of permanent availability from $5.5 million to $7.5 million and allowed the Company to convert the $23 million of accounts payable after consideration of a $6.0 million payment in March 2005 to AmerisourceBergen Drug Corporation (“ABDC”) into a subordinated convertible debenture in the original principal amount of $11,500,000 (the “Subordinated Debenture”) and a subordinated promissory note in the original principal amount of $11,500,000 (the “Subordinated Note”).

The Subordinated Note is due and payable in quarterly installments of $575,000 beginning on December 1, 2005 through September 1, 2010, on which date all outstanding amounts are due. The Subordinated Note bears interest at the prime rate plus 2.0% per annum, provided that in no event shall the interest rate in effect be less than 5.0% per annum or greater than 10% per annum. Interest accrued on the Subordinated Note is payable quarterly commencing June 1, 2005.

The Subordinated Debenture is due and payable in quarterly installments of $605,263 commencing on March 1, 2006 through August 15, 2010, on which date all outstanding amounts are due. Quarterly principal payments are payable in cash or in shares of common stock in an amount equal to $605,263 divided by $3.4416 (the “Issue Price”) at the Company’s option. The Subordinated Debenture bears interest at 10%, if the quarterly interest payment is made in common stock or the prime rate plus 1% per annum, if the quarterly interest payment is made in cash, provided that in no event shall the interest rate in effect be less than 5.0% per annum or greater than 10% per annum. Quarterly interest payments are required to be paid in common stock. Commencing March 1, 2006, quarterly interest payments may be paid in cash or common stock in an amount equal to the interest then due and owing divided by the Issue Price, or a combination thereof.

If common stock is used to pay the Subordinated Debenture, and the proceeds ABDC receives upon any sale of the Company’s common stock (or ABDC would have received upon a sale in the event no shares are sold by ABDC) are less than the principal and interest due, the Company is required to pay such difference to ABDC in cash on the date of maturity of the Subordinated Debenture. Through December 31, 2005, ABDC may not sell any shares of our common stock received that, in the aggregate, exceed 25% of the average trading volume of our stock for the preceding 10 trading days.

As a result of the Subordinated Debenture and Subordinated Note, $22,425,000 of accounts payable to ABDC have been classified as long term liability in the accompanying consolidated balance sheet as of January 1, 2005. The Subordinated Debenture and Subordinated Note are guaranteed by certain subsidiaries, including Valley Drug Company, Valley Drug Company South, and Familymeds, Inc.

Prior to the Merger between The Company and FMG, the specialty pharmacies relied primarily on ABDC for their prescription drugs, over-the-counter products and personal care items. Under the agreement with ABDC dated May 1, 2003, FMG’s specialty pharmacies were required to purchase a minimum of 90% of their pharmaceuticals from ABDC. This agreement was due to expire May 1, 2006. The Company’s drug distribution operations also maintained a relationship with ABDC. In September 2004, prior to the Merger with FMG, ABDC ceased supplying product on credit to the Company’s drug distribution operations. On October 22, 2004, ABDC filed a lien in Louisiana against Valley Drug Company South’s assets. In December 2004, the Company entered into a prime warehouse supplier agreement with D&K Healthcare Resources, Inc. (“D&K”). The D&K agreement contains certain volume requirements and has an initial term of two years, which renews automatically for successive one-year periods unless either party provides the other party a written non-renewal notice. Either party may terminate this agreement for material breach, and subsequent failure to cure, including failure to make payments when due.

On March 14, 2005, the Company entered into a new strategic relationship with ABDC, which includes a new supply agreement pursuant to which ABDC will supply the Company with certain branded and generic prescription products. The ABDC agreement has a term of five years and has no minimum purchase commitments. In connection with the supply agreement, the Subordinated Note and the Subordinated Debenture, ABDC released its lien against the assets of Valley Drug Company South.

F-25

17. SUBSEQUENT EVENTS - OTHER

New Credit Facility

On October 12, 2005, the Company entered into a secured senior credit agreement with Wells Fargo Retail Finance, LLC (“Wells Fargo”), which matures on October 12, 2010. Available credit under this facility is based on eligible receivables, inventory and prescription files, as defined in the agreement. The $70 million of maximum availability is reduced by an $11.5 million reserve. While the credit facility currently does not require compliance with financial covenants, the Company has the ability to reduce this reserve by $3.5 million by agreeing to implement one or more financial covenants.

Interest on the revolving credit facility is calculated at either the index rate (as defined) plus an applicable index margin (as defined) or, at the option of the Company, at an adjusted monthly LIBOR index rate plus an applicable LIBOR margin (as defined). The applicable index margin as of October 31, 2005 was 1.75%. As of October 31, 2005, the interest rates including applicable margin, used to calculate accrued interest was 6.75%. Interest is payable monthly. The New Credit Facility prohibits the payment of dividends in cash, the repurchase of equity securities in excess of $17.0 million per fiscal year and other restrictions.

The New Credit Facility includes an early termination fee of $650,000 if paid in full before the third anniversary date. The New Credit Facility is secured by substantially all assets of the Company. As of October 31, 2005, $24.3 million was outstanding on the line and $20.1 million was available for additional borrowings, based on eligible receivables and inventory.

Sale of Securities

On September 23, 2005 and September 26, 2005 the Company entered into securities purchase agreements to sell to selling shareholders an aggregate of 44,093,432 shares of our common stock and warrants to purchase 22,046,715 shares of our common stock for an aggregate of $51,104,340. The offering was executed in two traunches at market price as determined by the closing bid price on each day. A purchase agreement for the first traunch was executed on September 23, 2005, for an aggregate of $47,814,265. The unit price of the common stock and corresponding warrant was $1.1525. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.09 per share. A purchase agreement for the second traunch executed on September 26, 2005, for an aggregate of $3,290,075. The unit price of the common stock and corresponding warrant was $1.2625. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.20 per share. The Company used a Black Scholes pricing model to determine the fair value of each warrant which was determined to be $0.0625.

The aggregate commissions and expenses payable in connection with the private placement the Companyre approximately $3,750,000.

Redemption of Preferred A Stock

On December 2, 2004, for an aggregate purchase price of $17 million, the Company sold to certain qualified institutional buyers and accredited investors an aggregate of 17,000 shares of Series A convertible redeemable preferred stock in separate transactions. In addition, the investors received warrants to purchase an aggregate of 1,378,374 shares of our common stock. The exercise price of each warrant is $4.25 per share, the warrants are exercisable into common stock and expire on the fifth anniversary of the closing.

Effective April 20, 2005, the Company suspended sales under the previously filed registration statement to resell such securities. Under the terms of the registration agreement, the investors the Companyre entitled to liquidated damages until such time as the registration statement was declared effective. On July 7, 2005, the Company amended the certificate of designation to reduce the conversion price from $3.70 to $2.80. In exchange, investors representing 95% of the preferred shareholders agreed to waive liquidated damages under the registration rights agreement through the date of the amendment and to amend the registration rights agreement to require the filing of a registration statement covering the registrable securities by July 8, 2005 and to require the effectiveness of such registration statement to be no later than October 1, 2005.

On September 26, 2005, the Company entered into agreements with its Series A Preferred Stock to have their shares of Series A Preferred Stock redeemed for cash upon the closing of the sale of the common stock and warrants described above. Accordingly, in connection with the closing of the private placement described elsewhere in this document, the Company has redeemed all of the Series A Preferred Stock. The redemption price was 100% of stated value, $17 million. In addition, the Company issued 488,070 shares of common stock to certain of the holders of its Series A Preferred Stock in connection with the redemption.

F-26

In connection with the redemption, the holders also agreed:

·   to waive any right of first refusal, participation or similar right they may have had with respect to the offering described above or any other offerings by the Company; and

·   to amend the terms of the warrants issued to the purchasers of Series A Preferred Stock in order to reduce the exercise price of warrants to $1.09 and to remove any right to further adjustment of the exercise price (other than equitable adjustments).

Increase in Authorized Shares

On October 3, 2005, the Articles of Incorporation were amended to increase the number of shares of common stock authorized from 45,000,000 to 100,000,000. Additionally, on October 25, 2005, the Articles of Incorporation were amended to increase the number of shares of common stock authorized from 100,000,000 to 200,000,000.

Drug Distribution Operations

In August 2005, Hurricane Katrina resulted in the closure of the warehouse facility located in St. Rose, Louisiana. As of October 31, 2005, this facility is still closed and non-operational. The Company is currently evaluating whether to permanently close the facility due to its inability to ship and receive product. The Company maintains insurance coverage for this type of loss which provides for reimbursement from losses resulting from property damage, loss of product and as business interruption coverage. The Company estimates approximately $0.2 million of inventory was damaged during the hurricane.

Also, subsequent to July 2, 2005, the Company determined as part of its ongoing Merger integration plan that it would exit the legacy drug distribution business primarily providing wholesale branded pharmaceuticals to independent pharmacies and regional chain stores. The business expected to be exited consists principally of non-core, low margin branded drug distribution wholesale. The Company believes that by exiting this lower gross margin component of its distribution business, it will improve overall operating company results, while maintaining its core strategy of specialty pharmaceutical distribution. The Company expects to exit this business component during the second half of 2005 and has engaged a nationally known advisor to conduct a sale of this business.

F-27

DRUGMAX, INC. AND SUBSIDIARIES

(formerly, Familymeds Group, Inc.)

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

FOR THE FISCAL YEARS ENDED JANUARY 1, 2005, DECEMBER 27, 2003 AND

DECEMBER 28, 2002

	Balance, beginning of year		Charged to cost and expenses		Balance from Merger		Deductions			Balance at end of year
Allowance for doubtful accounts:
Fiscal year ended January 1, 2005	$	1,717,852	$	341,995	$	2,182,942	$	(346,270	)	$	3,896,519
Fiscal year ended December 27, 2003		3,100,641		615,465		—		(1,998,255	)		1,717,851
Fiscal year ended December 28, 2002		5,235,144		4,105,776		—		(6,240,279	)		3,100,641
Inventory Reserve:
Fiscal year ended January 1, 2005	$	1,045,588	$	659,352	$	285,900	$	(1,088,255	)	$	902,585
Fiscal year ended December 27, 2003		1,374,240		531,835		—		(860,487	)		1,045,588
Fiscal year ended December 28, 2002		800,416		1,706,245		—		(1,132,421	)		1,374,240
Valuation allowance for Deferred Tax Asset:
Fiscal year ended January 1, 2005	$	46,529,330	$	3,594,654	$	—	$	—		$	50,123,984
Fiscal year ended December 27, 2003		41,645,492		4,883,838		—		—			46,529,330
Fiscal year ended December 28, 2002		35,876,122		5,769,370		—		—			41,645,492

F-28

DRUGMAX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	July 2, 2005			January 1, 2005
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	1,205,524		$	2,331,552
Trade receivables, net of allowance for doubtful accounts of approximately $2,250,000 and $3,897,000 in 2005 and 2004, respectively		18,261,093			20,570,053
Inventories		37,934,110			34,525,247
Prepaid expenses and other current assets		1,631,804			1,965,515
Total current assets		59,032,531			59,392,367
PROPERTY AND EQUIPMENT—Net of accumulated depreciation and amortization of approximately $12,933,000 and $11,707,000 in 2005 and 2004, respectively		5,314,616			5,250,684
GOODWILL		19,858,507			19,813,080
OTHER INTANGIBLE ASSETS—Net of accumulated amortization of approximately $16,877,000 and $15,350,000 in 2005 and 2004, respectively		9,458,796			10,570,061
OTHER NONCURRENT ASSETS		645,699			571,874
TOTAL	$	94,310,149		$	95,598,066
LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
CURRENT LIABILITIES:
Revolving credit facility	$	42,663,896		$	32,870,787
Promissory notes payable		1,857,405			2,284,212
Current portion of obligations under capital leases		7,750			30,092
Accounts payable		22,565,130			26,132,491
Accrued expenses		6,995,006			5,949,342
Current portion of notes payable		2,935,526			—
Total current liabilities		77,024,713			67,266,924
LONG-TERM ACCOUNTS PAYABLE		—			22,425,000
NOTES PAYABLE		20,064,474			—
OTHER LONG-TERM LIABILITIES		151,224			50,854
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ (DEFICIT) EQUITY:
Common stock, $.001 par value, 45,000,000 shares authorized for 2005 and 2004; 20,019,495 and 19,483,674 shares issued and outstanding for 2005 and 2004, respectively		20,019			19,484
Additional paid in capital		176,900,246			175,499,012
DrugMax Series A Convertible Preferred Stock, $1,000 par value, 17,000 shares issued and outstanding for 2005 and 2004; 5,000,000 shares authorized in 2005 and 2004 (involuntary liquidation value $17,000,000 for 2005 and 2004)		14,647,092			14,026,902
Accumulated deficit		(192,256,387	)		(177,841,211	)
Unearned compensation		(2,241,232	)		(5,848,899	)
Total stockholders’ (deficit) equity		(2,930,262	)		5,855,288
TOTAL	$	94,310,149		$	95,598,066

See notes to condensed consolidated financial statements.

F-29

DRUGMAX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months Ended						Six Months Ended
	July 2, 2005			June 26, 2004			July 2, 2005			June 26, 2004
NET REVENUES	$	82,047,523		$	55,807,889		$	169,286,046		$	112,026,592
COST OF SALES		71,242,245			44,136,575			146,157,153			88,638,799
Gross margin		10,805,278			11,671,314			23,128,893			23,387,793
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		15,487,412			10,688,817			30,987,014			22,184,626
DEPRECIATION AND AMORTIZATION EXPENSE		1,160,059			1,126,854			2,412,138			2,411,879
LOSS (GAIN) ON DISPOSAL OF FIXED ASSETS AND INTANGIBLE ASSETS		8,769			976			8,769			(773,148	)
OPERATING LOSS		(5,850,962	)		(145,333	)		(10,279,028	)		(435,564	)
OTHER INCOME (EXPENSE):
Interest expense		(1,408,504	)		(723,818	)		(2,182,005	)		(1,493,826	)
Interest income		4,297			11,219			14,436			23,762
Other income (expense)		90,190			(7,010	)		285,974			156,961
Total other expense, net		(1,314,017	)		(719,609	)		(1,881,595	)		(1,313,103	)
NET LOSS		(7,164,979	)		(864,942	)		(12,160,623	)		(1,748,667	)
FMG Redeemable Preferred Stock Dividends		—			(1,289,421	)		—			(2,593,329	)
DrugMax Preferred Stock Dividends		(1,622,805	)		—			(2,254,553	)		—
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS	$	(8,787,784	)	$	(2,154,363	)	$	(14,415,176	)	$	(4,341,996	)
BASIC AND DILUTED LOSS PER SHARE:
Net loss available to common stockholders	$	(0.44	)	$	(1.67	)	$	(0.73	)	$	(3.37	)
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic and Diluted Shares		19,917,787			1,288,909			19,754,285			1,288,909

See notes to condensed consolidated financial statements.

F-30

DRUGMAX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended
	July 2, 2005			June 26, 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(12,160,623	)	$	(1,748,667	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		2,412,138			2,411,879
Stock compensation expense		3,941,166			—
Noncash interest expense		354,327			140,000
Amortization of deferred financing costs		153,016			137,175
Provision for (benefit from) doubtful accounts		33,643			(273,209	)
Loss (gain) on disposal of fixed assets and intangible assets		8,769			(773,148	)
Effect of changes in operating assets and liabilities:
Trade receivables		2,275,317			1,158,859
Inventories		(3,408,863	)		872,606
Prepaid expenses and other current assets		333,711			(581,707	)
Accounts payable		(2,992,361	)		1,952,506
Accrued expenses		(192,638	)		(1,083,503	)
Other		26,545			220,765
Net cash (used in) provided by operating activities		(9,215,853	)		2,433,556
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(1,091,849	)		(253,720	)
Disposals of property and equipment		—			110,417
Proceeds from sale of prescription files, net		—			752,100
Net cash (used in) provided by investing activities		(1,091,849	)		608,797
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds (repayment) on revolving credit facility, net		9,793,109			(3,343,610	)
Repayment of promissory notes payable		(701,807	)		—
Repayment of obligations under capital leases		(22,342	)		(22,976	)
Payment of deferred financing costs		(434,741	)		(100,500	)
Proceeds from exercise of stock options		547,455			—
Net cash provided by (used in) financing activities		9,181,674			(3,467,086	)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(1,126,028	)		(424,733	)
CASH AND CASH EQUIVALENTS—Beginning of period		2,331,552			1,307,094
CASH AND CASH EQUIVALENTS—End of period	$	1,205,524		$	882,361
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest	$	1,827,677		$	1,216,651
Noncash transactions—
Payment of DrugMax Series A preferred stock dividends in common stock	$	294,194		$	—
Conversion of accounts payable to subordinated notes payable	$	23,000,000		$	—

See notes to condensed consolidated financial statements.

F-31

DRUGMAX, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

(For the Three Months and Six Months ended July 2, 2005 and June 26, 2004)

NOTE A – BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements include the accounts of DrugMax, Inc. and its wholly-owned subsidiaries (collectively referred to as the “Company”). All significant intercompany accounts and transactions have been eliminated.

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for a full year. These statements should be read in conjunction with the accompanying consolidated financial statements.

The Company’s fiscal year begins on January 2, 2005 and ends on December 31, 2005. The Company’s second fiscal quarter ends on the Saturday closest to June 30. The second fiscal quarter of 2005 and 2004 each include 13 weeks.

NOTE B – MERGER, BUSINESS AND GOING CONCERN

Merger —On March 19, 2004, Familymeds Group, Inc. (“FMG”) entered into an Agreement and Plan of Merger which was amended on July 1, 2004 and also on October 11, 2004 (as amended, the “Merger Agreement”) with DrugMax, Inc. (“DrugMax”). Under the terms of the Merger Agreement, on November 12, 2004, FMG merged into DrugMax, and DrugMax became the surviving corporation in the Merger (the “Merger”). The Merger was treated as a purchase of DrugMax by FMG for accounting purposes. Accordingly, for periods prior to the Merger, the information herein is historical information of FMG.

The results of operations of DrugMax have been included in the Company’s consolidated statements of operations since the date of acquisition. The excess of the purchase price over the estimated fair values of the underlying assets acquired and liabilities assumed was allocated to goodwill. The allocation of the purchase price is based upon preliminary estimates and assumptions. Accordingly, the allocation is subject to revision when the Company receives final information, including appraisals and other analysis. Revisions to the fair values, which may be significant, will be recorded by the Company as further adjustments to the purchase price allocations.

In connection with the Merger, the Company terminated certain DrugMax employees. Included in a restructuring liability as of the Merger date was total severance obligations of approximately $966,000, $170,000 of which had been paid as of July 2, 2005. Additionally, an accrued lease liability of $89,000 was recorded related to an office location that will no longer be used.

In the Merger, the shareholders of FMG (along with certain FMG warrant holders and note holders) received an aggregate of 10,470,507 shares of the Company’s common stock along with warrants to purchase an additional 3,500,090 shares of the Company’s common stock. The exercise price of the warrants is $2.61 per share. In addition, in connection with the Merger, the Company issued an aggregate of 656,047 shares of restricted common stock, along with options to purchase an additional 1,574,369 shares of common stock, to certain employees and directors of FMG. The exercise price of the stock options is $0.57 per share. The noncash compensation charge recorded during the three months and six months ended July 2, 2005 relating to the restricted stock and stock options related to the Merger was $1,940,344 and $3,775,416, respectively, which was based on the provisions of the restricted stock and stock option agreements. During the six months ended July 2, 2005, an additional 38,200 warrants were issued to former FMG shareholders. The additional warrants were valued at $45,426 which was reflected as an adjustment to goodwill in the six months ended July 2, 2005.

Business —As of July 2, 2005, the Company owned or franchised pharmacy locations in 13 states. As of July 2, 2005 and June 26, 2004 there were 77 and 76 owned locations, respectively, including one home health center and one non-pharmacy mail order center, and seven franchised pharmacy locations. The Company is not actively seeking to franchise additional pharmacy locations. Additionally, the Company has two drug distribution centers located in New Castle, PA and St. Rose, LA.

Going Concern- The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company is in violation of certain financial and other covenants on its Senior Credit Facility and the lender can demand repayment of the $42.7 million outstanding as of July 2, 2005 and could foreclose upon all or substantially all of the Company’s assets and the assets of its subsidiaries. Additionally, the Company has a history of operating losses. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management believes that, with the purchasing synergies from the Merger and the effect of the reduction in costs associated with the elimination of certain redundant positions as a result of the Merger, as well as the recently approved plan to exit the low margin component of our distribution business and to reduce personnel and other selling and administrative costs, the Company will continue as a going concern. Also, the Company expects to refinance the Senior Credit Facility with a major lender other than the current lender during the third quarter of 2005. However, there is no assurance that we will be able to obtain alternative financing and the lender could demand repayment of the $42.7 million outstanding as of July 2, 2005 and could foreclose upon all or substantially all of our assets and the assets of our subsidiaries. (See Note L – Subsequent Events.)

F-32

NOTE C – LOSS PER SHARE

For periods prior to the Merger, the weighted average shares outstanding have been computed based on the number of shares that former FMG common shareholders would have received in the transaction, on an as-if converted basis (i.e., if the preferred shares were converted to common shares prior to the Merger) and had the Merger consideration not been distributed to the preferred shareholders based on liquidation values. Based on the exchange ratio, the FMG common shareholders would have received 1,288,909 shares of common stock. Accordingly, for periods prior to the Merger, all per share information herein previously presented has been restated from the amounts previously reported by FMG. For the periods subsequent to the Merger, the total outstanding shares represent actual weighted average shares outstanding. For the six months ended July 2, 2005 and June 26, 2004, 3,253,901 and 672,393 options to purchase common stock have not been considered in the calculations of loss per share as their effect would have been anti-dilutive.

NOTE D – STOCK BASED COMPENSATION

The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“Opinion 25”), and its related interpretations in accounting for employee stock compensation and Emerging Issues Task Force (“EITF”) 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, to account for options issued to non-employees. Forfeitures are accounted for in the period the options are actually forfeited. Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value of the awards at the grant dates, consistent with the method of SFAS No. 123, Accounting for Stock-Based Compensation, the Company’s net loss would have been the pro forma amounts indicated below:

	Three Months Ended						Six Months Ended
	July 2, 2005			June 26, 2004			July 2, 2005			June 26, 2004
Net loss available to common shareholders, as reported	$	(8,787,784	)	$	(2,154,363	)	$	(14,415,176	)	$	(4,341,996	)
Add: actual expense, as reported (1)		2,000,822			—			3,941,166			—
Less: Pro forma stock-based compensation expense determined under fair value method valuation for all awards		(1,366,982	)		(3,461	)		(2,719,243	)		(6,922	)
Pro forma net loss available to common shareholders	$	(8,153,944	)	$	(2,157,824	)	$	(13,193,253	)	$	(4,348,918	)
Basic and diluted net loss per share:
Net loss available to common shareholders, as reported	$	(0.44	)	$	(1.67	)	$	(0.73	)	$	(3.37	)
Pro forma net loss available to common shareholders	$	(0.41	)	$	(1.67	)	$	(0.67	)	$	(3.37	)
Shares used in basic and diluted net loss per share		19,917,787			1,288,909			19,754,285			1,288,909

(1) Includes $894,318 and $1,776,999 of expense relating to restricted stock for the three and six months ended July 2, 2005, respectively.

No stock options were granted during the six months ended June 26, 2004. The fair value of each option grant during the three months ended July 2, 2005 was determined using the Black Scholes pricing model with the following assumptions:

	Three Months Ended July 2, 2005
Risk-free interest rate	3.42%/3.55%
Expected life	3 years
Volatility	35%/27%
Dividend yield	—
Weighted average fair value of each option granted	$0.89/$0.58

During the six months ended July 2, 2005, the Company granted 90,000 shares of restricted stock to directors. The restricted stock vests one third upon grant date, one third on the first anniversary, and one third on the second anniversary.

F-33

NOTE E – NEW ACCOUNTING PRONOUNCEMENTS

In December 2004 the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment, which requires that the cost resulting for all share-based payment transactions be recognized in the financial statements. This statement is effective for the Company for the first fiscal year beginning after June 15, 2005 (as a result of the deferral of the effective date in April 2005) and applies to all awards granted in periods after the effective date and unvested awards as of the effective date. The Company is in the process of evaluating the method of adoption and the resulting impact of SFAS No. 123R on the Company upon adoption.

NOTE F – GOODWILL AND OTHER INTANGIBLE ASSETS

The carrying value of goodwill and other intangible assets is as follows:

	July 2, 2005					January 1, 2005
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Other intangible assets	$	26,335,538	$	(16,876,742	)	$	25,919,769	$	(15,349,708	)
Goodwill		19,858,507		—			19,813,080		—

The weighted average amortization period for intangible assets is approximately 7.3 years. Amortization expense related to other intangible assets was approximately $676,000 and $577,000 for the three months ended July 2, 2005 and June 26, 2004, respectively. Amortization expense related to other intangible assets was approximately $1,406,000 and $1,281,000 for the six months ended July 2, 2005 and June 26, 2004, respectively.

Estimated future amortization expense is as follows:

Fiscal year ending	Amount
2005	$	2,847,045
2006		2,111,332
2007		1,064,356
2008		647,058
2009		555,450

NOTE G —DEBT

Debt at July 2, 2005 and January 1, 2005 consisted of the following:

	July 2, 2005		January 1, 2005
Revolving credit facility	$	42,663,896	$	32,870,787
Promissory notes payable		1,857,405		2,284,212
Subordinated notes payable(1)		23,000,000		—
Total	$	67,521,301	$	35,154,999
Long-term accounts payable, including current portion(1)	$	—	$	23,000,000

(1) Represents $23.0 million of accounts payable converted to subordinated notes payable on March 21, 2005.

F-34

Revolving Credit Facility

On December 9, 2004, the Company entered into the Second Amended and Restated Credit Agreement (the “Senior Credit Facility”) with GECC, which increased the facility from $31 million to $65 million. The $65 million of maximum availability was reduced by $5.5 million of permanent availability, until the March 2005 Amendment discussed below, which increased the permanent availability reduction to $7.5 million. The Senior Credit Facility matures on December 9, 2007. The Senior Credit Facility includes a prepayment penalty of $1,300,000 if paid in full before December 9, 2005, $975,000 if paid in full after December 9, 2005 but before December 9, 2006 and $650,000 if paid after December 9, 2006. The Senior Credit Facility is secured by substantially all assets of the Company. As of July 2, 2005, $42.7 million was outstanding under the Senior Credit Facility and $0.4 million was available for additional borrowings, based on eligible receivables and inventory.

Interest on the revolving credit facility is calculated at either the index rate (as defined) plus an applicable index margin (as defined) or, at the option of the Company, at an adjusted monthly LIBOR index rate plus an applicable LIBOR margin (as defined). The applicable index margin as of July 2, 2005 and January 1, 2005 was 2.75% and 0.5%, respectively. The interest rates, including applicable margin, that were used to calculate accrued interest were 6.5% and 5.75% as of July 2, 2005, and January 1, 2005, respectively. Interest is payable monthly. The Senior Credit Facility prohibits the payment of dividends in cash.

The Senior Credit Facility requires monthly compliance with certain restrictive covenants including, but not limited to, minimum EBITDA, maximum capital expenditures, maximum fixed charge coverage ratio, minimum net worth, minimum inventory turnover, maximum trade receivable days sales outstanding, maximum accounts payable days outstanding and maximum ratio of non-pharmaceutical inventory to total inventory. The Company violated certain of these covenants as of January 1, 2005 and each subsequent month thereafter through July 31, 2005, including the EBITDA and net worth financial covenants, and other covenants, and as of such dates was in default on this obligation. We are currently exploring alternative financing and expect to refinance the Senior Credit Facility with a major lender other than the current lender during the third quarter of 2005. However, there is no assurance that we will be able to obtain alternative financing and the lender could demand repayment of the $42.7 million outstanding as of July 2, 2005 and could foreclose upon all or substantially all of our assets and the assets of our subsidiaries.

Subordinated Notes Payable

On March 22, 2005, the Company entered into the First Amendment to the Senior Credit Facility (the “March 2005 Amendment”). The March 2005 Amendment provided for an increase in the reduction of permanent availability from $5.5 million to $7.5 million and allowed the Company to convert the $23.0 million of accounts payable after consideration of a $6.0 million payment in March 2005 to AmerisourceBergen Drug Corporation (“ABDC”) into a subordinated convertible debenture in the original principal amount of $11,500,000 (the “Subordinated Convertible Debenture”) and a subordinated promissory note in the original principal amount of $11,500,000 (the “Subordinated Note”).

The Subordinated Note is due and payable in quarterly installments of $575,000 beginning on December 1, 2005 through September 1, 2010, on which date all outstanding amounts are due. The Subordinated Note bears interest at the prime rate plus 2.0% per annum (7.5% as of July 2, 2005), provided that in no event will the interest rate in effect be less than 5.0% per annum or greater than 10.0% per annum. Interest accrued on the Subordinated Note is payable quarterly and interest payments commenced June 1, 2005. Interest of $231,757 and $260,507 was expensed during the three months and six months ended July 2, 2005, respectively.

The Subordinated Convertible Debenture is due and payable in quarterly installments of $605,263 commencing on March 1, 2006 through August 15, 2010, on which date all outstanding amounts are due. Quarterly principal payments are payable in cash or in shares of common stock in an amount equal to $605,263 divided by $3.4416 (the “Issue Price”), at the Company’s option. The Subordinated Convertible Debenture bears interest at 10.0%, if the quarterly interest payment is made in common stock or the prime rate plus 1% per annum (6.5% as of July 2, 2005), if the quarterly interest payment is made in cash, provided that in no event will the interest rate in effect be less than 5.0% per annum or greater than 10.0% per annum. Quarterly interest payments are required to be paid in common stock through February 28, 2006. Commencing March 1, 2006, quarterly interest payments may be paid in cash or common stock in an amount equal to the interest then due and owing divided by the Issue Price, or a combination thereof. The first interest payment of $233,194 was made on June 1, 2005 by issuing 67,757 shares of common stock. Interest of $287,500 and $325,833 was expensed during the three months and six months ended July 2, 2005, respectively.

If common stock is used to make principal or interest payments on the Subordinated Convertible Debenture, and the proceeds ABDC receives upon any sale of the Company’s common stock (or the proceeds ABDC would have received upon a sale in the event no shares are sold by ABDC) are less than the principal and interest due, the Company is required to pay such difference to ABDC in cash on the date of maturity of the Subordinated Convertible Debenture. Through December 31, 2005, ABDC may not sell any shares of the Company’s common stock received that, in the aggregate, exceed 25% of the average trading volume of the Company’s common stock for the preceding 10 trading days.

In connection with the Subordinated Convertible Debenture, DrugMax entered into a registration rights agreement dated March 21, 2005 with ABDC pursuant to which the Company agreed to file a registration statement with the SEC to register the resale of all common stock issuable to ABDC in connection with the Subordinated Debenture no later than May 30, 2005. Further on May 26, 2005, ABDC granted the Company a 45 day extension to file the registration statement. On July 7, 2005, the company filed a registration statement on Form S-1. The SEC declared the Form S-1 effective on August 10, 2005. The Subordinated Debenture and Subordinated Note are guaranteed by DrugMax and certain of DrugMax subsidiaries, including Valley Drug Company, Valley Drug Company South, Familymeds, and Familymeds Holdings, Inc. (the “Debtors”) pursuant to Continuing Guaranty Agreements dated as of March 21, 2005. The Debtors also entered into a subordinated security agreement dated as of March 21, 2005, pursuant to which each of the Debtors agreed that upon the occurrence of certain defaults, each Debtor would be deemed at that point to have granted to ABDC a springing lien upon and a security interest in substantially all of its assets to secure the Subordinated Debenture and the Subordinated Note. However, pursuant to a subordination agreement dated March 21, 2005, the Subordinated Debenture, the Subordinated Note, the Guarantees and the Security Agreement are subordinated to the Senior Credit Facility.

F-35

NOTE H- DRUGMAX SERIES A CONVERTIBLE PREFERRED STOCK

On December 2, 2004, for an aggregate purchase price of $17 million, the Company sold to certain qualified institutional buyers and accredited investors an aggregate of 17,000 shares of series A convertible redeemable preferred stock (the “Series A”). These shares were convertible into an aggregate of 4,594,591 shares of the Company’s common stock, based upon an initial conversion price of $3.70 per share. However, in an amendment to the certificate of designation, on July 7, 2005, the conversion price was reduced from $3.70 per share to $2.80 per share and the Series A shares are now convertible into an aggregate of 6,071,425 shares of DrugMax common stock. In addition, the investors received warrants to purchase an aggregate of 1,378,374 shares of DrugMax common stock. The exercise price of the warrants is $4.25 per share. The warrants are exercisable into common stock and expire on the fifth anniversary of the closing. Midsummer Investment, Ltd. acted as the lead investor in the private placement. First Albany Capital served as the lead placement agent for the transaction and the Maxim Group, LLC served as co-agent.

The Company filed a registration on Form S-3 to register the resale of the shares of common stock issuable upon the conversion of the series A preferred stock and the exercise of the warrants. The Company is required to maintain the registration effective until all of such shares have been sold or may be sold without volume restrictions pursuant to rule 144. The Form S-3 was declared effective by the SEC on January 19, 2005. The Company’s agreement with the preferred stockholders contains a provision to the effect that if the registration statement ceases for any reason to remain continuously effective or the holders are not permitted to utilize the prospectus therein to resell such registrable securities for 10 consecutive calendar days but no more than an aggregate of 15 calendar days during any 12-month period (the “Event Date”), then in addition to any other rights the holders may have, the Company shall pay to each holder an amount in cash equal to 2% of the aggregate purchase price paid by such holder as partial liquidated damages. Such amounts shall be payable on the Event Date and on each monthly anniversary of the Event Date until such time as the registration statement becomes effective or until the holders are permitted to utilize the prospectus to resell securities.

Effective April 20, 2005, the Company suspended sales under the previously filed registration statement to resell such securities. Under the terms of the registration agreement, the investors were entitled to liquidated damages until such time as the registration statement became effective. On July 7, 2005, the Company amended the certificate of designation to reduce the conversion price of the Series A from $3.70 to $2.80 per share. In exchange, investors representing 95% of the Series A shareholders agreed to waive liquidated damages under the registration rights agreement through the date of the amendment and to amend the registration rights agreement to require the filing of a registration statement covering the registrable securities by July 8, 2005 and to require the effectiveness of such registration statement to be no later than October 1, 2005. On July 7, 2005, the Company filed a registration statement on Form S-1. The SEC declared the Form S-1 effective on August 10, 2005. The amount of the liquidated damages owed as of July 2, 2005, $1.0 million, substantially all of which was subsequently waived by the shareholders, has been recorded as additional DrugMax preferred stock dividends in the three and six months ended July 2, 2005. Accrued dividends not paid pursuant to the July waiver will be reversed during the third quarter of 2005. The revised conversion price does not represent a beneficial conversion feature.

The Series A is convertible into an aggregate of 6,071,425 shares of common stock, based upon the conversion price of $2.80 per share. The conversion price is subject to anti-dilution adjustments pursuant to the certificate of designation. Further, in the event the Company is in compliance with all of the provisions of the securities purchase agreements and related documents, and the common stock has a value weighted average price for 20 consecutive trading days which exceeds the conversion price by 150% for each of such 20 trading days, then the company can require the holders of the preferred shares to convert 50% of their holdings into common stock at the then current conversion price. In the event such trading prices exceed the conversion price by 200%, then the company can require the holders of the preferred shares to convert 100% of their holdings into common stock at the then current conversion price. Furthermore, after the fourth anniversary of the closing, provided the company has satisfied the equity conditions set forth in the certificate of designation, the company may at its option, redeem the Series A stock. If the redemption date occurs following the fourth anniversary of the closing but prior to the fifth anniversary, the redemption price shall be $1,200 per share plus all accrued and unpaid dividends, all liquidated damages and other amounts due in respect of the Series A stock. If the redemption date occurs on or following the fifth anniversary of the closing but prior to the sixth anniversary, the redemption price shall be $1,100 per share plus all accrued and unpaid dividends, all liquidated damages and other amounts due in respect of the Series A stock. If the redemption date occurs on or following the sixth anniversary of the closing, the redemption price shall be $1,050 per share, plus all accrued and unpaid dividends, all liquidated damages and other amounts due in respect of the Series A stock. Pursuant to the certificate of designation, upon any liquidation, dissolution or winding-up of DrugMax, whether voluntary or involuntary, the holders of the series A stock shall be entitled to receive out of the assets of DrugMax, $1,000 for each share of Series A stock plus any accrued and unpaid dividends thereon and any other fees or liquidated damages owing thereon before any distribution or payment shall be made to the holders of any junior securities, including the common stock.

The Series A convertible redeemable preferred stock contains an increasing-rate dividend as follows: 7% per annum until the fourth anniversary; 9% per annum from the fourth until the fifth anniversary; 11% per annum from the fifth until the sixth anniversary and 14% per annum thereafter. In accordance with SEC Staff Accounting Bulletin Topic 5, Miscellaneous Accounting, Section Q, the Company has recorded a discount of $4,166,000 that will be amortized over years one through six (the pre-perpetual dividend period), so that the effective rate of the dividend is consistent for the life of the preferred stock.

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NOTE I- SEGMENT INFORMATION

The Company operated as one business segment for all periods presented. This segment includes two reporting units: specialty pharmacy operations and drug distribution operations.

NOTE J- INCOME TAXES

The Company incurred net losses for the three months and six months ended July 2, 2005, and June 26, 2004. No income tax benefit has been recorded in these periods due to uncertainty of realization.

NOTE K- CONTINGENCIES

On June 8, 2005, a complaint to recover preferential payments previously paid to Valley Drug Company South was filed against Valley Drug Company South by Safescript Pharmacies, Inc. et al in the United States Bankruptcy Court for the Eastern District of Texas, Tyler Division. The complaint seeks judgment against Valley Drug Company South in the amount of approximately $874,000. As a result of the early stage of this proceeding, the company cannot currently estimate its outcome and have made no provision in the accompanying condensed consolidated financial statements for the resolution of the matter. (See Note L – Subsequent Events - Contingencies)

NOTE L - SUBSEQUENT EVENTS

New Credit Facility

On October 12, 2005, we entered into a secured senior credit agreement with Wells Fargo Retail Finance, LLC (“Wells Fargo”), which matures on October 12, 2010. Available credit under this facility is based on eligible receivables, inventory and prescription files, as defined in the agreement. The $65 million of maximum availability is reduced by an $11.5 million reserve. While the credit facility currently does not require compliance with financial covenants, the Company has the ability to reduce this reserve by $3.5 million by agreeing to implement one or more financial covenants.

Interest on the revolving credit facility is calculated at either the index rate (as defined) plus an applicable index margin (as defined) or, at the option of the Company, at an adjusted monthly LIBOR index rate plus an applicable LIBOR margin (as defined). The applicable index margin as of October 31, 2005 was 1.75%. As of October 31, 2005, the interest rates including applicable margin, used to calculate accrued interest was 6.75%. Interest is payable monthly. The New Credit Facility prohibits the payment of dividends in cash, the repurchase of equity securities in excess of $17.0 million per fiscal year, and requires that any equity proceeds received through the issuance of new stock shall be remitted in the following manner:

·The first $20.0 million as payment against the credit facility;

·The next $40.0 million to be used by the Company for general corporate purposes; and

·All amounts in excess of $60.0 million fifty percent (50%) shall be made as payment against the credit facility.

The New Credit Facility includes an early termination fee of $650,000 if paid in full before the third anniversary date. The New Credit Facility is secured by substantially all assets of the Company. As of October 31, 2005, $24.3 million was outstanding on the line and $29.2 million was available for additional borrowings, based on eligible receivables and inventory.

Sale of Securities

On September 23, 2005 and September 26, 2005 we entered into securities purchase agreements to sell to selling shareholders an aggregate of 44,093,432 shares of our common stock and warrants to purchase 22,046,715 shares of our common stock for an aggregate of $51,104,340. The offering was executed in two traunches at market price as determined by the closing bid price on each day. A purchase agreement for the first traunch was executed on September 23, 2005, for an aggregate of $47,814,265. The unit price of the common stock and corresponding warrant was $1.1525. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.09 per share. A purchase agreement for the second traunch executed on September 26, 2005, for an aggregate of $3,290,075. The unit price of the common stock and corresponding warrant was $1.2625. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.20 per share. The Company used a Black Scholes pricing model to determine the fair value of each warrant which was determined to be $0.0625.

The aggregate commissions and expenses payable in connection with the private placement were approximately $3,750,000.

Redemption of Preferred A Stock

On December 2, 2004, for an aggregate purchase price of $17 million, we sold to certain qualified institutional buyers and accredited investors an aggregate of 17,000 shares of Series A convertible redeemable preferred stock in separate transactions. In addition, the investors received warrants to purchase an aggregate of 1,378,374 shares of our common stock. The exercise price of each warrant is $4.25 per share, the warrants are exercisable into common stock and expire on the fifth anniversary of the closing.

Effective April 20, 2005, the Company suspended sales under the previously filed registration statement to resell such securities. Under the terms of the registration agreement, the investors were entitled to liquidated damages until such time as the registration statement was declared effective. On July 7, 2005, we amended the certificate of designation to reduce the conversion price from $3.70 to $2.80. In exchange, investors representing 95% of the preferred shareholders agreed to waive liquidated damages under the registration rights agreement through the date of the amendment and to amend the registration rights agreement to require the filing of a registration statement covering the registrable securities by July 8, 2005 and to require the effectiveness of such registration statement to be no later than October 1, 2005.

On September 26, 2005, the Company entered into agreements with its Series A Preferred Stock to have their shares of Series A Preferred Stock redeemed for cash upon the closing of the sale of the common stock and warrants described above. Accordingly, in connection with the closing of the private placement described elsewhere in this document, the Company has redeemed all of the Series A Preferred Stock. The redemption price was 100% of stated value, $17 million. In addition, the Company issued 488,070 shares of common stock to certain of the holders of its Series A Preferred Stock in connection with the redemption.

In connection with the redemption, the holders also agreed:

·   to waive any right of first refusal, participation or similar right they may have had with respect to the offering described above or any other offerings by the Company; and

·   to amend the terms of the warrants issued to the purchasers of Series A Preferred Stock in order to reduce the exercise price of warrants to $1.09 and to remove any right to further adjustment of the exercise price (other than equitable adjustments).

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Increase in Authorized Shares

On October 3, 2005, the Articles of Incorporation were amended to increase the number of shares of common stock authorized from 45,000,000 to 100,000,000. Additionally, on October 25, 2005, the Articles of Incorporation were amended to increase the number of shares of common stock authorized from 100,000,000 to 200,000,000.

Drug Distribution Operations

In August 2005, Hurricane Katrina resulted in the closure of our warehouse facility located in St. Rose, Louisiana. As of October 31, 2005, this facility is still closed and non-operational. The Company is currently evaluating whether to permanently close the facility due to its inability to ship and receive product. The Company maintains insurance coverage for this type of loss which provides for reimbursement from losses resulting from property damage, loss of product and business interruption coverage. The Company estimates approximately $0.2 million of inventory was damaged during the hurricane.

Also, subsequent to July 2, 2005, the Company determined as part of its ongoing Merger integration plan that it would exit the legacy drug distribution business primarily providing wholesale branded pharmaceuticals to independent pharmacies and regional chain stores. The business expected to be exited consists principally of non-core, low margin branded drug distribution wholesale. The Company believes that by exiting this lower gross margin component of its distribution business, it will improve overall operating company results, while maintaining its core strategy of specialty pharmaceutical distribution. The Company expects to exit this business component during the second half of 2005 and has engaged a nationally known advisor to conduct a sale of this business.

Contingencies

On June 8, 2005, a complaint to recover preferential payments previously paid to Valley Drug Company South was filed against Valley Drug Company South by Safescript Pharmacies, Inc. et al in the United States Bankruptcy Court for the Eastern District of Texas, Tyler Division. The complaint saught judgment against Valley Drug Company South in the amount of approximately $874,000. On October 24, 2005, the plaintiff filed a motion requesting the court to dismiss this matter. We expect the court to file its order of dismissal in due course.

Restructuring

Also subsequent to July 2, 2005, a plan was approved to reduce the Company’s workforce and implement tighter controls over other selling and administrative costs substantially by the end of the third quarter of 2005. The expected annual savings from these reductions is estimated at $1.9 million with approximately $0.6 million realizable in the second half of 2005. The Company expects to record a charge of approximately $220,000 in the third quarter of 2005 principally for severance costs.

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PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

Item 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the estimated costs and expenses, other than underwriting discounts and commissions, if any, all of which are payable by DrugMax (the “Registrant”), in connection with the sale of the common stock being offered by the selling shareholders.

SEC registration fee	$	12,155
Legal fees and expenses	$	20,000
Accounting fees and expenses	$	50,000
Printing expenses	$	50,000
Miscellaneous	$	—
Total	$	132,155

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Item 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 78.7502 of the Nevada General Corporation Law provides that:

1. A corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, except an action by or in the right of the corporation, by reason of the fact that he is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses, including attorneys’ fees, judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with the action, suit or proceeding if he:

(a) Is not liable pursuant to Section 78.138 of the Nevada General Corporation Law; or

(b) Acted in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful.

2. A corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses, including amounts paid in settlement and attorneys’ fees actually and reasonably incurred by him in connection with the defense or settlement of the action or suit if he:

(a) Is not liable pursuant to Section 78.138; or

(b) Acted in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the corporation.

Indemnification may not be made for any claim, issue or matter as to which such a person has been adjudged by a court of competent jurisdiction, after exhaustion of all appeals therefrom, to be liable to the corporation or for amounts paid in settlement to the corporation, unless and only to the extent that the court in which the action or suit was brought or other court of competent jurisdiction determines upon application that in view of all the circumstances of the case, the person is fairly and reasonably entitled to indemnity for such expenses as the court deems proper.

3. To the extent that a director, officer, employee or agent of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections 1 and 2, or in defense of any claim, issue or matter therein, the corporation shall indemnify him against expenses, including attorneys’ fees, actually and reasonably incurred by him in connection with the defense.

Section 78.138 of the Nevada General Corporation Law provides, in part, that:

1. Directors and officers shall exercise their powers in good faith and with a view to the interests of the corporation; and

2. A director or officer is not individually liable to the corporation or its stockholders for any damages as a result of any act or failure to act in his capacity as a director or officer unless it is proven that:

(a) His act or failure to act constituted a breach of his fiduciary duties as a director or officer; and

(b) His breach of those duties involved intentional misconduct, fraud or a knowing violation of law.

Further, DrugMax’s amended and restated articles of incorporation limit the personal liability for a breach of duty as a director of each member on its board of directors to DrugMax and its stockholders to the amount of compensation, if any, received by the director for serving DrugMax as a director during the year in which the breach of duty occurred. Further, the amended and restated articles of incorporation provide for mandatory indemnification by DrugMax of its directors and officers and permissive indemnification of its employees and agents.

DrugMax maintains directors’ and officers’ liability insurance for all its directors and officers. Further, DrugMax has entered into indemnification agreements with its directors and executive officers.

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Item 15. RECENT SALES OF UNREGISTERED SECURITIES

1. Between May 1, 2002 and November 1, 2005, we issued options to approximately 427 employees, and directors, to purchase up to an aggregate total of 3,574,366 shares of our common stock under our 1999 stock option plan. The exercise prices per share ranged from $0.57 to $15.25. No consideration was paid to us by any recipient of any of the foregoing options for the grant of such options. As of November 1, 2005, 32 option holders had exercised options for an aggregate of 539,503 shares and we received an aggregate of $929,620 upon the exercise of such options. In addition, during the same period, we issued 956,047 shares of stock to employees and directors pursuant to our 2003 restricted stock plan. There were no underwriters employed in connection with any of these transactions. The sales and issuances of securities listed above were deemed to be exempt from registration under the Securities Act of 1933, as amended (the "Securities Act") by virtue of [Rule 701] promulgated under Section 3(b) of the Securities Act as transactions pursuant to compensation benefit plans and contracts relating to compensation.

2. On March 18, 2004, we sold 1,000,000 shares of our common stock in a private placement to accredited investors for $3.21 million. The expenses related to this offering approximated $360,000. Maxim Group LLC, a New York-based investment firm, acted as the placement agent for DrugMax in the private placement. Net proceeds were used for working capital and general corporate purposes. The private placement was made under an exemption from the registration requirements of the Securities Act, and the investors purchasing shares in the private placement may not offer or sell the securities sold in the offering in the absence of an effective registration statement or exemption from registration requirements.

3. On December 2, 2004, for an aggregate purchase price of $17 million, we sold to certain qualified institutional buyers and accredited investors an aggregate of 17,000 shares of Series A convertible redeemable preferred stock. In addition, the investors received warrants to purchase an aggregate of 1,378,374 shares of common stock of the Company. Midsummer Investment, Ltd. acted as the lead investor in the private placement. First Albany Capital served as the lead placement agent for the transaction and the Maxim Group, LLC served as co-agent. The exercise price of the warrant is $4.25 per share (which have been subsequently reduced to $1.09 per share), the warrants are exercisable into common stock of the Company and the warrants expire on the fifth anniversary of the closing. Net proceeds were used for working capital and general corporate purposes. On October 3, 2005, the Company redeemed all of the preferred stock for $17 million and 992,952 shares of the Company's common stock (which consisted of 488,070 shares as payment to certain shareholders and 504,883 shares as payment for dividends).

The sales and issuances of securities listed above were deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) of the Act and/or Regulation D promulgated thereunder since, among other things, the transaction did not involve a public offering, the investors were accredited investors and/or qualified institutional buyers, the investors had access to information about the company and their investment, the investors took the securities for investment and not resale, and we took appropriate measures to restrict the transfer of the securities.

4. On November 12, 2004, we merged with FMG. In connection therewith, the shareholders of FMG, along with certain FMG warrant holders and note holders, received an aggregate of 10,470,507 shares of DrugMax common stock along with warrants to purchase an additional 3,538,290, shares of DrugMax common stock. The exercise price of the warrants is $2.61 per share. For their services rendered in connection with the Merger, on May 20, 2005, First Albany Capital received warrants to purchase 100,000 shares of DrugMax common stock at an exercise price of $4.80. The closing bid price for the shares of our common stock on November 12, 2004, the last trading day immediately preceding the closing of the Merger, was $3.98. The DrugMax Common Stock issued in connection with the Merger was issued without registration under the Securities Act of 1933 or applicable state securities laws in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act, Rule 506 of Regulation D promulgated under the Securities Act, and various state exemptions.

5. On March 22, 2005, DrugMax converted $23.0 million in accounts payable owed to AmerisourceBergen Drug Company (“ABDC”) (after having repaid $6,000,000 on March 23, 2005 in connection with the closing of the new vendor supply agreement) into (a) a subordinated convertible debenture in the original principal amount of $11.5 million (the “Subordinated Debenture”) and (b) a subordinated promissory note in the original principal amount of $11.5 million. Pursuant to the Subordinated Debenture, principal is due and payable in 19 successive quarterly installments each in the amount of $0.6 million commencing on March 1, 2006 and continuing until August 15, 2010, on which date all outstanding amounts are required to be paid. Quarterly principal payments are payable in cash or in shares of common stock in an amount equal to $0.6 million divided by $3.4416 (the “Issue Price”). Prior to March 1, 2006, quarterly interest payments are required to be paid in common stock. Commencing March 1, 2006, quarterly interest payments may be paid in cash or common stock in an amount equal to the interest then due and owing divided by the Issue Price, or a combination thereof. As of November 1, 2005, we have made two interest payments to ABDC, which payments totalled with 151,293 shares of common stock of the Company. The sales and issuances of these securities were deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) of the Act and/or Regulation D promulgated thereunder since, among other things, the transaction did not involve a public offering, the investor is accredited, the investor had access to information about the company and their investment, the investor took the securities for investment and not resale.

II-3

6. On September 23, 2005 and September 26, 2005 we entered into securities purchase agreements to sell to selling shareholders an aggregate of 44,093,432 shares of our common stock for an aggregate of $51,104,340. We issued to the selling shareholders warrants to purchase an aggregate of 22,046,715 shares of our common stock. The offering was executed in two traunches at market price as determined by the closing bid price on each day. A purchase agreement for the first traunch was executed on September 23, 2005, for an aggregate of $47,814,265. The unit price of the common stock and corresponding warrant was $1.1525. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.09 per share. A purchase agreement for the second traunch executed on September 26, 2005, for an aggregate of $3,290,075. The unit price of the common stock and corresponding warrant was $1.2625. The warrants are exercisable for a period of five years from the closing date at an exercise price of $1.20 per share. The Company used a Black Scholes pricing model to determine the fair value of each warrant which was determined to be $0.0625. The sales and issuances of securities listed above were deemed to be exempt from registration under the Securities Act of 1933, as amended (the "Securities Act") by virtue of [Rule 701] promulgated under Section 3(b) of the Securities Act as transactions pursuant to compensation benefit plans and contracts relating to compensation.

II-4

Item 16. Exhibits and Financial Statement Schedule

(a) Exhibits.

2.1	Agreement and Plan of Merger between DrugMax, Inc. and Familymeds Group, Inc. dated March 19, 2004, as amended(5)
2.2	First Amendment to Agreement and plan of Merger between DrugMax, Inc. and Familymeds Group, Inc., dated July 1, 2004(12)
2.3	Second Amendment to Agreement and plan of Merger between DrugMax, Inc. and Familymeds Group, Inc., dated October 11, 2004(7)
3.1	Amended and Restated Articles of Incorporation of DrugMax, Inc. filed November 12, 2004(8)
3.2	Amended and Restated Bylaws, dated February 24, 2005(12)
3.3	Certificate of Designation, creating Series A Preferred Stock(9)
3.4	Amendment to Certificate of Designation, filed July 7, 2005(5)
3.5	Certificate of Amendment to Amended and Restated Articles of Incorporation dated effective as of October 3, 2005.*
3.6	Certificate of Amendment to Amended and Restated Articles of Incorporation dated effective as of October 25, 2005*
4.1	Specimen of Stock Certificate(1)
5.1	Opinion of Sichenzia Ross Friedman Ference LLP*
10.1	Employment Agreement by and between DrugMax, Inc. and Jugal K. Taneja dated as of June 7, 2005(14)
10.2	Employment Agreement by and between Familymeds, Inc. and Edgardo Mercadante, dated as of June 7, 2005(14)
10.3	Employment Agreement by and between Familymeds, Inc. and James Searson, dated June 7, 2005(14)
10.4	Employment Agreement, as amended by and between Familymeds, Inc. and James Beaumariage effective as May 29, 1998(13)
10.5	DrugMax.com, Inc. 1999 Incentive and Non-Statutory Stock Option Plan(1)
10.6	Amendment No. 1 to DrugMax, Inc. 1999 Incentive and Non-Statutory Stock Option Plan, dated June 5, 2002(2)
10.7	DrugMax, Inc. 2003 Restricted Stock Plan dated August 27, 2003(4)
10.8	Commercial Lease between Becan Development LLC and Valley Drug Company, dated January 1, 2004(6)
10.9	Commercial Lease between River Road Real Estate, LLC and DrugMax, Inc. dated October 18, 2001(6)
10.10	Prime Warehouse Supplier Agreement among Familymeds, Inc. and D&K Healthcare Resources, Inc. dated December 28, 2004(11)
10.11	Subordinated Convertible Debenture in the original principal amount of $11,500,000 dated March 21, 2005(11)
10.12	Subordinated Promissory Note in the original principal amount of $11,500,000 dated March 21, 2005(11)
10.13	Registration Rights Agreement among DrugMax, Inc. and AmerisourceBergen Drug Corporation dated March 21, 2005(11)
10.14	Security Agreement among DrugMax, Inc., Valley Drug Company, Valley Drug Company South, Familymeds, Inc. and AmerisourceBergen Drug Corporation dated March 21, 2005(11)
10.15	Form of Securities Purchase Agreement among DrugMax, Inc. and various Investors (regarding first traunch of common stock dated September 23, 2005)(16)
10.16	Form of Securities Purchase Agreement among DrugMax, Inc. and various Investors (regarding second traunch of common stock dated September 26, 2005)(16)
10.17	Form of Common Stock Purchase Warrant issued in connection with Securities Purchase Agreement dated as of September 23, 2005(17)
10.18	Form of Common Stock Purchase Warrant issued in connection with Securities Purchase Agreement dated as of September 26, 2005(17)
10.19	Form of Registration Rights Agreement executed in connection with Securities Purchase Agreement dated as of September 23, 2005(17)
10.20	Form of Registration Rights Agreement executed in connection with Securities Purchase Agreement dated as of September 26, 2005(17)
10.21	Form of Agreement between DrugMax, Inc. and holders of Series A Preferred Stock(16)
10.22	Loan and Security Agreement between DrugMax, Inc. and Wells Fargo Retail Finance, LLC dated October 12, 2005*
21.0	Subsidiaries of DrugMax, Inc.(12)
23.1	Consent of Deloitte & Touche LLP*
23.2	Consent of Sichenzia Ross Friedman Ference LLP (included in Exhibit 5.1)*
24.1	Power of Attorney (see signature page)

* Filed herewith.

II-5

(1)	Incorporated by reference to DrugMax’s Form 10-KSB/A, filed July 14, 2000, File No. 0-24362.
(2)	Incorporated by reference to DrugMax’s Form 10-KSB, filed July 1, 2002.
(3)	Incorporated by reference to DrugMax’s Form 10-K/A, filed July 29, 2003.
(4)	Incorporated by reference to DrugMax’s Definitive Proxy Statement filed September 8, 2003.
(5)	Incorporated by reference to DrugMax’s Form 10-K, filed July 14, 2004.
(6)	Incorporated by reference to DrugMax’s Form 10-K/A, filed October 1, 2004.
(7)	Incorporated by reference to DrugMax’s Definitive Proxy Statement filed October 12, 2004.
(8)	Incorporated by reference to DrugMax’s Form 8-K, filed November 18, 2004. Incorporated by reference to DrugMax’s Form 10-K, filed July 14, 2004. Incorporated by reference to DrugMax’s Form 8-K, filed November 18, 2004.
(9)	Incorporated by reference to DrugMax’s Form 8-K, filed December 8, 2004.
(10)		Incorporated by reference to DrugMax’s Form 8-K, filed December 15, 2004.
(11)		Incorporated by reference to DrugMax’s Form 8-K, filed March 25, 2005.
(12)		Incorporated by reference to DrugMax’s Form 10-K, filed April 18, 2005.
(13)		Incorporated by reference to DrugMax’s Form 10-K/A, filed May 2, 2005.
(14)		Incorporated by reference to DrugMax’s Form 8-K, filed June 13, 2005.
(15)		Incorporated by reference to DrugMax’s Form 8-K, filed July 7, 2005.
(16)		Incorporated by reference to DrugMax’s Form 8-K, filed September 27, 2005.
(17)		Incorporated by reference to DrugMax’s Form 8-K, filed October 5, 2005.

(b) Financial Statement Schedules

The following schedule required to be filed by Item 16(b) is contained on page F-28 of this Report:

Schedule II—Valuation and Qualifying Accounts for the fiscal years ended January 1, 2005, December 27, 2003 and December 28, 2002.

All other schedules have been omitted because they are either inapplicable or the required information has been given in the consolidated financial statements or the notes thereto.

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Item 17. UNDERTAKINGS

The undersigned Registrant hereby undertakes:

(1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement:

(a) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933;

(b) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Securities and Exchange Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20 percent change in the maximum aggregate offering price set forth in the “Calculation of Registration Fee” table in the effective registration statement;

(c) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement;

provided, however, that paragraphs (1)(a) and (1)(b) do not apply if the registration statement is on Form S-3, Form S-8 or Form F-3, and the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed with or furnished to the Commission by the registrant pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the registration statement.

(2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

(3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of this offering.

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described under Item 14, or otherwise, the Registrant has been advised that in the opinion of the 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.

II-7

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and current reports, proxy statements and other documents with the Securities and Exchange Commission under the Securities Exchange Act of 1934. You may read and copy any of those reports, proxy statements or other documents at the public reference facilities maintained by the Commission at 100 F Street NE, Washington, DC 20549. Please call the Commission at 1-800-SEC-0330 for further information on its public reference facilities. These filings are also available to the public from commercial document retrieval services and at the Commission’s Web site at www.sec.gov. You may also read and copy our annual and quarterly reports from our website at www.drugmax.com.

Our common stock is quoted on the Nasdaq Capital Market. Reports, proxy statements and other information concerning DrugMax that we file with Nasdaq can be inspected at the offices of the National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006. In addition, we maintain a website at www.drugmax.com that contains additional information, including news releases, about our business and operations. Information contained in this website does not constitute, and shall not be deemed to constitute, part of this prospectus.

This prospectus constitutes a part of a registration statement on Form S-1 filed by us with the Commission under the Securities Act. This prospectus does not contain all the information that is contained in the registration statement, some of which we are allowed to omit under the rules and regulations of the Commission. We refer to the registration statement and to the exhibits filed with the registration statement for further information with respect to DrugMax. Copies of the registration statement and the exhibits to the registration statement are on file at the offices of the Commission and may be obtained upon payment of the prescribed fee or may be examined without charge at the public reference facilities of the Commission described above. Statements contained in this prospectus concerning the provisions of documents are summaries of the material provisions of those documents, and each of those statements is qualified in its entirety by reference to the copy of the applicable document filed with the Commission. Since this prospectus may not contain all of the information that you may find important, you should review the full text of these documents.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Farmington, Connecticut on November 2, 2005.

DRUGMAX, INC.
By:
Name:	Edgardo A. Mercadante
Title:	Co-Chairman, President and Chief Executive Officer

II-8

POWER OF ATTORNEY

Each person whose name appears below hereby constitutes and appoints each of Edgardo A. Mercadante and James E. Searson, or either of them, each acting alone, such person’s true and lawful attorney-in-fact, with full power of substitution to sign for such person and in such person’s name and capacity indicated below, in connection with this Registrant’s registration statement on Form S-1, including to sign this registration statement and any and all amendments to this registration statement, including Post-Effective Amendments, and to file the same with the Securities and Exchange Commission, hereby ratifying and confirming such person’s signature as it may be signed by said attorneys-in-fact to any and all amendments.

Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.

Signature		Title	Date
By:	Edgardo A. Mercadante	Co-Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer)	November 2, 2005
By:	James E. Searson	Chief Financial Officer (Principal Financial Accounting Officer) and Director	November 2, 2005
By:	Jugal K. Taneja	Co-Chairman of the Board and Director	November 2, 2005
By:	Philip P. Gerbino	Director	November 2, 2005
By:	Peter J. Grua	Director	November 2, 2005
By:	Mark T. Majeske	Director	November 2, 2005
By:	Rakesh K. Sharma	Director	November 2, 2005
By:	Laura L. Witt	Director	November 2, 2005

II-9

EX-3.5

EX-3.6

EX-10.22

[CONFIDENTIAL TREATMENT HAS BEEN REQUESTED BY DRUGMAX, INC. CONFIDENTIAL PORTIONS OF THIS DOCUMENT HAVE BEEN REDACTED AND HAVE BEEN SEPARATELY FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.]

LOAN AND SECURITY AGREEMENT

WELLS FARGO RETAIL FINANCE, LLC

Agent for

The Lenders Referenced Herein

DRUGMAX, INC.

The Lead Borrower

For:

The Borrowers

October 12, 2005

Article 1 - - Definitions:		10
Article 2 - The Revolving Credit:		31
2.1.	Establishment of Revolving Credit.	31
2.2.	Advances in Excess of Borrowing Base (OverLoans).	32
2.3.	Risks of Value of Collateral.	32
2.4.	Commitment to Make Revolving Credit Loans and Support Letters of Credit	32
2.5.	Revolving Credit Loan Requests.	33
2.6.	Suspension of Revolving Credit	34
2.7.	Making of Revolving Credit Loans.	34
2.8.	The Loan Account.	34
2.9.	The Revolving Credit Notes	35
2.10.	Payment of The Loan Account.	35
2.11.	Interest on Revolving Credit Loans.	36
2.12.	Unused Line Fee	37
2.13.	Revolving Credit Early Termination Fee	37
2.14.	Concerning Fees	37
2.15.	Agent's and Revolving Credit Lenders' Discretion.	37
2.16.	Procedures For Issuance of L/C's.	38
2.17.	Fees For L/C's.	39
2.18.	Concerning L/C's.	40
2.19.	Changed Circumstances.	41
2.20.	Designation of Lead Borrower as Borrowers' Agent.	42
2.21.	Lenders' Commitments	42
Article 3 - Conditions Precedent:		44
3.1.	Corporate Due Diligence.	44
3.2.	Opinion	44
3.3.	Additional Documents	44

(i)

3.4.	Officers' Certificates	45
3.5.	Representations and Warranties	45
3.6.	Minimum Day One Availability	45
3.7.	All Fees and Expenses Paid	45
3.8.	No Borrower In Default	45
3.9.	No Adverse Change	46
3.10.	Benefit of Conditions Precedent	46
Article 4 - General Representations, Covenants and Warranties:		46
4.1.	Payment and Performance of Liabilities	46
4.2.	Due Organization. Authorization. No Conflicts.	46
4.3.	Trade Names.	47
4.4.	Infrastructure.	47
4.5.	Locations.	48
4.6.	Encumbrances	48
4.7.	Indebtedness	49
4.8.	Insurance.	49
4.9.	Licenses	50
4.10.	Leases	50
4.11.	Requirements of Law	50
4.12.	Labor Relations.	50
4.13.	Maintain Properties	51
4.14.	Taxes.	51
4.15.	No Margin Stock	52
4.16.	ERISA.	52
4.17.	Hazardous Materials.	53
4.18.	Litigation	53
4.19.	Dividends. Investments. Corporate Action	53

(ii)

4.20.	Loans	54
4.21.	Protection of Assets	55
4.22.	Line of Business	55
4.23.	Affiliate Transactions	55
4.24.	Further Assurances.	55
4.25.	Adequacy of Disclosure.	56
4.26.	No Restrictions on Liabilities	56
4.27.	Other Covenants	56
4.28.	Pharmaceutical Laws.	57
4.29.	HIPAA Compliance.	57
4.30.	Compliance with Health Care Laws.	57
4.31.	Prescription Files	58
4.32.	Sale of Valley Drug Company	59
Article 5 - Financial Reporting and Performance Covenants:		59
5.1.	Maintain Records	59
5.2.	Access to Records.	60
5.3.	Immediate Notice to Agent.	60
5.4.	Borrowing Base Certificate	61
5.5.	Intentionally Omitted.	61
5.6.	Monthly Reports	61
5.7.	Intentionally Omitted	61
5.8.	Annual Reports.	61
5.9.	Officers' Certificates	62
5.10.	Inventories, Appraisals, and Audits.	62
5.11.	Additional Financial Information.	63
5.12.	Financial Performance Covenants	64

(iii)

Article 6 - Use of Collateral:		64
6.1.	Use of Inventory Collateral.	64
6.2.	Inventory Quality	64
6.3.	Adjustments and Allowances	65
6.4.	Validity of Accounts.	65
6.5.	Notification to Account Debtors	65
Article 7 - Cash Management. Payment of Liabilities:		65
7.1.	The Concentration, Blocked, and Operating Accounts.	65
7.2.	Proceeds and Collections.	66
7.3.	Payment of Liabilities.	66
7.4.	The Operating Account	67
7.5.	Medicare and Medicaid Payments.	67
Article 8 - Grant of Security Interest:		68
8.1.	Grant of Security Interest	68
8.2.	Extent and Duration of Security Interest.	69
Article 9 - Agent As Borrowers' Attorney-In-Fact:		69
9.1.	Appointment as Attorney-In-Fact	69
9.2.	No Obligation to Act	70
Article 10 - Events of Default:		70
10.1.	Failure to Pay the Revolving Credit	70
10.2.	Failure To Make Other Payments	70
10.3.	Failure to Perform Covenant or Liability (No Grace Period)	70
10.4.	Failure to Perform Covenant or Liability (Grace Period)	70
10.5.	Misrepresentation	70
10.6.	Acceleration of Other Debt. Breach of Lease	71
10.7.	Default Under Other Agreements	71
10.8.	Uninsured Casualty Loss	71
10.9.	Attachment. Judgment. Restraint of Business.	71

(iv)

10.10.	Business Failure	71
10.11.	Bankruptcy	72
10.12.	Indictment - Forfeiture	72
10.13.	Guarantor's Default	72
10.14.	Termination of Guaranty	72
10.15.	Challenge to Loan Documents.	72
10.16.	Change in Control	72
Article 11 - Rights and Remedies Upon Default:		72
11.1.	Acceleration	72
11.2.	Rights of Enforcement	73
11.3.	Sale of Collateral.	73
11.4.	Occupation of Business Location	74
11.5.	Grant of Nonexclusive License	74
11.6.	Assembly of Collateral	74
11.7.	Rights and Remedies	74
Article 12 - Revolving Credit Fundings and Distributions:		74
12.1.	Revolving Credit Funding Procedures	74
12.2.	Agent's Covering of Fundings:	75
12.3.	Ordinary Course Distributions	76
Article 13 - Acceleration and Liquidation:		77
13.1.	Acceleration Notices	77
13.2.	Acceleration	77
13.3.	Initiation of Liquidation	77
13.4.	Actions At and Following Initiation of Liquidation	77
13.5.	Agent's Conduct of Liquidation	78
13.6.	Distribution of Liquidation Proceeds:	78
13.7.	Relative Priorities To Proceeds of Liquidation	78

(v)

Article 14 - The Agent:		79
14.1.	Appointment of The Agent	79
14.2.	Responsibilities of Agent	79
14.3.	Concerning Distributions By the Agent	80
14.4.	Dispute Resolution	81
14.5.	Distributions of Notices and Other Documents	81
14.6.	Confidential Information	81
14.7.	Reliance by Agent	82
14.8.	Non-Reliance on Agent and Other Revolving Credit Lenders	82
14.9.	Indemnification	83
14.10.	Resignation of Agent.	83
Article 15 - Action By Agent - Consents - Amendments - Waivers:		83
15.1.	Administration of Credit Facilities.	83
15.2.	Actions Requiring or On Direction of Majority Lenders	84
15.3.	Actions Requiring or On Direction of SuperMajority Lenders	84
15.4.	Action Requiring Certain Consent	85
15.5.	Actions Requiring or Directed By Unanimous Consent	85
15.6.	Actions Requiring Agent's Consent.	86
15.7.	Miscellaneous Actions	86
15.8.	Actions Requiring Lead Borrower's Consent	87
15.9.	NonConsenting Revolving Credit Lender	87
Article 16 - Assignments By Revolving Credit Lenders:		88
16.1.	Assignments and Assumptions:	88
16.2.	Assignment Procedures	89
16.3.	Effect of Assignment.	89
Article 17 - Notices:		90
17.1.	Notice Addresses	90

(vi)

If to the Agent:		90
17.2.	Notice Given.	91
17.3.	Wire Instructions. Notice Given	91
Article 18 - Term:		91
18.1.	Termination of Revolving Credit	91
18.2.	Actions On Termination.	91
Article 19 - General:		92
19.1.	Protection of Collateral	92
19.2.	Publicity	92
19.3.	Successors and Assigns	92
19.4.	Severability	93
19.5.	Amendments. Course of Dealing.	93
19.6.	Power of Attorney	93
19.7.	Application of Proceeds	93
19.8.	Increased Costs	93
19.9.	Costs and Expenses of the Agent .	94
19.10.	Copies and Facsimiles	94
19.11.	Massachusetts Law	95
19.12.	Consent to Jurisdiction.	95
19.13.	Indemnification	95
19.14.	Rules of Construction	96
19.15.	Intent	97
19.16.	Right of Set-Off	98
19.17.	Pledges To Federal Reserve Banks	98
19.18.	Maximum Interest Rate	98
19.19.	Waivers.	98

(vii)

EXHIBITS

1	:	Borrowers
2.9	:	Revolving Credit Note
2.22	:	Revolving Credit Lenders' Commitments
4.2	:	Affiliates
4.2(h)		Inactive Subsidiary Assets
4.3	:	Trade Names
4.5	:	Locations
4.6	:	Permitted Encumbrances
4.7	:	Permitted Indebtedness
4.8	:	Insurance
4.10	:	Capital Leases
4.12		Loans
4.14	:	Taxes
4.18	:	Litigation
4.20		Loans by Borrowers
4.29	:	Business Associate Agreements
4.30	:	Participation Agreements
5.4	:	Borrowing Base Certificate
5.6	:	Monthly Financial Reporting Requirements
5.12(a)	:	Financial Performance Covenants
5.12(b)	:	Business Plan
8.2(b)	:	Excluded Assets
16.2	:	Assignment / Acceptance

LOAN AND SECURITY AGREEMENT

October 12, 2005

THIS AGREEMENT is made between

WELLS FARGO RETAIL FINANCE, LLC, a Delaware limited liability company with offices at One Boston Place - - 18^th Floor, Boston, Massachusetts 02109, as agent (in such capacity, herein the "Agent") for the ratable benefit of the "Revolving Credit Lenders", who are, at present, those financial institutions identified on the signature pages of this Agreement and who in the future are those Persons (if any) who become "Revolving Credit Lenders" in accordance with the provisions of Article 16 - , below;

and

The Revolving Credit Lenders;

and

DRUGMAX, INC. (in such capacity, the "Lead Borrower"), a Nevada corporation with its principal executive offices at 312 Farmington Avenue, Farmington, Connecticut 06032, as agent for the Persons listed on EXHIBIT 1, annexed hereto (individually, a "Borrower" and collectively, the "Borrowers"),

in consideration of the mutual covenants contained herein and benefits to be derived herefrom,

WITNESSETH:

Article 1 - - Definitions:

As used herein, the following terms have the following meanings or are defined in the section of this Agreement so indicated:

"Acceleration": The making of demand or declaration that any indebtedness, not otherwise due and payable, is due and payable. Derivations of the word "Acceleration" (such as "Accelerate") are used with like meaning in this Agreement.

"Acceleration Notice": Written notice as follows:

(a) From the Agent to the Revolving Credit Lenders, as provided in Section 13.1(a).

(b) From the SuperMajority Lenders to the Agent, as provided in Section 13.1(b).

"Account Debtor": Has the meaning given that term in the UCC.

"Accounts" and "Accounts Receivable": Include, without limitation, "accounts" as defined in the UCC, and also all: accounts, accounts receivable, receivables, and rights to payment (whether or not earned by performance) for: property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of; services rendered or to be rendered; a policy of insurance issued or to be issued; a secondary obligation incurred or to be incurred; energy provided or to be provided; for the use or hire of a vessel; arising out of the use of a credit or charge card or information contained on or used with that card; winnings in a lottery or other game of chance; and Health-Care-Insurance receivables; and also all Inventory which gave rise thereto, and all rights associated with such Inventory, including the right of stoppage in transit; all reclaimed, returned, rejected or repossessed Inventory (if any) the sale of which gave rise to any Account.

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"ACH": Automated clearing house.

"Affiliate": The following:

(a) With respect to any two Persons, a relationship in which (i) one holds, directly or indirectly, not less than Fifty Percent (50%) of the capital stock, beneficial interests, partnership interests, or other equity interests of the other; or (ii) one has, directly or indirectly, the right, under ordinary circumstances, to vote for the election of a majority of the directors (or other body or Person who has those powers customarily vested in a board of directors of a corporation); or (iii) not less than Fifty Percent (50%) of their respective ownership is directly or indirectly held by the same third Person.

(b) Any Person which: is a parent, brother-sister, subsidiary, or affiliate, of a Borrower; could have such enterprise's tax returns or financial statements consolidated with that Borrower's; could be a member of the same controlled group of corporations (within the meaning of Section 1563(a)(1), (2) and (3) of the Internal Revenue Code of 1986, as amended from time to time) of which any Borrower is a member; or controls or is controlled by any Borrower.

"Agent": Is referred to in the Preamble.

"Agent's Cover": Is defined in Section 12.2(c)(i).

"Agent's Rights and Remedies": Is defined in Section 11.7.

"Applicable Law": As to any Person: (i) All statutes, rules, regulations, orders, or other requirements having the force of law and (ii) all court orders and injunctions, arbitrator's decisions, and/or similar rulings, in each instance ((i) and (ii)) of or by any federal, state, municipal, and other governmental authority, or court, tribunal, panel, or other body which has or appropriately claims jurisdiction over such Person, or any property of such Person, or of any other Person for whose conduct such Person would be responsible.

“Appraised Prescription Files Liquidation Value”: The net appraised liquidation value of the Borrowers’ Prescription Files as determined from time to time by an independent appraiser reasonably satisfactory to the Agent rolled forward monthly based on recent pharmacy Prescription Files activity.

"Assigning Revolving Credit Lender": Is defined in Section 16.1(a).

"Assignment and Acceptance": Is defined in Section 16.2.

"Availability": The result of the following:

(a) The lesser of:

(i) The Revolving Credit Ceiling

or

(ii) The Borrowing Base

Minus

(b) The sum of:

(i) The aggregate unpaid balance of the Loan Account,

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(ii) The aggregate undrawn Stated Amount of all then outstanding L/C's,

(iii) The aggregate of the Availability Reserves, and

(iv) The Minimum Reserve.

"Availability Reserves": Such reserves as the Agent from time to time determines in the Agent's discretion as being appropriate to reflect the impediments to the Agent's ability to realize upon the Collateral. Without limiting the generality of the foregoing, Availability Reserves may include (but are not limited to) reserves based on the following (without duplication for any Inventory Reserves, Receivables Reserves, and Prescription Files Reserves):

(a)	Rent in an amount equal to One (1) month’s rent for each of the Borrowers’ leased locations (but only if a landlord's waiver, acceptable to the Agent, has not been received by the Agent).
(b)	Customer Credit Liabilities.
(c)	Bank Product Reserves.
(d)	Taxes and other governmental charges, including, ad valorem, personal property, and other taxes which might have priority over the Collateral Interests of the Agent in the Collateral.

“Average Excess Availability”: Means, for the applicable quarter, the aggregate of the amount of Excess Availability on each day in such quarter, divided by the number of days in such quarter.

“Bank Product Agreements”: Those certain cash management service agreements entered into from time to time by the Borrowers in connection with any of the Bank Products.

“Bank Product Obligations”: All obligations, liabilities, contingent reimbursement obligations, fees, and expenses owing by the Borrowers to Wells Fargo Bank, N. A. or any of its Affiliates pursuant to or evidenced by the Bank Product Agreements and irrespective of whether for the payment of money, whether direct or indirect, absolute or contingent, due or to become due, now existing or hereafter arising, and including all such amounts that the Borrowers are obligated to reimburse to any Revolving Credit Lender as a result of such Revolving Credit Lender purchasing participations or executing indemnities or reimbursement obligations with respect to the Bank Products provided to the Borrowers pursuant to the Bank Product Agreements.

“Bank Products” Any service or facility extended to the Borrowers by Wells Fargo Bank, N. A. or any of its Affiliates, including the following:

(a) credit cards,

(b) credit card processing services,

(c) debit cards,

(d) purchase cards,

(e) ACH Transactions,

(f) cash management, including controlled disbursement, accounts or services, and

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(g) hedge agreements.

“Bank Product Reserves”: As of any date of determination, the amount of reserves that the Agent has established (based upon Wells Fargo Bank, N. A.’s or its Affiliate’s reasonable determination of the credit exposure in respect of then extant Bank Products) for Bank Products then provided or outstanding.

"Bankruptcy Code": Title 11, U.S.C., as amended from time to time.

"Blocked Account": Any DDA into which the contents of any other DDA is transferred.

"Blocked Account Agreement": An Agreement, in form satisfactory to the Agent, which Agreement recognizes the Agent's Collateral Interest in the contents of the DDA which is the subject of such Agreement and agrees that such contents shall be transferred only to the Concentration Account or as otherwise instructed by the Agent.

“BOA”: Bank of America, N.A.

"Borrower" and "Borrowers": Is defined in the Preamble.

"Borrowing Base": The sum of:

(a) The lesser of

(i)	The (x) Cost of Eligible Retail Inventory (net of Inventory Reserves) multiplied by the Inventory Advance Rate, plus (y) Cost of Eligible Wholesale Inventory (net of Inventory Reserves) multiplied by the Inventory Advance Rate and
(ii)	The (x) Cost of Eligible Retail Inventory (net of Inventory Reserves) multiplied by ** of the NRLV and (y) Cost of Eligible Wholesale Inventory (net of  Inventory Reserves) multiplied by ** of the NRLV
plus
(b)	The lesser of
(i)	the sum of :
(x)	The face amount of Eligible Credit Card Receivables multiplied by the Credit Card Advance Rate, plus
(y)	The face amount of Eligible Third Party Receivables (net of Receivables Reserves) multiplied by the Third Party Receivables Advance Rate,
and
(ii)	**
plus
(c)	The lesser of (i) ** and (ii) the result of the Appraised Prescription Files Liquidation Value (net of Prescription Files Reserves) multiplied by the Prescription Files Advance Rate,

"Borrowing Base Certificate": Is defined in Section 5.4.

-13-

"Business Day": Any day other than (a) a Saturday or Sunday; (b) any day on which banks in Boston, Massachusetts or in Hartford, Connecticut, generally are not open to the general public for the purpose of conducting commercial banking business; or (c) a day on which the principal office of the Agent is not open to the general public to conduct business.

"Business Plan": The Borrowers' business plan annexed hereto as EXHIBIT 5.12(b) and any revision, amendment, or update of such business plan to which the Lender has provided its written sign-off.

"Capital Expenditures": The expenditure of funds or the incurrence of liabilities which may be capitalized in accordance with GAAP.

"Capital Lease": Any lease which may be capitalized in accordance with GAAP.

"Change in Control": The occurrence of any of the following:

(a) The acquisition, by any group of persons (within the meaning of the Securities Exchange Act of 1934, as amended) or by any Person, of beneficial ownership (within the meaning of Rule 13d-3 of the Securities and Exchange Commission) of 33 1/3% or more of the issued and outstanding capital stock of the Lead Borrower having the right, under ordinary circumstances, to vote for the election of directors of the Lead Borrower.

(b) More than half of the persons who were directors of the Lead Borrower on the first day of any period consisting of twelve (12) consecutive calendar months (the first of which twelve (12) month periods commencing with the first day of the month during which this Agreement was executed), cease, for any reason other than death or disability, to be directors of the Lead Borrower.

(c) Failure of the Lead Borrower to own, beneficially and of record, directly or indirectly, 100% of the capital stock of all other Borrowers.

"Chattel Paper": Has the meaning given that term in the UCC.

"Collateral": Is defined in Section 8.1.

"Collateral Interest": Any interest in property to secure an obligation, including, without limitation, a security interest, mortgage, and deed of trust.

"Concentration Account": Is defined in Section 7.1.

"Consent": Actual consent given by the Revolving Credit Lender from whom such consent is sought; or the passage of seven (7) Business Days from receipt of written notice to a Revolving Credit Lender from the Agent of a proposed course of action to be followed by the Agent without such Revolving Credit Lender's giving the Agent written notice of that Revolving Credit Lender's objection to such course of action, provided that the Agent may rely on such passage of time as consent by a Revolving Credit Lender only if such written notice states that consent will be deemed effective if no objection is received within such time period.

"Consolidated": When used to modify a financial term, test, statement, or report, refers to the application or preparation of such term, test, statement or report (as applicable) based upon the consolidation, in accordance with GAAP, of the financial condition or operating results of the Borrowers.

"Cost": The lower of (a) or (b), where:

-14-

(a) is the calculated cost of purchases, based upon the Borrowers' accounting practices, known to the Agent, which practices are in effect on the date on which this Agreement was executed as such calculated cost is determined from: invoices received by the Borrowers; the Borrowers' purchase journal; or the Borrowers' stock ledger.

(b) is the cost equivalent of the lowest ticketed or promoted price at which the subject Inventory is offered to the public, after all mark-downs (whether or not such price is then reflected on the Borrowers' accounting system), which cost equivalent is determined in accordance with the FIFO method of accounting,reflecting the Borrowers' historic business practices.

("Cost" does not include inventory capitalization costs or other non-purchase price charges (such as freight) used in the Borrowers' calculation of cost of goods sold).

"Costs of Collection": Includes, without limitation, all attorneys' reasonable fees and reasonable out-of-pocket expenses incurred by the Agent's attorneys, and all reasonable out-of-pocket costs incurred by the Agent in the administration of the Liabilities and/or the Loan Documents, including, without limitation, reasonable costs and expenses associated with travel on behalf of the Agent, where such costs and expenses are directly or indirectly related to or in respect of the Agent's: administration and management of the Liabilities; negotiation, documentation, and amendment of any Loan Document; or efforts to preserve, protect, collect, or enforce the Collateral, the Liabilities, and/or the Agent's Rights and Remedies and/or any of the rights and remedies of the Agent against or in respect of any guarantor or other person liable in respect of the Liabilities (whether or not suit is instituted in connection with such efforts). "Costs of Collection" also includes the reasonable fees and expenses of Lenders' Special Counsel. The Costs of Collection are Liabilities, and at the Agent's option may bear interest at the then effective Prime Margin Rate.

"Credit Card Advance Rate": **

"Customer Credit Liability": Gift certificates, customer deposits, merchandise credits, layaway obligations, frequent shopping programs, and similar liabilities of any Borrower to its retail customers and prospective customers.

"DDA": Any checking or other demand daily depository account maintained by any Borrower other than any Exempt DDA.

"Delinquent Revolving Credit Lender": Is defined in Section 12.2(c).

"Deposit Account": Has the meaning given that term in the UCC and also includes all demand, time, savings, passbook, or similar accounts maintained with a bank.

"Documents": Has the meaning given that term in the UCC.

"Documents of Title": Has the meaning given that term in the UCC.

"EBITDA": The Borrowers' Consolidated earnings before interest, taxes, depreciation, and amortization, but excluding extraordinary gains and losses and gains and losses from the sale of assets other than in the ordinary course of business, and excluding non-cash compensation charges related to stock options and restricted stock, each as determined in accordance with GAAP.

"Eligible Assignee": A bank, insurance company, or company engaged in the business of making commercial loans having a combined capital and surplus in excess of $50,000,000.00 or any Affiliate of any Revolving Credit Lender, or any Person to whom a Revolving Credit Lender assigns its rights and obligations under this Agreement as part of a programmed assignment and transfer of such Revolving Credit Lender's rights in and to a material portion of such Revolving Credit Lender's portfolio of asset based credit facilities.

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"Eligible Credit Card Receivables": Under four (4) Business Day accounts due on a non-recourse basis from major credit card processors (which, if due on account of a private label credit card program, are deemed in the reasonable discretion of the Agent to be eligible).

"Eligible Inventory": Eligible Retail Inventory and Eligible Wholesale Inventory.

"Eligible Retail Inventory": Such of the Borrowers' Retail Inventory, at such locations, and of such types, character, qualities and quantities, as the Agent in its reasonable discretion from time to time determines to be acceptable for borrowing, as to which Inventory, the Agent has a perfected security interest which is prior and superior to all security interests, claims, and Encumbrances (other than Permitted Encumbrances).

"Eligible Wholesale Inventory": Such of the Borrowers' Wholesale Inventory, at such locations, and of such types, character, qualities and quantities, as the Agent in its reasonable discretion from time to time determines to be acceptable for borrowing, as to which Inventory, the Agent has a perfected security interest which is prior and superior to all security interests, claims, and Encumbrances (other than Permitted Encumbrances).

“Eligible Third Party Receivables”: Accounts due to the Borrowers on a non-recourse basis from insurance companies and other Persons reasonably acceptable to the Agent as arise in the ordinary course of business including, without limitation, prescription receivables, which have been earned by performance, have been adjudicated and are deemed by the Agent in its reasonable discretion to be eligible for inclusion in the calculation of the Borrowing Base. Without limiting the foregoing, unless otherwise approved in writing by the Agent, none of the following shall be deemed to be Eligible Third Party Receivables:

(a)	Accounts that have been outstanding for more than ninety (90) days past billing date;
(b)	Accounts due from any insurance company to the extent that fifty percent (50%) or more of all Accounts from such insurance company are not Eligible Third Party Receivables under clause (a) above;
(c)	Accounts with respect to which no Borrower has good, valid and marketable title, free and clear of any Encumbrance (other than Encumbrances granted to the Agent);
(d)	Accounts that are not subject to a first priority security interest in favor of the Agent;
(e)	Accounts which are disputed, are with recourse, or with respect to which a claim, counterclaim, offset or chargeback has been asserted (to the extent of such claim, counterclaim, offset or chargeback);
(f)	The aggregate of all Accounts which are owed by any person employed by, or a salesperson of, any Borrower;
(g)	Accounts with credit balances which are more than 90 days past due;
(h)	Voided sales in an amount equal to such percentage of the aggregate amount of Accounts Receivable at such time as shall be in accordance with Borrowers’ historical performance;
(i)	Intercompany Accounts Receivable;
(j)	Finance Charges with respect to any Accounts Receivable;

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(k)	COD Accounts Receivable; or
(l)	Accounts which the Agent determines in its reasonable discretion to be uncertain of collection.

"Employee Benefit Plan": As defined in ERISA.

"Encumbrance": Each of the following:

(a)

A Collateral Interest or agreement to create or grant a Collateral Interest; the interest of a lessor under a Capital Lease; conditional sale or other title retention agreement; sale of accounts receivable or chattel paper; or other arrangement pursuant to which any Person is entitled to any preference or priority with respect to the property or assets of another Person or the income or profits of such other Person; each of the foregoing whether consensual or non-consensual and whether arising by way of agreement, operation of law, legal process or otherwise.

(b)

The filing of any financing statement under the UCC or comparable law of any jurisdiction.

"End Date": The date upon which all of the following conditions are met: (a) all payment Liabilities described in Section 18.2(a) have been paid in full; (b) all obligations of any Revolving Credit Lender to make loans and advances and to provide other financial accommodations to the Borrowers hereunder shall have been irrevocably terminated; and (c) those arrangements concerning L/C's, Bank Products, and Bank Product Obligations which are described in Section 18.2(b) have been made.

"Environmental Laws": All of the following:

(a)	Applicable Law which regulates or relates to, or imposes any standard of conduct or liability on account of or in respect to environmental protection matters, including, without limitation, Hazardous Materials, as are now or hereafter in effect.
(b)	The common law relating to damage to Persons or property from Hazardous Materials.

"Equipment": Includes, without limitation, "equipment" as defined in the UCC, and also all furniture, store fixtures, motor vehicles, rolling stock, machinery, office equipment, plant equipment, tools, dies, molds, and other goods, property, and assets which are used and/or were purchased for use in the operation or furtherance of a Borrowers' business, and any and all accessions or additions thereto, and substitutions therefor.

“Equity Proceeds”: Cash proceeds received by Lead Borrower as a result of the issuance and sale of common stock of the Lead Borrower, net of reasonable expenses related thereto incurred by Lead Borrower.

"ERISA": The Employee Retirement Income Security Act of 1974, as amended.

"ERISA Affiliate": Any Person which is under common control with a Borrower within the meaning of Section 4001 of ERISA or is part of a group which includes any Borrower and which would be treated as a single employer under Section 414 of the Internal Revenue Code of 1986, as amended.

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"Events of Default": Is defined in Article 10 - . An "Event of Default" shall be deemed to have occurred and to be continuing unless and until that Event of Default has been duly waived in accordance with this Agreement.

“Excess Availability”: As of any date of determination, the excess, if any, of (a) Availability over (b) the sum of (i) all then held checks (other than held checks drawn to pay accounts which are not more than thirty (30) days beyond stated credit terms); (ii) accounts payable which are more than sixty (60) days beyond credit terms (including any extended vendor credit terms, but specifically excluding extended term amounts, not to exceed $10 million at any time outstanding, owed to Borrowers' prime pharmaceutical vendor) then accorded the Borrowers other than by reason of bona fide dispute; and (iii) overdrafts.

"Exempt DDA": A depository account maintained by any Borrower, the only contents of which may be transfers from the Operating Account and actually used solely (i) for petty cash purposes; or (ii) for payroll.

“Existing Credit Facility”: That certain Second Amended and Restated Credit Agreement, dated as of December 9, 2004 by and among Familymeds, Inc., Valley Drug Company and Valley Drug Company South, the other parties signatory thereto and General Electric Capital Corporation, as agent.

“Fee Letter”: The Fee Letter dated the Closing Date between and among the Borrowers and Agent.

"Fiscal": When followed by "month" or "quarter", the relevant fiscal period based on the Borrowers' fiscal year and accounting conventions (e.g. reference to "Fiscal 2005" is to the fiscal month of the Borrowers’ fiscal year ending in 2005). When followed by reference to a specific year, the fiscal year which ends in a month of the year to which reference is being made (e.g. if the Borrowers' fiscal year ends in January 2005 reference to that year would be to the Borrowers' "Fiscal 2005").

“Fiscal Intermediary”: Any qualified insurance company or other financial institution that has entered into an ongoing relationship with any Governmental Authority to make payments to payees under Medicare, Medicaid or any other Federal, State or local public health care or medical assistance program pursuant to any of the Health Care Laws.

"Fixtures": Has the meaning given that term in the UCC.

"GAAP": Principles which are consistent with those promulgated or adopted by the Financial Accounting Standards Board and its predecessors (or successors) in effect and applicable to that accounting period in respect of which reference to GAAP is being made.

"General Intangibles": Includes, without limitation, "general intangibles" as defined in the UCC; and also all: rights to payment for credit extended; deposits; amounts due to any Borrower; credit memoranda in favor of any Borrower; warranty claims; tax refunds and abatements; insurance refunds and premium rebates; all means and vehicles of investment or hedging, including, without limitation, options, warrants, and futures contracts; records; customer lists; telephone numbers; goodwill; causes of action; judgments; payments under any settlement or other agreement; literary rights; rights to performance; royalties; license and/or franchise fees; rights of admission; licenses; franchises; license agreements, including all rights of any Borrower to enforce same; permits, certificates of convenience and necessity, and similar rights granted by any governmental authority; patents, patent applications, patents pending, and other intellectual property; internet addresses and domain names; developmental ideas and concepts; proprietary processes; blueprints, drawings, designs, diagrams, plans, reports, and charts; catalogs; manuals; technical data; computer software programs (including the source and object codes therefor), computer records, computer software, rights of access to computer record service bureaus, service bureau computer contracts, and computer data; tapes, disks, semi-conductors chips and printouts; trade secrets rights, copyrights, mask work rights and interests, and derivative works and interests; user, technical reference, and other manuals and materials; trade names, trademarks, service marks, and all goodwill relating thereto; applications for registration of the foregoing; and all other general intangible property of any Borrower in the nature of intellectual property; proposals; cost estimates, and reproductions on paper, or otherwise, of any and all concepts or ideas, and any matter related to, or connected with, the design, development, manufacture, sale, marketing, leasing, or use of any or all property produced, sold, or leased, by any Borrower or credit extended or services performed, by any Borrower, whether intended for an individual customer or the general business of any Borrower, or used or useful in connection with research by any Borrower.

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"Goods": Has the meaning given that term in the UCC, and also includes all things movable when a security interest therein attaches and also all computer programs embedded in goods and any supporting information provided in connection with a transaction relating to the program if (i) the program is associated with the goods in such manner that it customarily is considered part of the goods or (ii) by becoming the owner of the goods, a Person acquires a right to use the program in connection with the goods.

“Governmental Receivables Blocked Account Agreement”: The Blocked Account Agreement ( Government Healthcare Receivables) dated as of October 12, 2005, among the Agent, FamilyMeds, Inc. and BOA.

“Government Receivables Blocked Account”: Is defined in Section 7.5.

“Governmental Receivables Lockbox Account Agreement”: The Lockbox Account Agreement ( Government Healthcare Receivables) dated as of October 12, 2005, among the Agent, FamilyMeds, Inc. and BOA.

“Government Receivables Lockbox Account”: Is defined in Section 7.5.

"Gross Margin": With respect to the subject accounting period for which being calculated, the decimal equivalent of the following (determined in accordance with the retail method of accounting):

Sales (Minus) Cost of Goods Sold

Sales

"Hazardous Materials": Any (a) substance which is defined or regulated as a hazardous material in or under any Environmental Law and (b) oil in any physical state.

"Health Care Laws": All Federal, State and local laws, rules, regulations, interpretations, guidelines, ordinances and decrees primarily relating to patient healthcare, any health care provider, medical assistance and cost reimbursement program, as now or at any time hereafter in effect, including, but not limited to, the Social Security Act, the Social Security Amendments of 1972, the Medicare-Medicaid Anti-Fraud and Abuse Amendments of 1977, the Medicare and Medicaid Patient and Program Protection Act of 1987 and HIPAA.

"Health-Care-Insurance-Receivable": Has the meaning given that term in UCC and also refers to any interest in or claim under a policy of insurance which is a right to payment of a monetary obligation for healthcare goods or services provided.

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 "HIPAA": The Health Insurance Portability and Accountability Act of 1996, as the same now exists or may hereafter from time to time be amended, modified, recodified or supplemented, together with all rules and regulations thereunder.

“HIPAA Compliance Plan”: Is defined in Section 4.29.

“Inactive Companies”: Arrow Prescription Leasing Corp., Desktop Media Group, Discount RX, Inc., a Louisiana corporation, Discount RX, Inc., a Nevada corporation, DrugMax.com, Inc., Familymeds Holdings, Inc. and Vetmall.

"Indebtedness": All indebtedness and obligations of or assumed by any Person on account of or in respect to any of the following:

(a)	In respect of money borrowed (including any indebtedness which is non-recourse to the credit of such Person but which is secured by an Encumbrance on any asset of such Person) whether or not evidenced by a promissory note, bond, debenture or other written obligation to pay money.
(b)	In connection with any letter of credit or acceptance transaction (including, without limitation, the face amount of all letters of credit and acceptances issued for the account of such Person or reimbursement on account of which such Person would be obligated).
(c)	In connection with the sale or discount of accounts receivable or chattel paper of such Person.
(d)	On account of deposits or advances.
(e)	As lessee under Capital Leases.
(f)	In connection with any sale and leaseback transaction.

"Indebtedness" also includes:

(x)	Indebtedness of others secured by an Encumbrance on any asset of such Person, whether or not such Indebtedness is assumed by such Person.
(y)	Any guaranty, endorsement, suretyship or other undertaking pursuant to which that Person may be liable on account of any obligation of any third party.
(z)	The Indebtedness of a partnership or joint venture for which such Person is liable as a general partner or joint venturer.

"In Default": Any occurrence, circumstance, or state of facts with respect to a Borrower which (a) is an Event of Default; or (b) would become an Event of Default if any requisite notice were given and/or any requisite period of time were to run and such occurrence, circumstance, or state of facts were not absolutely cured within any applicable grace period.

"Indemnified Person": Is defined in Section 19.13.

"Instruments": Has the meaning given that term in the UCC.

"Interest Payment Date": With reference to:

(a)  Each LIBOR Loan: The last day of the Interest Period relating thereto; the Termination Date; and the End Date.

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(b)  Each Prime Margin Loan: The first day of each month; the Termination Date; and the End Date.

"Interest Period": The following:

(a)	With respect to each LIBOR Loan: Subject to Subsection (c), below, the period commencing on the date of the making or continuation of, or conversion to, the subject LIBOR Loan and ending one (1), two (2) or three (3) months thereafter, as the Lead Borrower may elect by notice (pursuant to Section 2.5) to the Agent.
(b)	With respect to each Prime Margin Loan: Subject to Subsection (c), below, the period commencing on the date of the making or continuation of or conversion to such Prime Margin Loan and ending on that date (i) as of which the subject Prime Margin Loan is converted to a LIBOR Loan, as the Lead Borrower may elect by notice (pursuant to Section 2.5) to the Agent, or (ii) on which the subject Prime Margin Loan is paid by the Borrowers.
(c)	The setting of Interest Periods is in all instances subject to the following:
(i)	Any Interest Period for a Prime Margin Loan which would otherwise end on a day which is not a Business Day shall be extended to the next succeeding Business Day.
(ii)	Any Interest Period for a LIBOR Loan which would otherwise end on a day that is not a Business Day shall be extended to the next succeeding Business Day, unless thatsucceeding Business Day is in the next calendar month, in which event such Interest Period shall end on the last Business Day of the month during which the Interest Period ends.
(iii)	Subject to Subsection (iv), below, any Interest Period applicable to a LIBOR Loan, which Interest Period begins on a day for which there is no numerically corresponding day in the calendar month during which such Interest Period ends, shall end on the last Business Day of the month during which that Interest Period ends.
(iv)	Any Interest Period which would otherwise end after the Termination Date shall end on the Termination Date.
(v)	The number of Interest Periods in effect at any one time is subject to Section 2.11(e).

"Inventory": Includes, without limitation, "inventory" as defined in the UCC and also all: (a) Goods which are leased by a Person as lessor; are held by a Person for sale or lease or to be furnished under a contract of service; are furnished by a Person under a contract of service; or consist of raw materials, work in process, or materials used or consumed in a business; (b) Goods of said description in transit; (c) Goods of said description which are returned, repossessed and rejected; (d) packaging, advertising, and shipping materials related to any of the foregoing; (e) all names, marks, and General Intangibles affixed or to be affixed or associated thereto; and (f) Documents and Documents of Title which represent any of the foregoing.

"Inventory Advance Rate": **

"Inventory Reserves": Such Reserves as may be established from time to time by the Agent in the Agent's reasonable discretion with respect to the determination of the saleability, at retail, of the Eligible Inventory or which reflect such other factors as affect the market value of the Eligible Inventory. Without limiting the generality of the foregoing, Inventory may include (but are not limited to) reserves based on the following:

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(a)	Obsolescence (based upon Inventory on hand beyond a given number of days).
(b)	Seasonality.
(c)	Shrinkage.
(d)	Imbalance.
(e)	Change in Inventory character.
(f)	Change in Inventory composition
(g)	Change in Inventory mix.
(h)	Markdowns (both permanent and point of sale)
(i)	Retail markons and markups inconsistent with prior period practice and performance; industry standards; current business plans; or advertising calendar and  plannedadvertising events.

"Investment Property": Has the meaning given that term in the UCC.

"Issuer": The issuer of any L/C.

"L/C": Any letter of credit, the issuance of which is procured by the Agent for the account of any Borrower and any acceptance made on account of such letter of credit.

"Lead Borrower": Defined in the Preamble.

"Lease": Any lease or other agreement, no matter how styled or structured, pursuant to which a Borrower is entitled to the use or occupancy of any space.

"Leasehold Interest": Any interest of a Borrower as lessee under any Lease.

"Lenders' Special Counsel": A single counsel, selected by the Majority Lenders following the occurrence of an Event of Default, to represent the interests of the Revolving Credit Lenders in connection with the enforcement, attempted enforcement, or preservation of any rights and remedies under this, or any other Loan Document, as well as in connection with any "workout", forbearance, or restructuring of the credit facility contemplated hereby.

"Letter-of-Credit Right": Has the meaning given that term in UCC and also refers to any right to payment or performance under an L/C, whether or not the beneficiary has demanded or is at the time entitled to demand payment or performance.

"Liabilities": Includes, without limitation, the following:

(a)	All and each of the following, whether now existing or hereafter arising under this Agreement or under any of the other Loan Documents:
(i)	Any and all direct and indirect liabilities, debts, and obligations of each Borrower to the Agent or any Revolving Credit Lender, each of every kind, nature, and description.

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(ii)	Each obligation to repay any loan, advance, indebtedness, note, obligation, overdraft, or amount now or hereafter owing by any Borrower to the Agent or any Revolving Credit Lender (including all future advances whether or not made pursuant to a commitment by the Agent or any Revolving Credit Lender), whether or not any of such are liquidated, unliquidated, primary, secondary, secured, unsecured, direct, indirect, absolute, contingent, or of any other type, nature, or description, or by reason of any cause of action which the Agent or any Revolving Credit Lender may hold against any Borrower.
(iii)	All notes and other obligations of each Borrower now or hereafter assigned to or held by the Agent or any Revolving Credit Lender, each of every kind, nature, and description.
(iv)	All interest, fees, and charges and other amounts which may be charged by the Agent or any Revolving Credit Lender to any Borrower and/or which may be due from any Borrower to the Agent or any Revolving Credit Lender from time to time.
(v)	All Bank Product Obligations.
(vi)	All costs and expenses incurred or paid by the Agent or any Revolving Credit Lender in respect of any agreement between any Borrower and the Agent or any Revolving Credit Lender or instrument furnished by any Borrower to the Agent or any Revolving Credit Lender (including, without limitation, Costs of Collection, attorneys' reasonable fees, and all court and litigation costs and expenses).
(vii)	Any and all covenants of each Borrower to or with the Agent or any Revolving Credit Lender and any and all obligations of each Borrower to act or to refrain from acting in accordance with any agreement between that Borrower and the Agent or any Revolving Credit Lender or instrument furnished by that Borrower to the Agent or any Revolving Credit Lender.
(viii)	Each of the foregoing as if each reference to the " the Agent or any Revolving Credit Lender" were to each Affiliate of the Agent.
(b)	Any and all direct or indirect liabilities, debts, and obligations of each Borrower to the Agent or any Affiliate of the Agent, each of every kind, nature, and description owing on account of any service or accommodation provided to, or for the account of any Borrower pursuant to this or any other Loan Document, including cash management services and the issuances of L/C's.

"LIBOR Business Day": Any day which is both a Business Day and a day on which the principal interbank market for LIBOR deposits in London in which Wells Fargo Bank, N. A. participates is open for dealings in United States Dollar deposits.

"LIBOR Loan": Any Revolving Credit Loan which bears interest at a LIBOR Rate.

"LIBOR Margin": The following applicable percentage, based upon the corresponding Average Excess Availability:

Level	LIBOR Margin	Average Excess Availability
I	**	Less than $3,000,000.00
II	**	Greater than or equal to $3,000,000.00 but less than $10,000,000.00
III	**	Greater than or equal to $10,000,000.00

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The Margin on the Closing Date shall be established at Level II and adjusted quarterly thereafter based upon the applicable Average Excess Availability.

"LIBOR Offer Rate": That rate of interest (rounded upwards, if necessary, to the next 1/100 of 1%) determined by the Agent to be the highest prevailing rate per annum at which deposits on U.S. Dollars are offered to Wells Fargo Bank, N. A., by first-class banks in the London interbank market in which Wells Fargo Bank, N. A. participates at or about 10:00 a.m. (Boston Time) two (2) LIBOR Business Days before the first day of the Interest Period for the subject LIBOR Loan, for a deposit approximately in the amount of the subject loan for a period of time approximately equal to such Interest Period.

"LIBOR Rate": That per annum rate which is the aggregate of the LIBOR Offer Rate plus the LIBOR Margin except that, in the event that the Agent determines that any Revolving Credit Lender may be subject to the Reserve Percentage, the "LIBOR Rate" shall mean, with respect to any LIBOR Loans then outstanding (from the date on which that Reserve Percentage first became applicable to such loans), and with respect to all LIBOR Loans thereafter made, an interest rate per annum equal the sum of (a) plus (b), where:

 (a) is the decimal equivalent of the following fraction:

LIBOR Offer Rate

1 minus Reserve Percentage

and

 (b) is the applicable LIBOR Margin.

"Liquidation": The exercise, by the Agent, of those rights accorded to the Agent under the Loan Documents as a creditor of the Borrowers following and on account of the occurrence of an Event of Default looking towards the realization on the Collateral. Derivations of the word "Liquidation" (such as "Liquidate") are used with like meaning in this Agreement.

"Loan Account": Is defined in Section 2.8.

"Loan Commitment": With respect to each Revolving Credit Lender, that respective Revolving Credit Lender's Revolving Credit Dollar Commitment.

"Loan Documents": This Agreement and each other instrument or document from time to time executed and/or delivered in connection with the arrangements contemplated hereby or in connection with any transaction with the Agent or any Affiliate of the Agent, including, without limitation, any transaction which arises out of any cash management, depository, investment, letter of credit, interest rate protection, or equipment leasing services provided by the Agent or any Affiliate of the Agent, including any Bank Product Agreements, as each may be amended from time to time.

"Lockbox": An arrangement to which the Borrower is a party, pursuant to which payments on account of the Borrower's Receivables Collateral are made to a post office box, access to which is limited to a bank which processes such payments and forwards the proceeds thereof in accordance with instructions provided by the Borrower.

"Majority Lenders": Means:

(a) If there are two (2) or fewer Revolving Credit Lenders who are not Delinquent Revolving Credit Lenders, all Revolving Credit Lenders who are not Delinquent Revolving Credit Lenders.

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(b) If there are three (3) or more Revolving Credit Lenders who are not Delinquent Revolving Credit Lenders, Revolving Credit Lenders (other than Delinquent Revolving Credit Lenders) holding more than 50% of the Revolving Credit Percentage Commitments (calculated without regard to any Revolving Credit Percentage Commitment of any Delinquent Revolving Credit Lender).

"Material Accounting Change": Any change in GAAP applicable to accounting periods subsequent to the Borrowers' fiscal year most recently completed prior to the execution of this Agreement, which change has a material effect on the Borrowers' Consolidated financial condition or operating results, as reflected on financial statements and reports prepared by or for the Borrowers, when compared with such condition or results as if such change had not taken place or where preparation of the Borrowers' statements and reports in compliance with such change results in the breach of a financial performance covenant imposed pursuant to Section 5.12 where such a breach would not have occurred if such change had not taken place or visa versa.

“Material Adverse Change”: Any event, fact, circumstance, change in, or effect, on the business of any Borrower or on the Borrowers, taken as a whole, which, individually or in the aggregate or on a cumulative basis with any other circumstance, changes in, or effects on, any Borrower, the Borrowers, taken as a whole, or the Collateral, constitutes any of the following:

(a) A material adverse change in the business, operations, results of operations, assets, liabilities, or condition (financial or otherwise) of any Borrower or on the Borrowers taken as a whole.

(b) The material impairment of any Borrower’s ability to perform its obligations under the Loan Documents or of the Agent’s ability to enforce the Liabilities or to realize on any of the Collateral.

(c) A material adverse effect on the value of the Collateral or the amount which the Agent is likely to receive (after giving consideration to delays in payment and costs of enforcement).

(d) A material impairment to the priority of the Agent’s Collateral Interests in the Collateral.

"Maturity Date": October 12, 2010.

“Medicaid”: The health care financial assistance program jointly financed and administered by the Federal and State governments under Title XIX of the Social Security Act.

“Medicaid Account”: Any Accounts of Borrowers arising pursuant to services rendered by Borrowers to eligible Medicaid beneficiaries to be paid by a Fiscal Intermediary or by the United States of America acting under the Medicaid program, any State or the District of Columbia acting pursuant to a health plan adopted pursuant to Title XIX of the Social Security Act or any other Governmental Authority under Medicaid.

“Medicare”: The health care financial assistance program under Title XVIII of the Social Security Act.

“Medicare Account”: Any Accounts of Borrowers arising pursuant to goods sold or services rendered by Borrowers to eligible Medicare beneficiaries to be paid by a Fiscal Intermediary or by the United States of America acting under the Medicare program or any other Governmental Authority under Medicare.

“Minimum Reserve”: (i) ** from the Closing Date to such date, if any, as one or more financial performance covenants shall be effective under Section 5.12, and (ii) ** from such date as one or more financial performance covenants shall be effective under Section 5.12 and at all times thereafter.

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"Nominee": A business entity (such as a corporation or limited partnership) formed by the Agent to own or manage any Post Foreclosure Asset.

“NRLV”: The net recovery value (liquidation value) of Inventory expressed as a percentage of the cost of such Inventory, as determined by the Agent in its discretion based upon the most recent Inventory appraisal available to the Agent conducted by an appraiser reasonably acceptable to the Agent.

"Operating Account": Is defined in Section 7.1.

"OverLoan": A loan, advance, or providing of credit support (such as the issuance of any L/C) to the extent that, immediately after its having been made, Availability is less than zero.

"Payment Intangible": As defined in the UCC and also any general intangible under which the Account Debtor's primary obligation is a monetary obligation.

“Permitted Acquisition”: An acquisition of the stock or assets of a Person engaged in substantially the same business as that in which a Borrower is engaged on the Closing Date, so long as all the following conditions shall be met to the Agent’s satisfaction

(a)	No Event of Default shall have occurred and be continuing prior to and after giving effect to any such acquisition,
(b)	The Lead Borrower provides the Agent with sufficient prior notice and information regarding such acquisition that Agent is able to (i) perfect a security interest in all acquired assets and/or (ii) enter into such subordination or intercreditor agreement as Agent deems necessary in its reasonable discretion,
(c)	Lead Borrower provides Agent with written evidence satisfactory to the Agent that Lead Borrower projects, on a good faith, pro-forma basis, Excess Availability of at least $11,500,000 (including in the calculation, for these purposes, the then applicable Minimum Reserve) for the next thirty (30) days, such pro-forma forecast to be acceptable to the Agent in its reasonable discretion,
(d)	The Acquisition is made solely with (i) cash-on-hand, (ii) Equity Proceeds or (iii) Revolving Credit Loans; and
(e)	The total amount spent by Borrowers on acquisitions in any fiscal year, including the proposed acquisition, does not exceed $30,000,000.00.

“Permitted Dispositions”: The following:

(a)	Sales or other dispositions of Inventory to buyers in the ordinary course of business, including, without limitation, ordinary course retail sales from time to time.
(b)	The sale of Valley Drug Company South in accordance with Section 4.32.
(c)	Sales or other dispositions of obsolete or worn-out equipment in the ordinary course of business.
(d)	Sales or other dispositions of other property or assets for cash in an aggregate amount not less than the fair market value of such property or assets,

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provided that the amount of dispositions in the case of clauses (c) and (d) shall not exceed $1,000,000.00 in the aggregate in any fiscal year.

"Permitted Encumbrances": The following:

(a)	Encumbrances in favor of the Agent.
(b)	Those Encumbrances (if any) listed on EXHIBIT 4.6, annexed hereto.
(c)	Liens arising under Capitalized Leases or securing purchase money Indebtedness permitted under the definition of Permitted Indebtedness; provided, however, that (i) no such Lien shall extend to or cover any other property of any Borrower, and (ii) the principal amount of the Indebtedness secured by any such Lien shall not exceed the lesser of 80% of the fair market value or the cost of the property so held or acquired.
(d)	Liens securing real property purchased in a Permitted Acquisition to the extent permitted under (i) Section 4.7(d) or (ii) clause (d) of the definition “Permitted Indebtedness”.
(e)	Liens for taxes, assessments or other governmental charges not yet due and payable.
(f)	Pledges or deposits made in the ordinary course of business in compliance with obligations under workers compensation, unemployment compensation or similar laws.
(g)	Inchoate or unperfected mechanics liens arising in the normal course of business and securing obligations that are not overdue by more than thirty (30) days
(h)	Landlord liens arising by operation of law in the ordinary course of business in respect of rent not in default.

"Permitted Indebtedness": The following:

(a)	Any Indebtedness on account of the Revolving Credit.
(b)	The Indebtedness (if any) listed on EXHIBIT 4.7, annexed hereto.
(c)	purchase money Indebtedness incurred to enable a Borrower to acquire Equipment in the ordinary course of its business, which Indebtedness, when aggregated with the principal amount of all Indebtedness incurred under this clause (c), does not exceed $2,000,000.00 at any time outstanding; and
(d)	Indebtedness incurred to enable a Borrower to acquire real property in the ordinary course of its business, which Indebtedness, when aggregated with the principal amount of all Indebtedness incurred under this clause (d), does not exceed $2,000,000.00 in the aggregate during the term of this Agreement.

"Permitted Investments": The following, in each instance only if subject to a prior perfected security interest in favor of the Agent to secure the Liabilities:

(a)	Indebtedness entitled to the full faith and credit of the United States.
(b)	Indebtedness which has at least the second highest rating of nationally recognized rating agency.

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"Person": Any natural person, and any corporation, limited liability company, trust, partnership, joint venture, or other enterprise or entity.

“Pharmaceutical Laws”: Federal, state and local laws, rules or regulations, codes, orders, decrees, judgments or injunctions issued, promulgated, approved or entered, relating to dispensing, storing or distributing prescription medicines or products, including laws, rules or regulations relating to the qualifications of Persons employed to do the same.

"Post Foreclosure Asset": All or any part of the Collateral, ownership of which is acquired by the Agent or a Nominee on account of the "bidding in" at a disposition as part of a Liquidation or by reason of a "deed in lieu" type of transaction.

“Prescription Files” shall mean all of Borrowers’ now owned or hereafter existing or acquired retail customer files, including prescriptions for retail customers and other medical information related thereto.

“Prescription Files Advance Rate”: Eighty-five percent (85%).

“Prescription Files Reserves”: Such Reserves as may be established from time to time by the Agent in the Agent’s discretion with respect to the determination of the saleability of the Prescription Files.

"Prime": The Prime Rate announced from time to time by Wells Fargo Bank, N. A. (or any successor in interest to Wells Fargo Bank, N. A.). In the event that said bank (or any such successor) ceases to announce such a rate, "Prime" shall refer to that rate or index announced or published from time to time as the Agent, in good faith, designates as the functional equivalent to said Prime Rate. Any change in "Prime" shall be effective, for purposes of the calculation of interest due hereunder, when such change is made effective generally by the bank on whose rate or index "Prime" is being set.

"Prime Margin Loan": Each Revolving Credit Loan while bearing interest at the Prime Margin Rate.

"Prime Margin Rate": The aggregate of Prime plus the following applicable percentage, based upon the corresponding Average Excess Availability:

Level	Prime Margin	Average Excess Availability
I	**	Less than $3,000,000.00
II	**	Greater than or equal to $3,000,000.00 but less than $10,000,000.00
III	**	Greater than or equal to $10,000,000.00

The Margin on the Closing Dateshall be established at Level II and adjusted quarterly thereafter based upon the applicable Average Excess Availability.

"Protective OverAdvances": Revolving Credit Loans which are OverLoans, but as to which each of the following conditions is satisfied: (a) the Revolving Credit Ceiling is not exceeded; and (b) when aggregated with all other Protective OverAdvances, such Revolving Credit Loans do not aggregate more than ten percent (10%) of the Borrowing Base; and (c) such Revolving Credit Loans are made or undertaken in the Agent's discretion to protect and preserve the interests of the Revolving Credit Lenders.

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"Proceeds": Includes, without limitation, "Proceeds" as defined in the UCC and each type of property described in Section 8.1.

"Receipts": All cash, cash equivalents, money, checks, credit card slips, receipts and other Proceeds from any sale of the Collateral.

"Receivables Collateral": That portion of the Collateral which consists of Accounts, Accounts Receivable, General Intangibles, Chattel Paper, Instruments, Documents of Title, Documents, Investment Property, Payment Intangibles, Letter-of-Credit Rights, Health-Care-Insurance-Receivables, bankers' acceptances, and all other rights to payment.

“Receivables Reserves”: Such Reserves as may be established from time to time by the Agent in the Agent’s reasonable discretion with respect to the determination of the collectibility in the ordinary course and of the creditworthiness of the relevant Account Debtor.

"Register": Is defined in Section 16.2(c).

"Requirements of Law": As to any Person:

(a)	Applicable Law.
(b)	That Person's organizational documents.
(c)	That Person's by-laws and/or other instruments which deal with corporate or similar governance, as applicable.

"Reserve Percentage": The decimal equivalent of that rate applicable to a Revolving Credit Lender under regulations issued from time to time by the Board of Governors of the Federal Reserve System for determining the maximum reserve requirement of that Revolving Credit Lender with respect to "Eurocurrency liabilities" as defined in such regulations. The Reserve Percentage applicable to a particular Eurodollar Loan shall be based upon that in effect during the subject Interest Period, with changes in the Reserve Percentage which take effect during such Interest Period to take effect (and to consequently change any interest rate determined with reference to the Reserve Percentage) if and when such change is applicable to such loans.

Reserves: Availability Reserves, Inventory Reserves, Prescription Files Reserves, and Receivables Reserves as established by the Agent from time to time in accordance with this Agreement.

"Retail Inventory": Inventory (without duplication of Wholesale Inventory) that the Borrowers purchase, otherwise acquire or hold for direct sale to retail customers from any of the Borrowers’ retail store locations.

"Revolving Credit": Is defined in Section 2.1.

"Revolving Credit Ceiling": $65,000,000.00, as such amount may be reduced in accordance with Section 2.23(f).

"Revolving Credit Dollar Commitment": As set forth on EXHIBIT 2.22, annexed hereto (as such amounts may change in accordance with the provisions of this Agreement).

"Revolving Credit Early Termination Fee": Is defined in Section 2.14.

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"Revolving Credit Lenders": Each Revolving Credit Lender to which reference is made in the Preamble of this Agreement and any other Person who becomes a "Revolving Credit Lender" in accordance with the provisions of to this Agreement.

"Revolving Credit Loans": Loans made under the Revolving Credit, except that where the term "Revolving Credit Loan" is used with reference to available interest rates applicable to the loans under the Revolving Credit, it refers to so much of the unpaid principal balance of the Loan Account as bears the same rate of interest for the same Interest Period. (See Section 2.11(d)).

"Revolving Credit Note": Is defined in Section 2.9.

"Revolving Credit Percentage Commitment": As set forth on EXHIBIT 2.22, annexed hereto (as such amounts may change in accordance with the provisions of this Agreement).

"Stated Amount": The maximum amount for which an L/C may be honored.

"SuperMajority Lenders": Revolving Credit Lenders (other than Delinquent Revolving Credit Lenders) holding 66-2/3% or more the Revolving Credit Percentage Commitments (calculated without regard to any Revolving Credit Percentage Commitment of any Delinquent Revolving Credit Lender).

"Supporting Obligation": Has the meaning given that term in the UCC and also refers to a Letter-of-Credit Right or secondary obligation which supports the payment or performance of an Account, Chattel Paper, a Document, a General Intangible, an Instrument, or Investment Property.

"Termination Date": The earliest of: (a) the Maturity Date; (b) the occurrence of any event described in Section 10.11; (c) the Agent's notice to the Lead Borrower setting the Termination Date on account of the occurrence of any Event of Default other than as described in Section 10.11; or (d) that date, ninety (90) days irrevocable written notice of which is provided by the Lead Borrower to the Agent.

“Third Party Payor”: Means any Person, such as a Fiscal Intermediary, Blue Cross/Blue Shield, or private health insurance company, which is obligated to reimburse or otherwise make payments to health care providers who provide medical care or medical assistance or other goods or services for eligible patients under Medicare, Medicaid or any private insurance contract.

“Third Party Receivables Advance Rate”: **

"Transfer": Wire transfer pursuant to the wire transfer system maintained by the Board of Governors of the Federal Reserve Board, or as otherwise may be agreed to from time to time by the Agent making such Transfer and the subject Revolving Credit Lender. Wire instructions may be changed in the same manner that Notice Addresses may be changed (Section 17.1), except that no change of the wire instructions for Transfers to any Revolving Credit Lender shall be effective without the consent of the Agent.

"UCC": The Uniform Commercial Code as in effect from time to time in Massachusetts.

"Unanimous Consent" Consent of Revolving Credit Lenders (other than Delinquent Revolving Credit Lenders) holding 100% of the Loan Commitments (other than Loan Commitments held by a Delinquent Revolving Credit Lender).

"Unused Line Fee": Is defined in Section 2.13.

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“Valley Drug Company”: Valley Drug Company, an Ohio company.

"Wholesale Inventory": Inventory (without duplication of Retail Inventory) which Borrowers purchase or otherwise acquire for sale to merchants, distributors or other non-retail customers.

Article 2 - The Revolving Credit:

2.1. Establishment of Revolving Credit.

(a)The Revolving Credit Lenders hereby establish a revolving line of credit (the "Revolving Credit") in the Borrowers' favor pursuant to which each Revolving Credit Lender, subject to, and in accordance with, this Agreement, acting through the Agent, shall make loans and advances and otherwise provide financial accommodations t for the account of the Borrowers as provided herein.

(b)Loans, advances and, and financial accommodations under the Revolving Credit shall be made with reference to the Borrowing Base and shall be subject to Availability. The Borrowing Base and Availability shall be determined by the Agent by reference to Borrowing Base Certificates furnished as provided in Section 5.4 and shall be subject to the following:

(i)Such determination shall take into account such Reserves as the Agent may determine as being applicable thereto.

(ii)The Cost of Eligible Inventory will be determined in a manner consistent with current tracking practices, based on the Borrowers' stock ledger inventory.

(c)The commitment of each Revolving Credit Lender to provide such loans, advances, and financial accommodations is subject to Section 2.23.

(d)The proceeds of borrowings under the Revolving Credit shall be used (i) to repay the Existing Credit Facility, (ii) solely in accordance with the Business Plan, for the Borrowers' working capital and Capital Expenditures and (iii) for Permitted Acquisitions, all solely to the extent permitted by this Agreement. No proceeds of a borrowing under the Revolving Credit may be used, nor shall any be requested, with a view towards the accumulation of any general fund or funded reserve of the Borrowers other than in the ordinary course of the Borrowers' business and consistent with the provisions of this Agreement.

2.2.Advances in Excess of Borrowing Base (OverLoans).

(a)No Revolving Credit Lender has any obligation to the Borrowers to make any loan or advance, or otherwise to provide any credit to or for the benefit of the Borrowers where the result of such loan, advance, or credit is an OverLoan.

(b)The Revolving Credit Lenders' obligations, among themselves, are subject to (among other provisions of this Agreement) Section 12.2(a) (which relates to each Revolving Credit Lender's making amounts available to the Agent) and 15.3(a) (which relates to Protective OverAdvances).

(c)The Revolving Credit Lenders' providing of an OverLoan on any one occasion does not affect the obligations of each Borrower hereunder (including each Borrower's obligation to immediately repay any amount which otherwise constitutes an OverLoan) nor obligate the Revolving Credit Lenders to do so on any other occasion.

2.3.Risks of Value of Collateral. The Agent's reference to a given asset in connection with the making of loans, credits, and advances and the providing of financial accommodations under the Revolving Credit and/or the monitoring of compliance with the provisions hereof shall not be deemed a determination by the Agent or any Revolving Credit Lender relative to the actual value of the asset in question. All risks concerning the value of the Collateral are and remain upon the Borrowers. All Collateral secures the prompt, punctual, and faithful performance of the Liabilities whether or not relied upon by the Agent in connection with the making of loans, credits, and advances and the providing of financial accommodations under the Revolving Credit.

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2.4.Commitment to Make Revolving Credit Loans and Support Letters of Credit. Subject to the provisions of this Agreement, the Revolving Credit Lenders shall make a loan or advance under the Revolving Credit and the Agent shall endeavor to have an L/C issued for the account of the Lead Borrower, in each instance if duly and timely requested by the Lead Borrower as provided herein provided that:

(a)No OverLoan is then outstanding and none will result therefrom.

(b)No Borrower is then In Default and none will thereby become In Default.

2.5.Revolving Credit Loan Requests.

(a)Requests for loans and advances under the Revolving Credit or for the continuance or conversion of an interest rate applicable to a Revolving Credit Loan may be requested by the Lead Borrower in such manner as may from time to time be acceptable to the Agent.

(b)Subject to the provisions of this Agreement, the Lead Borrower may request a Revolving Credit Loan and elect an interest rate and Interest Period to be applicable to that Revolving Credit Loan by giving notice to the Agent by no later than the following:

(i)If such Revolving Credit Loan is to be or is to be converted to a Prime Margin Loan: By 11:30 a.m. on the Business Day on which the subject Revolving Credit Loan is to be made or is to be so converted. Prime Margin Loans requested by the Lead Borrower, other than those resulting from the conversion of a LIBOR Loan, shall not be less than $10,000.00.

(ii)If such Revolving Credit Loan is to be, or is to be continued as, or converted to, a LIBOR Loan: By 1:00 p.m. three (3) LIBOR Business Days before the commencement of any new Interest Period or the end of the then applicable Interest Period. LIBOR Loans and conversions to LIBOR Loans shall each be not less than $1,000,000.00 and in increments of $500,000.00 in excess of such minimum.

(iii)Any LIBOR Loan which matures while any Borrower is In Default shall be converted, at the option of the Agent, to a Prime Margin Loan notwithstanding any notice from the Lead Borrower that such Loan is to be continued as a LIBOR Loan.

(c)Any request for a Revolving Credit Loan or for the continuance or conversion of an interest rate applicable to a Revolving Credit Loan which is made after the applicable deadline therefor, as set forth above, shall be deemed to have been made at the opening of business on the then next Business Day or LIBOR Business Day, as applicable.

(d)The Lead Borrower may request that the Agent cause the issuance by the Issuer of L/C's for the account of the Borrowers as provided in Section 2.18.

(e)The Agent may rely on any request for a loan or advance, or other financial accommodation under the Revolving Credit which the Agent, in good faith, believes to have been made by a Person duly authorized to act on behalf of the Lead Borrower and may decline to make any such requested loan or advance, or issuance, or to provide any such financial accommodation pending the Agent's being furnished with such documentation concerning that Person's authority to act as may be satisfactory to the Agent.

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(f)A request by the Lead Borrower for loan or advance, or other financial accommodation under the Revolving Credit shall be irrevocable and shall constitute certification by each Borrower that as of the date of such request, each of the following is true and correct:

(i)There has been no Material Adverse Change.

(ii)All or a portion of any loan or advance so requested will be set aside by the Borrowers to cover the Borrowers' obligations for sales tax on account of sales since the then most recent borrowing pursuant to the Revolving Credit.

(iii)Each representation which is made herein or in any of the Loan Documents is then true and complete in all material respects as of and as if made on the date of such request.

(iv)Unless accompanied by a written Certificate of the Lead Borrower's President or its Chief Financial Officer describing (in reasonable detail) the facts and circumstances thereof and the steps (if any) being taken to remedy such condition, that no Borrower is or if a Borrower is In Default.

2.6.Suspension of Revolving Credit. If, at any time or from time to time, the Borrowers are In Default or there has occurred a Material Adverse Change:

(a)The Agent may suspend the Revolving Credit immediately, in which event, the Revolving Credit Lenders shall not be obligated, during such suspension, to make any loans or advance, or to provide any financial accommodation hereunder or to seek the issuance of any L/C.

(b)The Agent may suspend the right of the Lead Borrower to request any LIBOR Loan or to convert any Prime Margin Loan to a LIBOR Loan.

2.7.Making of Revolving Credit Loans.

(a)A loan or advance under the Revolving Credit shall be made by the transfer of the proceeds of such loan or advance to the Operating Account or as otherwise instructed by the Lead Borrower.

(b)A loan or advance shall be deemed to have been made under the Revolving Credit (and the Borrowers shall be indebted to the Agent and the Revolving Credit Lenders for the amount thereof immediately) at the following:

(i)The Agent's initiation of the transfer of the proceeds of such loan or advance in accordance with the Lead Borrower's instructions (if such loan or advance is of funds requested by the Lead Borrower).

(ii)The charging of the amount of such loan to the Loan Account (in all other circumstances).

(c)There shall not be any recourse to or liability of the Agent or any Revolving Credit Lender, on account of:

(i)Any delay in the making of any loan or advance requested under the Revolving Credit.

(ii)Any delay by any bank or other depository institution in treating the proceeds of any such loan or advance as collected funds.

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(iii)Any delay in the receipt, and/or any loss, of funds which constitute a loan or advance under the Revolving Credit, the wire transfer of which was properly initiated by the Agent in accordance with wire instructions provided to the Agent by the Lead Borrower.

2.8.The Loan Account.

(a)An account ("Loan Account") shall be opened on the books of the Agent in which a record shall be kept of all loans and advances made under the Revolving Credit.

(b)The Agent shall also keep a record (either in the Loan Account or elsewhere, as the Agent may from time to time elect) of all interest, fees, service charges, costs, expenses, and other debits owed to the Agent and each Revolving Credit Lender on account of the Liabilities and of all credits against such amounts so owed.

(c)All credits against the Liabilities shall be conditional upon final payment to the Agent for the account of each Revolving Credit Lender of the items giving rise to such credits. The amount of any item credited against the Liabilities which is charged back against the Agent or any Revolving Credit Lender or is disgorged for any reason or is not so paid shall be a Liability and shall be added to the Loan Account, whether or not the item so charged back or not so paid is returned.

(d)Except as otherwise provided herein, all fees, service charges, costs, and expenses for which any Borrower is obligated hereunder are payable on demand. In the determination of Availability, the Agent may deem fees, service charges, accrued interest, and other payments which will be due and payable between the date of such determination and the first day of the then next succeeding month as having been advanced under the Revolving Credit whether or not such amounts are then due and payable.

(e)The Agent, without the request of the Lead Borrower, may advance under the Revolving Credit any interest, fee, service charge, or other payment to which the Agent or any Revolving Credit Lender is entitled from any Borrower pursuant hereto and may charge the same to the Loan Account notwithstanding that an OverLoan may result thereby. Such action on the part of the Agent shall not constitute a waiver of the Agent's rights and each Borrower's obligations under Section 2.10(b). Any amount which is added to the principal balance of the Loan Account as provided in this Section 2.8(e) shall bear interest at the interest rate then and thereafter applicable to Prime Margin Loans.

(f)Any statement rendered by the Agent or any Revolving Credit Lender to the Lead Borrower concerning the Liabilities shall be considered correct and accepted by each Borrower and shall be conclusively binding upon each Borrower unless the Lead Borrower provides the Agent with written objection thereto within twenty (20) days from the mailing of such statement, which written objection shall indicate, with particularity, the reason for such objection. The Loan Account and the Agent's books and records concerning the loan arrangement contemplated herein and the Liabilities shall be prima facie evidence and proof of the items described therein.

2.9.The Revolving Credit Notes. The Borrowers' obligation to repay loans and advances under the Revolving Credit, with interest as provided herein, shall be evidenced by Notes (each, a "Revolving Credit Note") in the form of EXHIBIT 2.9, annexed hereto, executed by each Borrower, one payable to each Revolving Credit Lender. Neither the original nor a copy of any Revolving Credit Note shall be required, however, to establish or prove any Liability. In the event that any Revolving Credit Note is ever lost, mutilated, or destroyed, each Borrower shall execute a replacement thereof and deliver such replacement to the Agent.

2.10.Payment of The Loan Account.

(a)The Borrowers may repay all or any portion of the principal balance of the Loan Account from time to time until the Termination Date.

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(b)The Borrowers, without notice or demand from the Agent or any Revolving Credit Lender, shall pay the Agent that amount, from time to time, which is necessary so that there is no OverLoan outstanding.

(c)The Borrowers shall repay the then entire unpaid balance of the Loan Account and all other Liabilities on the Termination Date.

(d)The Agent shall endeavor to cause the application of payments (if any), pursuant to Sections 2.11(a)and 2.11(b) against LIBOR Loans then outstanding in such manner as results in the least cost to the Borrowers, but shall not have any affirmative obligation to do so nor liability on account of the Agent's failure to have done so. In no event shall action or inaction taken by the Agent excuse any Borrower from any indemnification obligation under Section 2.10(e).

(e)The Borrowers shall indemnify the Agent and each Revolving Credit Lender and hold the Agent and each Revolving Credit Lender harmless from and against any loss, cost or expense (including loss of anticipated profits and amounts payable by the Agent or such Revolving Credit Lender on account of "breakage fees" (so-called)) which the Agent or such Revolving Credit Lender may sustain or incur (including, without limitation, by virtue of acceleration after the occurrence of any Event of Default) as a consequence of the following:

(i)Default by any Borrower in payment of the principal amount of or any interest on any LIBOR Loan as and when due and payable, including any such loss or expense arising from interest or fees payable by such Revolving Credit Lender in order to maintain its LIBOR Loans.

(ii)Default by any Borrower in making a borrowing or conversion after the Lead Borrower has given (or is deemed to have given) a request for a Revolving Credit Loan or a request to convert a Revolving Credit Loan from one applicable interest rate to another.

(iii)The making of any payment on a LIBOR Loan or the making of any conversion of any such Loan to a Prime Margin Loan on a day that is not the last day of the applicable Interest Period with respect thereto.

2.11.Interest on Revolving Credit Loans.

(a)Each Revolving Credit Loan shall bear interest at the Prime Margin Rate unless timely notice is given (as provided in Section 2.5) that the subject Revolving Credit Loan (or a portion thereof) is, or is to be converted to, a LIBOR Loan.

(b)Each Revolving Credit Loan which consists of a LIBOR Loan shall bear interest at the applicable LIBOR Rate.

(c)Subject to, and in accordance with, the provisions of this Agreement, the Lead Borrower may cause all or a part of the unpaid principal balance of the Loan Account to bear interest at the Prime Margin Rate or the LIBOR Rate as specified from time to time by the Lead Borrower by notice to the Agent.

(d)For ease of reference and administration, each part of the Loan Account which bears interest at the same rate interest and for the same Interest Period is referred to herein as if it were a separate "Revolving Credit Loan".

(e)The Lead Borrower shall not select, renew, or convert any interest rate for a Revolving Credit Loan such that, in addition to interest at the Prime Margin Rate, there are more than four (4) LIBOR Rates applicable to the Revolving Credit Loans at any one time.

(f)The Borrowers shall pay accrued and unpaid interest on each Revolving Credit Loan in arrears as follows:

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(i)On the applicable Interest Payment Date for that Revolving Credit Loan.

(ii)On the Termination Date and on the End Date.

(iii)Following the occurrence of any Event of Default, with such frequency as may be determined by the Agent.

(g)Following the occurrence of any Event of Default (and whether or not the Agent exercises the Agent's rights on account thereof), all Revolving Credit Loans shall bear interest, at the option of the Agent or at the instruction of the SuperMajority Lenders at rate which is the aggregate of the rate applicable to Prime Margin Loans plus Two Percent (2%) per annum.

2.12.Intentionally Omitted.

2.13.Unused Line Fee. In addition to any other fee to be paid by the Borrowers on account of the Revolving Credit, the Borrowers shall pay the Agent the "Unused Line Fee" (so referred to herein) of 0.25% per annum of the average difference, during the month just ended (or relevant period with respect to the payment being made on the Termination Date) between the Revolving Credit Ceiling and the aggregate of the unpaid principal balance of the Loan Account and the undrawn Stated Amount of L/C's outstanding during the relevant period. The Unused Line Fee shall be paid in arrears, on the first day of each month after the execution of this Agreement and on the Termination Date.

2.14.Revolving Credit Early Termination Fee. In the event that the Termination Date occurs prior to the third anniversary of the Closing Date, for any reason, the Borrowers shall pay to the Agent, for the benefit of the Revolving Credit Lenders, the "Revolving Credit Early Termination Fee" (so referred to herein) in the amount of $650,000.00. All parties to this Agreement agree and acknowledge that the Revolving Credit Lenders will have suffered damages on account of the early termination of the Revolving Credit and that, in view of the difficulty in ascertaining the amount of such damages, that the Revolving Credit Early Termination Fee constitutes reasonable compensation and liquidated damages to compensate Revolving Credit Lenders on account thereof.

2.15.Intentionally Omitted.

2.16.Concerning Fees. The Borrowers shall not be entitled to any credit, rebate or repayment of any fee earned by the Agent or any Revolving Credit Lender pursuant to this Agreement or any Loan Document notwithstanding any termination of this Agreement or suspension or termination of the Agent's and any Revolving Credit Lender's respective obligation to make loans and advances hereunder.

2.17.Agent's and Revolving Credit Lenders' Discretion.

(a)Each reference in the Loan Documents to the exercise of discretion or the like by the Agent or any Revolving Credit Lender shall be to such Person's exercise of its judgment, in good faith (which shall be presumed), based upon such information of which that Person then has actual knowledge.

(b)In the exercise of such discretion, the following may be taken into account.

(i)The reasonable anticipation: of an adverse change to the value of the Collateral; the enforceability of the Agent's Collateral Interests therein; or the amount which the Agent would likely realize therefrom (taking into account delays which may possibly be encountered in the Agent's realizing upon the Collateral and likely Costs of Collection).

(ii)The content, completeness, and accuracy of any report or financial information delivered to the Agent or any Revolving Credit Lender by or on behalf of any Borrower and the manner by such report or financial information was prepared.

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(iii)The existence of circumstances which suggest an increase in the likelihood that any Borrower may become the subject of a bankruptcy or insolvency proceeding.

(iv)The existence of circumstances which suggest that any Borrower is In Default.

(c)In the exercise of such discretion, the Agent and each Revolving Credit Lender also may take into account any of the following factors:

(i)Those included in, or tested by, the definitions of Eligible Inventory”, “Eligible Credit Card Receivables”, “Eligible Third Party Receivables” and “Cost”.

(ii)The current financial and business climate of the industry in which each Borrower competes (having regard for that Borrower's position in that industry).

(iii)General macroeconomic conditions which have a material effect on the Borrowers' cost structure.

(iv)Material changes in or to the mix of the Borrowers' Inventory.

(v)Seasonality with respect to the Borrowers' Inventory and patterns of retail sales.

(vi)Such other factors as the Agent and each Revolving Credit Lender reasonably determine as having a material bearing on credit risks associated with the providing of loans and financial accommodations to the Borrowers.

(d)The burden of establishing the failure of the Agent or any Revolving Credit Lender to have acted in a reasonable manner in such Person's exercise of such discretion shall be the Borrowers' and may be made only by clear and convincing evidence.

2.18.Procedures For Issuance of L/C's.

(a)The Lead Borrower may request that the Agent cause the issuance by the Issuer of L/C's for the account of any Borrower. Each such request shall be in such manner as may from time to time be acceptable to the Agent.

(b)The Agent will endeavor to cause the issuance of any L/C so requested by the Lead Borrower, provided that , at the time that the request is made, the Revolving Credit has not been suspended as provided in Section 2.6 and if so issued:

(i)The aggregate Stated Amount of all L/C's then outstanding, does not exceed $10,000,000.00.

(ii)The expiry of the L/C is not later than the earlier of Thirty (30) days prior to the Maturity Date or the following:

(A)Standby's: One (1) year from initial issuance.

(B)Documentary's: Sixty (60) days from issuance.

(iii)If the expiry of an L/C is later than the Maturity Date, it is 103% cash collateralized at its issuance.

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(iv)An OverLoan will not result from the issuance of the subject L/C.

(c)Each Borrower shall execute such documentation to apply for and support the issuance of an L/C as may be required by the Issuer.

(d)There shall not be any recourse to, nor liability of, the Agent or any Revolving Credit Lender on account of

(i)Any delay or refusal by an Issuer to issue an L/C;

(ii)Any action or inaction of an Issuer on account of or in respect to, any L/C.

(e)The Borrowers shall reimburse the Issuer for the amount of any honoring of a drawing under an L/C on the same day on which such honoring takes place. The Agent, without the request of any Borrower, may advance under the Revolving Credit (and charge to the Loan Account) the amount of any honoring of any L/C and other amount for which any Borrower, the Issuer, or the Revolving Credit Lenders become obligated on account of, or in respect to, any L/C. Such advance shall be made whether or not any Borrower is In Default or such advance would result in an OverLoan. Such action shall not constitute a waiver of the Agent's rights under Section 2.11(b).

2.19.Fees For L/C's.

(a)The Borrowers shall pay to the Agent a fee, on account of L/C's, the issuance of which had been procured by the Agent, monthly in arrears, and on the Termination Date and on the End Date, equal to the following percentage per annum of the weighted average Stated Amount of all L/C's outstanding during the period in respect of which such fee is being paid based upon the corresponding amount of Average Excess Availability, except that, following the occurrence and during the continuance of any Event of Default, such fee shall be increased by two percent (2%) per annum.

Level	Standby Fee	Documentary Fee	Average Excess Availability
I	**	**	less than $ 3,000,000.00
II	**	**	greater than or equal to $3,000,000.00 but less than $10,00,000.00
III	**	**	greater than or equal to $10,000,000.00

The Standby Fee and the Documentary Fee on the Closing Dateshall be established at Level II and adjusted at the end of each fiscal quarter thereafter based upon the applicable Average Excess Availability.

(b)In addition to the fee to be paid as provided in Subsection 2.19(a), the Borrowers shall pay to the Agent (or to the Issuer, if so requested by Agent), on demand, all issuance, processing, negotiation, amendment, and administrative fees and other amounts charged by the Issuer on account of, or in respect to, any L/C.

(c)If any change in Applicable Law shall either:

(i)impose, modify or deem applicable any reserve, special deposit or similar requirements against letters of credit heretofore or hereafter issued by any Issuer or with respect to which any Revolving Credit Lender or any Issuer has an obligation to lend to fund drawings under any L/C; or

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(ii)impose on any Issuer any other condition or requirements relating to any such letters of credit;

and the result of any event referred to in Section 2.19(c)(i) or 2.19(c)(ii), shall be to increase the cost to any Revolving Credit Lender or to any Issuer of issuing or maintaining any L/C (which increase in cost shall be the result of such Issuer's reasonable allocation among that Revolving Credit Lender's or Issuer's letter of credit customers of the aggregate of such cost increases resulting from such events), then, upon demand by the Agent and delivery by the Agent to the Lead Borrower of a certificate of an officer of the subject Revolving Credit Lender or the subject Issuer describing such change in law, executive order, regulation, directive, or interpretation thereof, its effect on such Revolving Credit Lender or such Issuer, and the basis for determining such increased costs and their allocation, the Borrowers shall immediately pay to the Agent, from time to time as specified by the Agent, such amounts as shall be sufficient to compensate the subject Revolving Credit Lender or the subject Issuer for such increased cost. Any Revolving Credit Lender's or any Issuer's determination of costs incurred under Section 2.19(c)(i) or 2.19(c)(ii), and the allocation, if any, of such costs among the Borrowers and other letter of credit customers of such Revolving Credit Lender or such Issuer, if done in good faith and made on an equitable basis and in accordance with such officer's certificate, shall be conclusive and binding on the Borrowers.

2.20.Concerning L/C's.

(a)None of the Issuer, the Issuer's correspondents, any Revolving Credit Lender, the Agent, or any advising, negotiating, or paying bank with respect to any L/C shall be responsible in any way for:

(i)The performance by any beneficiary under any L/C of that beneficiary's obligations to any Borrower.

(ii)The form, sufficiency, correctness, genuineness, authority of any person signing; falsification; or the legal effect of; any documents called for under any L/C if (with respect to the foregoing) such documents on their face appear to be in order.

(b)The Issuer may honor, as complying with the terms of any L/C and of any drawing thereunder, any drafts or other documents otherwise in order, but signed or issued by an administrator, executor, conservator, trustee in bankruptcy, debtor in possession, assignee for the benefit of creditors, liquidator, receiver, or other legal representative of the party authorized under such L/C to draw or issue such drafts or other documents.

(c)Unless otherwise agreed to, in the particular instance, each Borrower hereby authorizes any Issuer to:

(i)Select an advising bank, if any.

(ii)Select a paying bank, if any.

(iii)Select a negotiating bank.

(d)All directions, correspondence, and funds transfers relating to any L/C are at the risk of the Borrowers. The Issuer shall have discharged the Issuer's obligations under any L/C which, or the drawing under which, includes payment instructions, by the initiation of the method of payment called for in, and in accordance with, such instructions (or by any other commercially reasonable and comparable method). None of the Agent, any Revolving Credit Lender, or the Issuer shall have any responsibility for any inaccuracy, interruption, error, or delay in transmission or delivery by post, telegraph or cable, or for any inaccuracy of translation.

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(e)The Agent's, each Revolving Credit Lender's, and the Issuer's rights, powers, privileges and immunities specified in or arising under this Agreement are in addition to any heretofore or at any time hereafter otherwise created or arising, whether by statute or rule of law or contract.

(f)The obligations of the Borrowers under this Agreement with respect to L/C's are absolute, unconditional, and irrevocable and shall be performed strictly in accordance with the terms hereof under all circumstances, whatsoever including, without limitation, the following:

(i)Any lack of validity or enforceability or restriction, restraint, or stay in the enforcement of this Agreement, any L/C, or any other agreement or instrument relating thereto.

(ii)Any Borrower's consent to any amendment or waiver of, or consent to the departure from, any L/C.

(iii)The existence of any claim, set-off, defense, or other right which any Borrower may have at any time against the beneficiary of any L/C.

(iv)Any good faith honoring of a drawing under any L/C, which drawing possibly could have been dishonored based upon a strict construction of the terms of the L/C.

2.21.Changed Circumstances.

(a)The Agent may advise the Lead Borrower that the Agent has made the good faith determination (which determination shall be final and conclusive) of any of the following:

(i)Adequate and fair means do not exist for ascertaining the rate for LIBOR Loans.

(ii)The continuation of or conversion of any Revolving Credit Loan to a LIBOR Loan has been made impracticable or unlawful by the occurrence of a contingency that materially and adversely affects the applicable market or the compliance by the Agent or any Revolving Credit Lender in good faith with any Applicable Law.

(iii)The indices on which the interest rates for LIBOR Loans are based shall no longer represent the effective cost to the Agent or any Revolving Credit Lender for U.S. dollar deposits in the interbank market for deposits in which it regularly participates.

(b)In the event that the Agent advises the Lead Borrower of an occurrence described in Section 2.23(a), then, until the Agent notifies the Lead Borrower that the circumstances giving rise to such notice no longer apply:

(i)The obligation of the Agent or each Revolving Credit Lender to make loans of the type affected by such changed circumstances or to permit the Lead Borrower to select the affected interest rate as otherwise applicable to any Revolving Credit Loans shall be suspended.

(ii)Any notice which the Lead Borrower had given the Agent with respect to any LIBOR Loan, the time for action with respect to which has not occurred prior to the Agent's having given notice pursuant to Section 2.11(a), shall be deemed at the option of the Agent to not having been given.

2.22.Designation of Lead Borrower as Borrowers' Agent.

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(a)Each Borrower hereby irrevocably designates and appoints the Lead Borrower as that Borrower's agent to obtain loans and advances under the Revolving Credit, the proceeds of which shall be available to each Borrower for those uses as those set forth in Section 2.1(d). As the disclosed principal for its agent, each Borrower shall be obligated to the Agent and each Revolving Credit Lender on account of loans and advances so made under the Revolving Credit as if made directly by the Revolving Credit Lenders to that Borrower, notwithstanding the manner by which such loans and advances are recorded on the books and records of the Lead Borrower and of any Borrower.

(b)Each Borrower recognizes that credit available to it under the Revolving Credit is in excess of and on better terms than it otherwise could obtain on and for its own account and that one of the reasons therefor is its joining in the credit facility contemplated herein with all other Borrowers. Consequently, each Borrower hereby assumes and agrees to fully, faithfully, and punctually discharge all Liabilities of all of the Borrowers.

(c)The Lead Borrower shall act as a conduit for each Borrower (including itself, as a "Borrower") on whose behalf the Lead Borrower has requested a Revolving Credit Loan.

(d)The proceeds of each loan and advance provided under the Revolving Credit which is requested by the Lead Borrower shall be deposited into the Operating Account or as otherwise indicated by the Lead Borrower. The Lead Borrower shall cause the transfer of the proceeds thereof to the (those) Borrower(s) on whose behalf such loan and advance was obtained. Neither the Agent nor any Revolving Credit Lender shall have any obligation to see to the application of such proceeds.

2.23.Lenders' Commitments

(a)Subject to Section 16.1 (which provides for assignments and assumptions of commitments), each Revolving Credit Lender's "Revolving Credit Percentage Commitment", and "Revolving Credit Dollar Commitment" (respectively so referred to herein) is set forth on EXHIBIT 2.22, annexed hereto.

(b)The obligations of each Revolving Credit Lender are several and not joint. No Revolving Credit Lender shall have any obligation to make any loan under the Revolving Credit in excess of either of the following:

(i)That Revolving Credit Lender's Revolving Credit Percentage Commitment of the subject loan or advance or of Availability.

(ii)Any loan which, when aggregated with all other loans made by that Revolving Credit Lender under the Revolving Credit and then outstanding, exceed that Revolving Credit Lender's Revolving Credit Dollar Commitment.

(c)No Revolving Credit Lender shall have any liability to the Borrowers on account of the failure of any other Revolving Credit Lender to provide any loan or advance under the Revolving Credit nor any obligation to make up any shortfall which may be created by such failure.

(d)The Revolving Credit Dollar Commitments, Revolving Credit Commitment Percentages, and identities of the Revolving Credit Lenders may be changed, from time to time by the reallocation or assignment of Revolving Credit Dollar Commitments and Revolving Credit Commitment Percentages amongst the Revolving Credit Lenders or with other Persons who determine to become "Revolving Credit Lenders", provided, however unless an Event of Default has occurred (in which event, no consent of any Borrower is required) any assignment to a Person not then a Revolving Credit Lender shall be subject to the prior consent of the Lead Borrower (not to be unreasonably withheld), which consent will be deemed given unless the Lead Borrower provides the Agent with written objection, not more than Five (5) Business Days after the Agent shall have given the Lead Borrower written notice of a proposed assignment).

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(e)Upon written notice given the Lead Borrower from time to time by the Agent, of any assignment or allocation referenced in Section 2.23(d):

(i)Each Borrower shall execute one or more replacement Revolving Credit Notes to reflect such changed Revolving Credit Dollar Commitments, Revolving Credit Commitment Percentages, and identities and shall deliver such replacement Revolving Credit Notes to the Agent (which promptly thereafter shall deliver to the Lead Borrower the Revolving Credit Notes so replaced) provided however, in the event that a Revolving Credit Note is to be exchanged following its acceleration or the entry of an order for relief under the Bankruptcy Code with respect to any Borrower, the Agent, in lieu of causing the Borrowers to execute one or more new Revolving Credit Notes, may issue the Agent's Certificate confirming the resulting Revolving Credit Dollar Commitments and Revolving Credit Percentage Commitments.

(ii)Such change shall be effective from the effective date specified in such written notice and any Person added as a Revolving Credit Lender shall have all rights and privileges of a Revolving Credit Lender hereunder thereafter as if such Person had been a signatory to this Agreement and any other Loan Document to which a Revolving Credit Lender is a signatory and any Person removed as a Revolving Credit Lender shall be relieved of any obligations or responsibilities of a Revolving Credit Lender hereunder thereafter.

(f)Upon at least three (3) Business Days’ prior written notice to the Agent, the Lead Borrower may permanently reduce the Revolving Credit Dollar Commitments. Each such reduction shall be in the principal amount of $7,500,000.00 and not more than two (2) such reductions may be made during the term of this Agreement. Each such reduction shall (i) be applied ratably to the Revolving Credit Dollar Commitments of each Revolving Credit Lender and (ii) be irrevocable when given. At the effective time of each such reduction, the Borrowers shall pay to the Agent for application as provided herein (i) all earned and unpaid interest and fees accrued on the amount of the Revolving Credit Commitments so reduced through the date thereof, and (ii) any amount by which the aggregate unpaid balance of the Loan Account and the aggregate undrawn Stated Amount of all then outstanding L/C's exceed the amount to which the Revolving Credit Commitments are to be reduced, in each case pro-rata based on the amount prepaid.

Article 3 - Conditions Precedent:

As a condition to the effectiveness of this Agreement, the establishment of the Revolving Credit, and the making of the first loan under the Revolving Credit, each of the documents respectively described in Sections 3.1 through and including 3.4, (each in form and substance satisfactory to the Agent) shall have been delivered to the Agent, and the conditions respectively described in Sections 3.5 through and including 3.9, shall have been satisfied:

3.1.Corporate Due Diligence.

(a)Certificates of corporate good standing for each Borrower, respectively issued by the Secretary of State for the state in which that Borrower is incorporated.

(b)Certificates of due qualification, in good standing, issued by the Secretary(ies) of State of each State in which the nature a Borrower's business conducted or assets owned could require such qualification.

(c)Certificates of each Borrower's Secretaries of the due adoption, continued effectiveness, and setting forth the texts of, each corporate resolution adopted in connection with the establishment of the loan arrangement contemplated by the Loan Documents and attesting to the true signatures of each Person authorized as a signatory to any of the Loan Documents.

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3.2.Opinion. An opinion of counsel to the Borrowers in form and substance satisfactory to the Agent.

3.3.Additional Documents. Such additional instruments and documents as the Agent or its counsel reasonably may require or request including, without limitation, the following:

(a)Appraisal of the Borrowers’ Inventory.

(b)Commercial finance examination performed by the Agent’s examiners and/or agents.

(c)Business Plan, including monthly balance sheet, profit and loss statements, and cash flow analysis that presents total usage and collateral availability consistent with the Borrowing Base.

(d)Background checks for key management.

(e)All Loan Documents.

(f)Lien search results with respect to the Borrowers’ locations.

(g)Confirmation of filing of all necessary and appropriate Financing Statements and such other documents as may be required to perfect the Agent’s and the Lenders’ security interest in the Collateral.

(h)Receipt of discharges, releases, and terminations required to afford the Agent and the Lenders a first, perfected security interest in and to all Collateral, free and clear of all liens and encumbrances, other than Permitted Encumbrances.

(i)Confirmation of insurance and appropriate endorsements in favor of the Agent and the Lenders.

(j)Collateral access agreements, as may be necessary.

3.4.Officers' Certificates. Certificates executed by the President and the Chief Financial Officer of the Lead Borrower which state that

(a)Such officer, acting on behalf of the Borrowers, has reviewed each of the Loan Documents and has had the benefit of independent counsel (Attorneys Robinson & Cole, LLP) of the Lead Borrower's selection in connection with the review and negotiation of the Loan Documents. In particular, and without limiting the generality of such review, the following provisions of the Loan Documents have been brought to the attention of the undersigned by such counsel:

(i)The waiver of the right to a trial by jury in connection with controversies arising out of the loan arrangement contemplated by the Loan Documents.

(ii)The designation of, and submission to the exclusive jurisdiction and venue of, certain courts.

(iii)Various other waivers and indemnifications included therein.

(iv)The circumstances under which the Liabilities could be accelerated and the grace periods available with respect to certain Events of Default.

(b)The representations and warranties made by the Borrowers to the Agent and the Revolving Credit Lenders in the Loan Documents are true and complete as of the date of such Certificate, and that no event has occurred which is or which, solely with the giving of notice or passage of time (or both) would be an Event of Default.

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3.5.Representations and Warranties. Each of the representations made by or on behalf of each Borrower in this Agreement or in any of the other Loan Documents or in any other report, statement, document, or paper provided by or on behalf of each Borrower shall be true and complete as of the date as of which such representation or warranty was made.

3.6.Minimum Day One Availability. After giving effect to the first funding under the Revolving Credit; all then held checks (if any); accounts payable which are beyond credit terms then accorded the Borrowers; overdrafts; any charges to the Loan Account made in connection with the establishment of the credit facility contemplated hereby; and L/C's to be issued at, or immediately subsequent to, such establishment, Availability shall not be less than $7,000,000.00.

3.7.All Fees and Expenses Paid. All fees due at or immediately after the first funding under the Revolving Credit and all costs and expenses incurred by the Agent in connection with the establishment of the credit facility contemplated hereby (including the fees and expenses of counsel to the Agent) shall have been paid in full.

3.8.No Borrower In Default. No Borrower is In Default.

3.9.No Adverse Change. There has been no Material Adverse Change and no event shall have occurred or failed to occur, which occurrence or failure is or could have a material adverse effect upon any Borrower's financial condition when compared with such financial condition at September 30, 2005.

3.10.Benefit of Conditions Precedent. The conditions set forth in this Article 3 - , are for the sole benefit of the Agent and each Revolving Credit Lender and may be waived by the Agent in whole or in part without prejudice to the Agent or any Revolving Credit Lender.

No document shall be deemed delivered to the Agent or any Revolving Credit Lender until received and accepted by the Agent at its offices in Boston, Massachusetts. Under no circumstances shall this Agreement take effect until executed and accepted by the Agent at said offices.

Article 4 - General Representations, Covenants and Warranties:

To induce each Revolving Credit Lender to establish the credit facility contemplated herein and to induce the Revolving Credit Lenders to provide loans and advances under the Revolving Credit (each of which loans shall be deemed to have been made in reliance thereupon) the Borrowers, in addition to all other representations, warranties, and covenants made by any Borrower in any other Loan Document, make those representations, warranties, and covenants included in this Agreement.

4.1.Payment and Performance of Liabilities. The Borrowers shall pay each payment Liability when due (or when demanded, if payable on demand) and shall promptly, punctually, and faithfully perform each other Liability.

4.2.Due Organization. Authorization. No Conflicts.

(a)Each Borrower presently is and hereafter shall remain in good standing as a corporation under the laws of the State in which it is organized, as set forth in the Preamble to this Agreement and is and shall hereafter remain duly qualified and in good standing in every other State in which, by reason of the nature or location of each Borrowers' assets or operation of each Borrowers' business, such qualification may be necessary, except where the failure to so qualify would have no more than a de minimis adverse effect on the business or a assets of any Borrower.

(b)Each Borrower's respective organizational identification number assigned to it by the State of its incorporation and its respective federal employer identification number is listed on EXHIBIT 4.2, annexed hereto.

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(c)No Borrower shall change its State of organization; any organizational identification number assigned to that Borrower by that State; or that Borrowers' federal taxpayer identification number.

(d)Each Affiliate is listed on EXHIBIT 4.2. The Lead Borrower shall provide the Agent with prior written notice of any entity's becoming or ceasing to be an Affiliate.

(e)Each Borrower has all requisite power and authority to execute and deliver all Loan Documents to which that Borrower is a party and has and will hereafter retain all requisite power to perform all Liabilities.

(f)The execution and delivery by each Borrower of each Loan Document to which it is a party; each Borrowers' consummation of the transactions contemplated by such Loan Documents (including, without limitation, the creation of Collateral Interests by that Borrower to secure the Liabilities); each Borrowers' performance under those of the Loan Documents to which it is a party

(i)Have been duly authorized by all necessary action.

(ii)Do not, and will not, contravene in any material respect any provision of any Requirement of Law or obligation of that Borrower.

(iii)Will not result in the creation or imposition of, or the obligation to create or impose, any Encumbrance upon any assets of that Borrower pursuant to any Requirement of Law or obligation, except pursuant to the Loan Documents.

(g)The Loan Documents have been duly executed and delivered by each Borrower and are the legal, valid and binding obligations of each Borrower, enforceable against each Borrower in accordance with their respective terms.

(h)As of the Closing Date, no Inactive Company conducts any business or owns any material assets or has any material liabilities other than those set forth on EXHIBIT 4.2(h), annexed hereto, and no such Inactive Company shall during the term of this Agreement conduct any business or own any material assets or incur any material liabilities. except that (i) Arrow Prescription Leasing Corp. may continue to be party to the leases listed on Exhibit 4.2(h) but may in no event enter into any new leases and shall make its best efforts to cause the leases listed on Exhibit 4.2(h), if renewed, to be assigned to or otherwise executed in the name of a Borrower, and (ii) Discount RX, Inc., may continue to own the patent and/or patent application set forth on Exhibit 4.2(h) so long as it complies with the terms and conditions of the Intellectual Property Security Agreement dated as of the Closing Date among the “Grantors” named therein and the Agent.

4.3.Trade Names.

(a)EXHIBIT 4.3, annexed hereto, is a listing of:

(i)All names under which any Borrower ever conducted its business.

(ii)All Persons with whom any Borrower ever consolidated or merged, or from whom any Borrower ever acquired in a single transaction or in a series of related transactions substantially all of such Person's assets.

(b)The Lead Borrower will provide the Agent with not less than twenty-one (21) days prior written notice (with reasonable particularity) of any change to any Borrowers' name from that under which that Borrower is conducting its business at the execution of this Agreement and will not effect such change unless each Borrower is then in compliance with all provisions of this Agreement.

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4.4.Infrastructure.

(a)Each Borrower has and will maintain a sufficient infrastructure to conduct its business as presently conducted and as contemplated to be conducted following its execution of this Agreement.

(b)Each Borrower owns and possesses, or has the right to use (and will hereafter own, possess, or have such right to use) all patents, industrial designs, trademarks, trade names, trade styles, brand names, service marks, logos, copyrights, trade secrets, know-how, confidential information, and other intellectual or proprietary property of any third Person necessary for that Borrower's conduct of that Borrower's business.

(c)The conduct by each Borrower of that Borrower's business does not presently infringe (nor will any Borrower conduct its business in the future so as to infringe) the patents, industrial designs, trademarks, trade names, trade styles, brand names, service marks, logos, copyrights, trade secrets, know-how, confidential information, or other intellectual or proprietary property of any third Person.

4.5.Locations.

(a)The Collateral, and the books, records, and papers of Borrowers' pertaining thereto, are kept and maintained solely at those locations which are listed on EXHIBIT 4.5, annexed hereto, which EXHIBIT includes, with respect to each such location, the name and address of the landlord on the Lease which covers such location (or an indication that a Borrower owns the subject location) and of all service bureaus with which any such records are maintained, and which EXHIBIT shall be deemed modified from time to time to reflect locations added or removed in accordance with the terms of this Agreement.

(b)No Borrower shall remove any of the Collateral from those locations listed on EXHIBIT 4.5 except for the following purposes:

(i)To accomplish sales of Inventory in the ordinary course of business.

(ii)To move Inventory from one such location to another such location.

(iii)To utilize such of the Collateral as is removed from such locations in the ordinary course of business (such as motor vehicles).

(c)No Borrower shall execute, alter, modify, or amend the rental provisions of any Lease or any other material provisions of any Lease except in the ordinary course of business.

(d)No Borrower shall commit to open or close, or open or close, any location at which a Borrower maintains, offers for sale or stores any of the Collateral, provided that if (a) no Event of Default has occurred and is continuing or will occur as a result of such commitment, store opening or closing and (b) Lead Borrower has provided Agent with at least thirty (30) days' prior written notice of such commitment, opening or closing, the Borrowers may open or close locations consistent with the terms of the Business Plan, plus an additional five (5) openings and five (5) closings each fiscal year; provided, however, that for any store closing, the Agent must consent in advance and in writing to the manner in which a Borrower intends to effect such closing, including, without limitation, any third party agent that a Borrower proposes to employ in connection therewith, which consent from Agent shall not be unreasonably withheld or delayed.

(e)Except as otherwise disclosed pursuant to, or permitted by, this Section 4.5, no tangible personal property of any Borrower is in the care or custody of any third party or stored or entrusted with a bailee or other third party and none shall hereafter be placed under such care, custody, storage, or entrustment.

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4.6.Encumbrances. The assets of the Borrowers are not subject to, and shall not hereafter be subject to, any encumbrances other than Permitted Encumbrances.

4.7.Indebtedness. The Borrowers do not and shall not hereafter have any Indebtedness other than any Permitted Indebtedness and the following:

(a)Any Indebtedness on account of the Revolving Credit.

(b)The Indebtedness (if any) listed on EXHIBIT 4.7, annexed hereto, and the extension of maturity, refinancing or modification of the terms thereof; provided, that (i) such extension, refinancing or modification is pursuant to terms that are not less favorable to the Borrowers than the terms of the Indebtedness being extended, refinanced or modified and (ii) after giving effect to such extension, refinancing or modification, the amount of such Indebtedness is not greater than the amount of Indebtedness outstanding immediately prior to such extension, refinancing or modification plus accrued interest thereon and reasonable fees incurred in connection with the extension, refinancing, or modification.

(c)Indebtedness between and among the Borrowers in the ordinary course of business in accordance with past practices.

(d)Indebtedness incurred by Borrowers in connection with a Permitted Acquisition, provided that any such Indebtedness shall (i) be on terms and conditions, including, without limitation, terms of subordination, satisfactory to Agent and (ii) not in any event be secured by any assets of the Borrowers other than real property purchased as part of such Permitted Acquisition, all of such encumbrance(s) to be on terms and conditions satisfactory to Agent and in any event not to secure more than $1,000,000.00 in aggregate Indebtedness at any time outstanding.

4.8.Insurance.

(a)EXHIBIT 4.8, annexed hereto, is a schedule of all insurance policies owned by the Borrowers or under which any Borrower is the named insured. Each of such policies is in full force and effect. Neither the issuer of any such policy nor any Borrower is in default or violation of any such policy.

(b)The Borrowers shall have and maintain at all times insurance covering such risks, in such amounts, containing such terms, in such form, for such periods, and written by such companies as may be satisfactory to the Agent.

(c)All insurance carried by the Borrowers shall provide for a minimum of Thirty (30) days' prior written notice of cancellation to the Agent and all such insurance which covers the Collateral shall

(i)Include an endorsement in favor of the Agent, which endorsement shall provide that the insurance, to the extent of the Agent's interest therein, shall not be impaired or invalidated, in whole or in part, by reason of any act or neglect of any Borrower or by the failure of any Borrower to comply with any warranty or condition of the policy.

(ii)Not include an endorsement of any property or casualty insurance in favor of any other Person.

(d)The coverage reflected on EXHIBIT 4.8 presently satisfies the foregoing requirements, it being recognized by each Borrower, however, that such requirements may change hereafter to reflect changing circumstances.

(e)The Lead Borrower shall furnish the Agent from time to time with certificates or other evidence satisfactory to the Agent regarding compliance by the Borrowers with the foregoing requirements.

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(f)In the event of the failure by the Borrowers to maintain insurance as required herein, the Agent, at its option and the Borrowers' expense, may obtain such insurance at the expense of the Borrowers, provided, however, the Agent's obtaining of such insurance shall not constitute a cure or waiver of any Event of Default occasioned by the Borrowers' failure to have maintained such insurance.

(g)The Borrowers shall maintain at all times those policies of insurance obtained by the Borrowers and assigned to the Lender.

4.9.Licenses. Each license, distributorship, franchise, and similar agreement issued to, or to which any Borrower is a party is in full force and effect. No party to any such license or agreement is in default or violation thereof where such default or violation would be reasonably likely to cause a Material Adverse Change. No Borrower has received any notice or threat of cancellation of any such license or agreement.

4.10.Leases.EXHIBIT 4.10, annexed hereto, is a schedule of all presently effective Capital Leases. (Exhibit 4.5 includes a list of all other presently effective Leases). Each of such Leases and Capital Leases is in full force and effect. No party to any such Lease or Capital Lease is in default or violation of any such Lease or Capital Lease where such default or violation would be reasonably likely to cause a Material Adverse Change. No Borrower has received any notice or threat of cancellation of any such Lease or Capital Lease. Each Borrower hereby authorizes the Agent at any time and from time to time to contact any of the Borrowers' respective landlords in order to confirm the Borrowers' continued compliance with the terms and conditions of the Lease(s) between the subject Borrower and that landlord and to discuss such issues, concerning the subject Borrower's occupancy under such Lease(s), as the Agent may determine.

4.11.Requirements of Law. Each Borrower is in compliance with, and shall hereafter comply with and use its assets in compliance with, all Requirements of Law except where the failure of such compliance will not have more than a de minimis adverse effect on the Borrowers' business or assets. No Borrower has received any notice of any violation of any Requirement of Law (other than of a violation which has no more than a de minimis adverse effect on the Borrowers' business or assets), which violation has not been cured or otherwise remedied.

4.12.Labor Relations.

(a)No Borrower has been, and none is presently a party to any collective bargaining or other labor contract.

(b)There is not presently pending and, to any Borrower's knowledge, there is not threatened any of the following:

(i)Any strike, slowdown, picketing, work stoppage, or employee grievance process.

(ii)Any proceeding against or affecting any Borrower relating to the alleged violation of any Applicable Law pertaining to labor relations or before National Labor Relations Board, the Equal Employment Opportunity Commission, or any comparable governmental body, organizational activity, or other labor or employment dispute against or affecting any Borrower, which, if determined adversely to that Borrower could have more than a de minimis adverse effect on that Borrower.

(iii)Any lockout of any employees by any Borrower (and no such action is contemplated by any Borrower).

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(iv)Any application for the certification of a collective bargaining agent.

(c)No event has occurred or circumstance exists which could provide the basis for any work stoppage or other labor dispute.

(d)Each Borrower:

(i)Has complied in all material respects with all Applicable Law relating to employment, equal employment opportunity, nondiscrimination, immigration, wages, hours, benefits, collective bargaining, the payment of social security and similar taxes, occupational safety and health, and plant closing.

(ii)Is not liable for the payment of more than a de minimis amount of compensation, damages, taxes, fines, penalties, or other amounts, however designated, for that Borrower's failure to comply with any Applicable Law referenced in Section 4.12(d)(i).

4.13.Maintain Properties. The Borrowers shall:

(a)Keep the Collateral in good order and repair (ordinary reasonable wear and tear and insured casualty excepted).

(b)Not suffer or cause the waste or destruction of any material part of the Collateral.

(c)Not use any of the Collateral in violation of any policy of insurance thereon.

(d)Not sell, lease, or otherwise dispose of any of the Collateral, other than the following:

(i)Permitted Dispositions.

(ii)The turning over to the Agent of all Receipts as provided herein.

(e)Not have any property on consignment to a Borrower.

4.14.Taxes.

(a)With respect to the Borrowers' federal, state, and local tax liability and obligations:

(i)The Lead Borrower, in compliance with all Applicable Law, has properly filed all returns due to be filed up to the date of this Agreement.

(ii)Except as described on EXHIBIT 4.14:

(A)At no time has any Borrower received from any taxing authority any request to perform any examination of or with respect to any Borrower nor any other written or verbal notice in any way relating to any claimed failure by any Borrower to comply with all Applicable Law concerning payment of any taxes or other amounts in the nature of taxes.

(B)No agreement is extant which waives or extends any statute of limitations applicable to the right of any taxing authority to assert a deficiency or make any other claim for or in respect to federal income taxes.

(C)No issue has been raised in any tax examination of any Borrower which, by application of similar principles, reasonably could be expected to result in the assertion of a deficiency for any fiscal year open for examination, assessment, or claim by any taxing authority.

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(b)The Borrowers have, and hereafter shall: pay, as they become due and payable, all taxes and unemployment contributions and other charges of any kind or nature levied, assessed or claimed against any Borrower or the Collateral by any person or entity whose claim could result in an Encumbrance upon any asset of any Borrower or by any governmental authority; properly exercise any trust responsibilities imposed upon any Borrower by reason of withholding from employees' pay or by reason of any Borrowers' receipt of sales tax or other funds for the account of any third party; timely make all contributions and other payments as may be required pursuant to any Employee Benefit Plan now or hereafter established by any Borrower; and timely file all tax and other returns and other reports with each governmental authority to whom any Borrower is obligated to so file.

4.15.No Margin Stock. No Borrower is engaged in the business of extending credit for the purpose of purchasing or carrying any margin stock (within the meaning of Regulations U, T, and X of the Board of Governors of the Federal Reserve System of the United States). No part of the proceeds of any borrowing hereunder will be used at any time to purchase or carry any such margin stock or to extend credit to others for the purpose of purchasing or carrying any such margin stock.

4.16.ERISA.

(a)Neither any Borrower nor any ERISA Affiliate has ever:

(i)Violated or failed to be in full compliance with any Borrower's Employee Benefit Plan.

(ii)Failed timely to file all reports and filings required by ERISA to be filed by any Borrower.

(iii)Engaged in any nonexempt "prohibited transactions" or "reportable events" (respectively as described in ERISA).

(iv)Engaged in, or committed, any act such that a tax or penalty reasonably could be imposed upon any Borrower on account thereof pursuant to ERISA.

(v)Accumulate any material cumulative funding deficiency within the meaning of ERISA.

(vi)Terminated any Employee Benefit Plan such that a lien could be asserted against any assets of any Borrower on account thereof pursuant to ERISA.

(vii)Been a member of, contributed to, or have any obligation under any Employee Benefit Plan which is a multiemployer plan within the meaning of Section 4001(a) of ERISA.

(b)Neither any Borrower nor any ERISA Affiliate shall ever engage in any action of the type described in Section 4.16(a).

4.17.Hazardous Materials.

(a)No Borrower has ever: (i) been legally responsible for any release or threat of release of any Hazardous Material or (ii) received notification of the incurrence of any expense in connection with the assessment, containment, or removal of any Hazardous Material for which that Borrower would be responsible.

(b)Each Borrower shall: (i) dispose of any Hazardous Material only in compliance with all Environmental Laws and (ii) have possession of any Hazardous Material only in the ordinary course of that Borrowers' business and in compliance with all Environmental Laws.

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4.18.Litigation. Except as described in EXHIBIT 4.18, annexed hereto, there is not presently pending or threatened by or against any Borrower any suit, action, proceeding, or investigation, including, without limitation, any relating to any Pharmaceutical Laws or Health Care Laws which, if determined adversely to any Borrower, would have more than a de minimis adverse effect upon a Borrower's financial condition or ability to conduct its business as such business is presently conducted or is contemplated to be conducted in the foreseeable future.

4.19.Dividends. Investments. Corporate Action. No Borrower shall:

(a)Pay any cash dividend or make any other distribution (other than in stock) in respect of any class of that Borrower's capital stock.

(b)Make any payment on account of any Indebtedness other than payment of the Liabilities.

(c)Own, redeem, retire, purchase, or acquire any of any Borrower's capital stock, other than amounts necessary to repurchase any equity securities of the Lead Borrower from its employees, officers or directors; provided that, (i) such repurchases shall not exceed $17,000,000.00 in any fiscal year, and (y) no Event of Default has occurred or would result therefrom.

(d)Invest in or purchase any stock or securities or rights to purchase any such stock or securities, of any Person other than a Permitted Investment or Permitted Acquisition.

(e)Merge or consolidate or be merged or consolidated with or into any other corporation or other entity.

(f)Consolidate any of that Borrower's operations with those of any other Person other than of another Borrower.

(g)Organize or create any Affiliate.

(h)Subordinate any debts or obligations owed to that Borrower by any third party to any other debts owed by such third party to any other Person.

(i)Except pursuant to a Permitted Acquisition, acquire any assets other than in the ordinary course and conduct of that Borrower's business as conducted at the execution of this Agreement.

(j)Acquire or obtain the right to use any Equipment, the acquisition or right to use of which Equipment is otherwise permitted by this Agreement, in which Equipment any third party has an interest, except for Equipment which is merely incidental to the conduct of that Borrowers' business.

(k)Issue or sell or enter into any agreement or arrangement for the issuance and sale of, any shares of its capital stock, any securities convertible into or exchangeable for its capital stock or any warrants, except, so long as no Change in Control shall be caused thereby, the issuance of equity by Lead Borrower so long as the Equity Proceeds received in connection therewith shall be applied by Lead Borrower as follows:

(i)the first $20,000,000.00 in Equity Proceeds received during the term of this Agreement shall be applied to payment of the outstanding Liabilities until paid in full (and the Agent may establish a funded reserve of up to 110% of the aggregate Stated Amounts of any outstanding L/C's), with the excess, if any, to be deposited in the Concentration Account to be held as additional Collateral;

(ii)the next $40,000,000.00 of Equity Proceeds received by Lead Borrower may (so long as no Event of Default shall have occurred and be continuing, in which event all such Equity Proceeds shall be remitted to the Agent for application in accordance with Section 19.7) be retained by the Lead Borrower for general corporate purposes in compliance with the terms of this Agreement including, without limitation, for Permitted Acquisitions; and

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(iii)Fifty percent (50%) of all Equity Proceeds received by Lead Borrower in excess of $60,000,000.00 during the term of this Agreement shall (so long as no Event of Default shall have occurred and be continuing, in which event all such Equity Proceeds shall be remitted to the Agent for application in accordance with Section 19.7) be applied to payment of the Liabilities (and the Agent may establish a funded reserve of up to 110% of the aggregate Stated Amounts of any outstanding L/C's), with the excess, if any, to be deposited in the Concentration Account to be held as additional Collateral, and fifty percent (50%) may be retained by the Lead Borrower for general corporate purposes in compliance with the terms of this Agreement including, without limitation, for Permitted Acquisitions.

4.20.Loans. No Borrower shall make any loans or advances to, nor acquire the Indebtedness of, any Person, provided, however, the foregoing does not prohibit any of the following:

(a)Advance payments made to that Borrower's suppliers in the ordinary course.

(b)Advances to that Borrower's officers, employees, and salespersons with respect to reasonable expenses to be incurred by such officers, employees, and salespersons for the benefit of that Borrower, which expenses are properly substantiated by the person seeking such advance and properly reimbursable by that Borrower.

(c)Advances to a Borrower's officers, employees, and salespersons in the ordinary course of business in accordance with past practices, in addition to those specified in clause (b), in an amount not to exceed $250,000.00 in the aggregate outstanding at any time.

(d)Loans by Borrowers listed on EXHIBIT 4.20, annexed hereto, and otherwise permitted under Section 4.20(c).

(e)Providing extended payment terms to pharmacies in the ordinary course of Borrowers’ business and in accordance with the Borrowers’ historical practices including, but not limited to, the issuance by a pharmacy, and acceptance by a Borrower, of a secured promissory note (which shall be duly endorsed to the order of, and delivered to, the Agent) to evidence indebtedness of the pharmacy owing to such Borrower related to past due Accounts Receivable.

4.21.Protection of Assets. The Agent, in the Agent's discretion, and from time to time, may discharge any tax or Encumbrance on any of the Collateral, or take any other action which the Agent may deem necessary or desirable to repair, insure, maintain, preserve, collect, or realize upon any of the Collateral. The Agent shall not have any obligation to undertake any of the foregoing and shall have no liability on account of any action so undertaken except where there is a specific finding in a judicial proceeding (in which the Agent has had an opportunity to be heard), from which finding no further appeal is available, that the Agent had acted in actual bad faith or in a grossly negligent manner. The Borrowers shall pay to the Agent, on demand, or the Agent, in its discretion, may add to the Loan Account, all amounts paid or incurred by the Agent pursuant to this Section 4.21.

4.22.Line of Business. No Borrower shall engage in any business other than the business in which it is currently engaged or a business reasonably related thereto.

4.23.Affiliate Transactions. No Borrower shall make any payment, nor give any value to any Affiliate except for goods and services actually purchased by that Borrower from, or sold by that Borrower to, such Affiliate for a price and on terms which shall

(a)be competitive and fully deductible as an "ordinary and necessary business expense" and/or fully depreciable under the Internal Revenue Code of 1986 and the Treasury Regulations, each as amended; and

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(b)be no less favorable to that Borrower than those which would have been charged and imposed in an arms length transaction.

4.24.Further Assurances.

(a)No Borrower is the owner of, nor has it any interest in, any property or asset which is not be subject to a perfected Collateral Interest in favor of the Agent (subject only to Permitted Encumbrances) to secure the Liabilities.

(b)No Borrower will hereafter acquire any asset or any interest in property which is not, immediately upon such acquisition, subject to such a perfected Collateral Interest in favor of the Agent to secure the Liabilities (subject only to Permitted Encumbrances).

(c)Each Borrower shall execute and deliver to the Agent such instruments, documents, and papers, and shall do all such things from time to time hereafter as the Agent may request to carry into effect the provisions and intent of this Agreement; to protect and perfect the Agent's Collateral Interests in the Collateral; and to comply with all applicable statutes and laws, and facilitate the collection of the Receivables Collateral. Each Borrower shall execute all such instruments as may be required by the Agent with respect to the recordation and/or perfection of the Collateral Interests created or contemplated herein.

(d)Each Borrower hereby designates the Agent as that Borrowers' true and lawful attorney, with full power of substitution, to sign and file any financing statements in order to perfect or protect the Agent's Collateral Interests in the Collateral.

(e)This Agreement constitutes an authenticated record which authorizes the Agent to file such financing statements as the Agent determines as appropriate to perfect or protect the Collateral Interests created by this Agreement.

(f)A carbon, photographic, or other reproduction of this Agreement or of any financing statement or other instrument executed pursuant to this Section 4.24 shall be sufficient for filing to perfect the security interests granted herein.

4.25.Adequacy of Disclosure.

(a)All financial statements furnished to the Agent and to each Revolving Credit Lender by each Borrower have been prepared in accordance with GAAP consistently applied and present fairly the condition of the Borrowers at the date(s) thereof and the results of operations and cash flows for the period(s) covered (provided however, that unaudited financial statements are subject to normal year end adjustments and to the absence of footnotes). There has been no change in the Consolidated financial condition, results of operations, or cash flows of the Borrowers since the date(s) of such financial statements, other than changes in the ordinary course of business, which changes have not been materially adverse, either singularly or in the aggregate.

(b)No Borrower has any contingent obligations or obligation under any Lease or Capital Lease which is not noted in the Borrowers' Consolidated financial statements furnished to the Agent and to each Revolving Credit Lender prior to the execution of this Agreement.

(c)No document, instrument, agreement, or paper now or hereafter given to the Agent or to any Revolving Credit Lender by or on behalf of each Borrower or any guarantor of the Liabilities in connection with the execution of this Agreement by the Agent and to each Revolving Credit Lender contains or will contain any untrue statement of a material fact or omits or will omit to state a material fact necessary in order to make the statements therein not misleading. There is no fact known to the Borrowers which has, or which, in the foreseeable future could reasonably be expected to have, a material adverse effect on the financial condition of the Borrowers which has not been disclosed in writing to the Lender.

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4.26.No Restrictions on Liabilities. No Borrower shall enter into or directly or indirectly become subject to any agreement which prohibits or restricts, in any manner, any Borrowers':

(a)Creation of, and granting of Collateral Interests in favor of the Agent.

(b)Incurrence of Liabilities.

4.27.Other Covenants. No Borrower shall indirectly do or cause to be done any act which, if done directly by that Borrower, would breach any covenant contained in this Agreement.

4.28.Pharmaceutical Laws.

(a)Each Borrower has obtained all permits, licenses and other authorizations which are required with respect to the ownership and operations of its businesses under any Pharmaceutical Law, except where the failure to obtain such permits, licenses or other authorizations could not reasonably be expected to have a material adverse effect on the financial condition of any Borrower.

(b)Each Borrower is in compliance with all terms and conditions of all such permits, licenses, orders and authorizations, and is also in compliance with all Pharmaceutical Laws, including all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in the Pharmaceutical Laws, except where the failure to comply with such terms, conditions or laws could not reasonably be expected to have a material adverse effect on the financial condition of any Borrower.

(c)No Borrower has any liabilities, claims against it, and presently outstanding notices imposed or based upon any provision of any Pharmaceutical Law, except for such liabilities, claims, citations or notices which individually or in the aggregate could not reasonably be expected to have a material adverse effect on the financial condition of any Borrower.

4.29.HIPAA Compliance.

(a)To the extent that and for so long as any Borrower is a “covered entity” within the meaning of HIPAA, such Borrower (i) has undertaken or will promptly undertake all applicable surveys, audits, inventories, reviews, analyses and/or assessments (including any required risk assessments) of all areas of its business and operations required by HIPAA and/or that could be adversely affected by failure of such Borrower to be HIPAA Compliant (as defined below); (ii) has developed or will promptly develop a detailed plan and time line for becoming HIPAA Compliant (a “HIPAA Compliance Plan”); and (iii) has implemented or will implement those provisions of such HIPAA Compliance Plan in all material respects necessary to ensure that such Borrower is or becomes HIPAA Compliant.

(b)For purposes hereof, “HIPAA Compliant” shall mean that a Borrower to the extent legally required (i) is or will use commercially reasonable efforts to be in compliance in all material respects with each of the applicable requirements of the so-called “Administrative Simplification” provisions of HIPAA on and as of each date that any part thereof, or any final rule or regulation thereunder, becomes effective in accordance with its or their terms, as the case may be (each such date, a “HIPAA Compliance Date”) and (ii) is not and could not reasonably be expected to become, as of any date following any such HIPAA Compliance Date, the subject of any civil or criminal penalty, process, claim, action or proceeding, or any administrative or other regulatory review, survey, process or proceeding (other than routine surveys or reviews conducted by any government health plan or other accreditation entity) that could result in any of the foregoing or that has or could reasonably be expected to have a material adverse effect on the financial condition of any Borrower.

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(c)Exhibit 4.29, annexed hereto, sets forth a complete list of all “business associate agreements” (as such term is defined in HIPAA) that the Borrowers have entered into with any Person as of the Closing Date and true, correct and complete copies of all of such agreements have been provided to Agent.

4.30.Compliance with Health Care Laws.

(a)Each Borrower is in compliance with all Health Care Laws, including all Medicare and Medicaid program rules and regulations applicable to it. Without limiting the generality of the foregoing, Borrower has not received notice of any violation of any provisions of the Medicare and Medicaid Anti-Fraud and Abuse or Anti-Kickback Amendments of the Social Security Act (presently codified in Section 1128(B)(b) of the Social Security Act) or the Medicare and Medicaid Patient and Program Protection Act of 1987.

(b)Each Borrower has maintained in all material respects all records required to be maintained by the Food and Drug Administration, Drug Enforcement Agency and State Boards of Pharmacy and the Federal and State Medicare and Medicaid programs as required by the Health Care Laws or other applicable law or regulation and such Borrower and the owners of the facilities and other businesses managed by such Borrower have all permits, licenses, franchises, certificates and other approvals or authorizations of Governmental Authority as are required under Health Care Laws and under such HMO or similar licensure laws and such insurance laws and regulations, as are applicable thereto, and with respect to those facilities and other businesses that participate in Medicare and/or Medicaid, to receive reimbursement under Medicare and Medicaid, except where the failure to obtain will cause a material adverse effect on the financial condition of any Borrower.

(c)Each Borrower who is a Certified Medicare Provider or Certified Medicaid Provider has in a timely manner filed all requisite cost reports, claims and other reports required to be filed in connection with all Medicare and Medicaid programs due on or before the date hereof, all of which are complete and correct in all material respects. There are no claims to the best of the Borrowers’ knowledge, actions or appeals pending (and no Borrower has filed any claims or reports which should result in any such claims, actions or appeals) before any Third Party Payor or Governmental Authority, including without limitation, any Fiscal Intermediary, the Provider Reimbursement Review Board or the Administrator of HCFA, with respect to any Medicare or Medicaid cost reports or claims filed by any Borrower on or before the date hereof. No validation review or program integrity review related to a Borrower as it may have a Material Adversely Effect, or the consummation of the transactions contemplated hereby, has been conducted by any Third Party Payor or Governmental Authority in connection with Medicare or Medicare programs, and to the best of Borrowers’ knowledge, no such reviews are scheduled, pending or threatened against or affecting any Borrower , or any of its assets, or, the consummation of the transactions contemplated hereby. To the best of the Borrowers’ knowledge, there currently exist no restrictions, deficiencies, required plans of correction actions or other such remedial measures with respect to Federal and State Medicare and Medicaid certifications or licensure against such parties. Borrower is not a participant in the Periodic Interim Payment Program established pursuant to the Social Security Act.

(d)EXHIBIT4.30 hereto sets forth an accurate, complete and current list of all participation agreements of the Borrowers with health maintenance organizations, insurance programs, preferred provider organizations and other Third Party Payors and all such agreements are in full force and effect and no material default exists thereunder.

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4.31.Prescription Files. With respect to the Prescription Files: (i) Borrowers shall at all times maintain the Prescription Files in a manner consistent with the requirements of Federal, state and local laws and regulations in all material respects, including all Health Care Laws, which files and records related thereto shall be correct and accurate in all material respects; (ii) Borrowers shall not remove any Prescription Files from the locations set forth or permitted herein, without the prior written consent of Agent, except for transfers of Prescription Files in the ordinary course of its business (including at the request of customers with respect to such customer’s own Prescription Files) and except to move Prescription Files directly from one location set forth or permitted herein to another such location or in connection with the sale of Prescription Files in the ordinary course of business in connection with the closing of any retail store not to exceed an aggregate of $1,000,000.00 per year, upon the consent of Agent, and (iii) Agent and Revolving Credit Lenders are permitted to rely upon any upon written appraisals as to the Prescription Files obtained by the Agent in accordance with the terms and conditions of this Agreement; provided, however, that, in the event that the form, scope or methodology of any such appraisal or the appraiser conducting such appraisal is not reasonably acceptable to Agent, upon Agent’s request, Borrowers shall, at their expense, deliver or cause to be delivered to Agent such appraisals reasonably acceptable to Agent and by an appraiser acceptable to Agent, addressed to Agent and Revolving Credit Lenders and upon which Agent and Revolving Credit Lenders are expressly permitted to rely; (iv) Borrowers shall use, store and maintain the Prescription Files with all reasonable care and caution and in accordance with applicable standards of any insurance and in conformity with applicable laws (including the requirements of the HIPAA) except where failure does not cause a material adverse effect; (v) there are no limitations or restrictions on the rights of Borrowers to sell, transfer or otherwise assign the Prescription Files to any third party so long as such third party has the licenses required under applicable state law to operate a pharmacy and sell products subject to a prescription; (vi) Borrowers assume all responsibility and liability arising from or relating to the use and sale of prescriptions and the maintenance and use of the Prescription Files; and (vii) Borrowers shall keep the Prescription Files in good and marketable condition.

4.32.Sale of Valley Drug Company. The Borrowers shall complete the sale of the inventory and accounts receivable located at the New Castle, Pennsylvania facility of Valley Drug Company, by not later than November 30, 2005 for a cash price equal to not less than the amount of Advances then attributed to the assets of Valley Drug Company under the Borrowing Base.

Article 5 - Financial Reporting and Performance Covenants:

5.1.Maintain Records. The Borrowers shall:

(a)At all times, keep proper books of account, in which full, true, and accurate entries shall be made of all of the Borrowers' financial transactions, all in accordance with GAAP applied consistently with prior periods to fairly reflect the Consolidated financial condition of the Borrowers at the close of, and its results of operations for, the periods in question.

(b)Timely provide the Agent with those financial reports, statements, and schedules required by this Article 5 or otherwise, each of which reports, statements and schedules shall be prepared, to the extent applicable, in accordance with GAAP applied consistently with prior periods to fairly reflect the Consolidated financial condition of the Borrowers at the close of, and the results of operations for, the period(s) covered therein.

(c)At all times, keep accurate current records of the Collateral including, without limitation, accurate current stock, cost, and sales records of its Inventory, accurately and sufficiently itemizing and describing the kinds, types, and quantities of Inventory and the cost and selling prices thereof.

(d)At all times, retain independent certified public accountants who are reasonably satisfactory to the Agent and instruct such accountants to fully cooperate with, and be available to, the Agent to discuss the Borrowers' financial performance, financial condition, operating results, controls, and such other matters, within the scope of the retention of such accountants, as may be raised by the Agent.

(e)Not change any Borrower's fiscal year.

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5.2.Access to Records.

(a)Upon reasonable prior notice, each Borrower shall accord the Agent with access from time to time as the Agent may require to all properties owned by or over which any Borrower has control. The Agent shall have the right, and each Borrower will permit the Agent from time to time as Agent may request, to examine, inspect, copy, and make extracts from any and all of the Borrowers' books, records, electronically stored data, papers, and files. Each Borrower shall make all of that Borrower's copying facilities available to the Agent.

(b)Each Borrower hereby authorizes the Agent to:

(i)Inspect, copy, duplicate, review, cause to be reduced to hard copy, run off, draw off, and otherwise use any and all computer or electronically stored information or data which relates to any Borrower, or any service bureau, contractor, accountant, or other person (other than confidential medical records), and directs any such service bureau, contractor, accountant, or other person fully to cooperate with the Agent with respect thereto.

(ii)Verify at any time the Collateral or any portion thereof, including verification with Account Debtors, and/or with each Borrower's computer billing companies, collection agencies, and accountants and to sign the name of each Borrower on any notice to each Borrower's Account Debtors or verification of the Collateral.

(c)The Agent from time to time may designate one or more representatives to exercise the Agent's rights under this Section 5.2 as fully as if the Agent were doing so.

5.3.Immediate Notice to Agent.

(a)The Lead Borrower shall provide the Agent with written notice promptly upon the occurrence of any of the following events, which written notice shall be with reasonable particularity as to the facts and circumstances in respect of which such notice is being given:

(i)Any change in any Borrower's President, chief executive officer, chief operating officer, and chief financial officer (without regard to the title(s) actually given to the Persons discharging the duties customarily discharged by officers with those titles).

(ii)Any ceasing of any Borrower's making of payment, in the ordinary course, to any of its creditors (other than its ceasing of making of such payments on account of a de minimis dispute).

(iii)Any failure by any Borrower to pay rent at any of that Borrower's locations, which failure continues for more than Three (3) days following the last day on which such rent was payable without more than a de minimis adverse effect to that Borrower.

(iv)Any Material Adverse Change.

(v)Any Borrower's becoming In Default.

(vi)Any intention on the part of any Borrower to discharge that Borrower's present independent accountants or any withdrawal or resignation by such independent accountants from their acting in such capacity (as to which, see Subsection 5.1(d)).

(vii)Any litigation which, if determined adversely to a Borrower, is reasonably likely to have a material adverse effect on the financial condition of such Borrower.

(b)The Lead Borrower shall:

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(i)Add the Agent as an addressee on all mailing lists maintained by or for each Borrower.

(ii)Provide the Agent, when received by any Borrower, with a copy of any management letter or similar communications from any accountant of any Borrower.

5.4.Borrowing Base Certificate. The Lead Borrower shall provide the Agent with a Borrowing Base Certificate (in the form of EXHIBIT 5.4 annexed hereto, as such form may be revised from time to time by the Agent) weekly, by 11:30 a.m. on Wednesday of each week (updated as of the then immediately preceding Friday), and on each day on which a Revolving Credit Loan or L/C is requested. Each weekly Borrowing Base Certificate shall be accompanied by such back-up documentation as may be reasonably requested from time to time by the Agent, including, without limitation, sales reports, monthly prescriptions-filled summary, accounts receivable agings, accounts payable agings, and such other information as may be reasonably requested from time to time by the Agent. The foregoing may be sent to the Agent by facsimile transmission, provided that the original thereof is forwarded to the Agent on the date of such transmission.

5.5.Intentionally Omitted.

5.6.Monthly Reports. Monthly, the Lead Borrower shall provide the Agent with those financial statements and reports described in EXHIBIT 5.6, annexed hereto.

5.7.Intentionally Omitted

5.8.Annual Reports.

(a)Annually, within ninety (90) days following the end of the Borrowers' fiscal year, the Lead Borrower shall furnish the Agent with the following:

(i)An original signed counterpart of the Borrowers' Consolidated annual financial statement, which statement shall have been prepared by, and bear the unqualified opinion of, the Lead Borrower's independent certified public accountants (i.e. said statement shall be "certified" by such accountants) and shall include, at a minimum (with comparative information for the then prior fiscal year) a balance sheet, income statement, statement of changes in shareholders' equity, cash flows, and schedules of consolidation.

(ii)The officer's compliance certificate described in Section 5.9.

(b)No later than the earlier of Fifteen (15) days prior to the end of each of the Borrowers' fiscal years or the date on which such accountants commence their work on the preparation of the Borrowers' annual financial statement, the Lead Borrower shall give written notice to such accountants (with a copy of such notice, when sent, to the Agent) that:

(i)Such annual financial statement will be delivered by the Lead Borrower to the Agent (for subsequent distribution to each Revolving Credit Lender).

(ii)It is the primary intention of the Borrowers, in its engagement of such accountants, to satisfy the financial reporting requirements set forth in this Article 5.

(iii)The Lead Borrower has been advised that the Agent and each Revolving Credit Lender will rely thereon with respect to the administration of, and transactions under, the credit facility contemplated by this Agreement.

(c)Each annual statement shall be accompanied by such accountant's Certificate indicating that, in conducting the audit for such annual statement, nothing came to the attention of such accountants to believe that the Borrower is not In Default (or that if the Borrower is in Default, the facts and circumstances thereof).

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(d)The Lead Borrower shall cause the delivery to the Agent, with the annual statement to be furnished by the Lead Borrower pursuant to this section, of an updated financial statement (in form satisfactory to the Agent) of, and signed by each guarantor of the Liabilities, which personal financial statement shall be of a date not more than Fourteen (14) days prior to the date of such delivery and each time when filed by the subject guarantor, a copy of that guarantor's federal income tax return so filed.

5.9.Officers' Certificates. The Lead Borrower shall cause the Lead Borrower's Chief Financial Officer, in each instance, to provide such Person's Certificate with those monthly financial statements to be provided within thirty (30) days of the end of each month and with those to be provided quarterly and annual statements to be furnished pursuant to this Agreement, which Certificate shall:

(a)Indicate that the subject statement was prepared in accordance with GAAP consistently applied and presents fairly the Consolidated financial condition of the Borrowers at the close of, and the results of the Borrowers' operations and cash flows for, the period(s) covered, subject, however to the following:

(i)Usual year end adjustments (this exception shall not be included in the Certificate which accompanies such annual statement).

(ii)Material Accounting Changes (in which event, such Certificate shall include a schedule (in reasonable detail) of the effect of each such Material Accounting Change) not previously specifically taken into account in the determination of the financial performance covenant imposed pursuant to Section 5.12.

(b)Indicate either that (i) no Borrower is In Default, or (ii) if such an event has occurred, its nature (in reasonable detail) and the steps (if any) being taken or contemplated by the Borrowers to be taken on account thereof.

(c)Include calculations concerning the Borrowers' compliance (or failure to comply) at the date of the subject statement with each of the financial performance covenants included in Section 5.12.

5.10.Inventories, Appraisals, and Audits.

(a)The Agent, at the expense of the Borrowers, may participate in and/or observe each physical count and/or inventory of so much of the Collateral as consists of Inventory which is undertaken on behalf of any Borrower.

(b)The Borrowers, at their own expense, shall cause not less than One (1) physical inventory to be undertaken in each Twelve (12) month period during which this Agreement is in effect conducted by such third-party inventory takers as are reasonably satisfactory to the Agent and following such methodology as may be reasonably satisfactory to the Agent.

(i)The Lead Borrower shall provide the Agent with a copy of the preliminary results of each such inventory (as well as of any other physical inventory undertaken by any Borrower) within Ten (10) days following the completion of such inventory.

(ii)The Lead Borrower, within Thirty (30) days following the completion of such inventory, shall provide the Agent with a reconciliation of the results of each such inventory (as well as of any other physical inventory undertaken by any Borrower) and shall post such results to the Borrowers' stock ledger and, as applicable to the Borrowers' other financial books and records.

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(iii)The Agent, in its discretion, if any Borrower is In Default, may cause such additional inventories to be taken as the Agent determines (each, at the expense of the Borrowers).

(c)The Agent may obtain appraisals of the Collateral, from time to time (in all events, at the Borrowers' expense) conducted by such third-party appraisers as are reasonably satisfactory to the Agent.

(d)The Agent contemplates conducting Four (4) commercial finance field examinations (in each event, at the Borrowers' expense) of the Borrowers' books and records during any Twelve (12) month period during which this Agreement is in effect, but in its discretion, may undertake additional such audits (likewise at the Borrower's expense) during such period.

5.11.Additional Financial Information.

(a)In addition to all other information required to be provided pursuant to this Article 5, the Lead Borrower promptly shall provide the Agent (and any guarantor of the Liabilities), with such other and additional information concerning the Borrowers, the Collateral, the operation of the Borrowers' business, and the Borrowers' financial condition, including original counterparts of financial reports and statements, as the Agent may from time to time reasonably request from the Lead Borrower.

(b)The Lead Borrower may provide the Agent, from time to time hereafter, with updated forecasts of the Borrowers' anticipated performance and operating results.

(c)In all events, the Lead Borrower, no sooner than Ninety (90) nor later than Sixty (60) days prior to the end of each of the Borrowers' fiscal years, shall provide the Agent with an updated and extended forecast which shall go out at least through the end of the then next fiscal year and shall include an income statement, balance sheet, and statement of cash flow, by month, each Consolidated (with consolidating schedules) and each prepared in conformity with GAAP and consistent with the Borrowers' then current practices.

(d)The Agent, following the receipt of any of such forecast, may, but shall not be under any obligation to, provide its written sign-off on such forecast (in which event, such forecast shall become the Business Plan) and if it provides such written sign-off, may by written notice to the Lead Borrower, extend or revise the financial performance covenants included on EXHIBIT 5.12, annexed hereto.

(e)In the event that the Agent does not provide its sign-off with respect to the updated and extended forecast to be provided at year-end pursuant to Section 5.11(c), then the Agent, by written notice to the Lead Borrower, may revise, roll-over, or extend, for the then coming fiscal year, the financial performance covenants applicable to the Borrowers pursuant to Section 5.12 by extrapolation from the Business Plan.

(f)Each Borrower recognizes that all appraisals, inventories, analysis, financial information, and other materials which the Agent may obtain, develop, or receive with respect to the Borrowers are confidential to the Agent and that, except as otherwise provided herein, no Borrower is entitled to receipt of any of such appraisals, inventories, analysis, financial information, and other materials, nor copies or extracts thereof or therefrom.

5.12.Financial Performance Covenants. Agent and Lead Borrower shall make good faith efforts to reach agreement as to applicable financial performance covenants. On and after such date as financial performance covenants are agreed upon, the Borrowers shall observe and comply with those financial performance covenants which shall be set forth on EXHIBIT 5.12(a), certain of which covenants shall be based on the then-current Business Plan. Such financial performance covenants shall be subject to change, revision, roll over, and extension as provided in Section 5.11(d). Compliance with such financial performance covenants shall be made as if no Material Accounting Changes had been made (other than any Material Accounting Changes specifically taken into account in the setting of such covenants). The Agent may determine the Borrowers' compliance with such covenants based upon financial reports and statements provided by the Lead Borrower to the Agent (whether or not such financial reports and statements are required to be furnished pursuant to this Agreement) as well as by reference to interim financial information provided to, or developed by, the Agent.

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Article 6 - Use of Collateral:

6.1.Use of Inventory Collateral.

(a)No Borrower shall engage in any of the following with respect to its Inventory:

(i)Any sale other than

(A)for fair consideration in the conduct of the Borrowers' business in the ordinary course or,

(B)a Permitted Disposition.

(ii)Sales or other dispositions to creditors.

(iii)Sales or other dispositions in bulk (other than as part of a Permitted Disposition).

(iv)Sales of any Collateral in breach of any provision of this Agreement.

(b)No sale of Inventory shall be on consignment, approval, or under any other circumstances such that, such Inventory may be returned to a Borrower without the consent of the Agent.

6.2.Inventory Quality. All Inventory now owned or hereafter acquired by each Borrower is and will be of good and merchantable quality and free from defects (other than defects within customary trade tolerances).

6.3.Adjustments and Allowances. Each Borrower may grant such allowances or other adjustments to that Borrower's Account Debtors (exclusive of extending the time for payment of any Account or Account Receivable, which shall not be done without first obtaining the Agent's prior written consent in each instance) as that Borrower may reasonably deem to accord with sound business practice, provided, however, the authority granted the Borrowers pursuant to this Section 6.3 may be limited or terminated by the Agent at any time in the Agent's discretion.

6.4.Validity of Accounts.

(a)The amount of each Account shown on the books, records, and invoices of the Borrowers represented as owing by each Account Debtor is and will be the correct amount actually owing by such Account Debtor and shall have been fully earned by performance by the Borrowers.

(b)The Agent from time to time may verify the Receivables Collateral directly with the Borrowers' Account Debtors, such verification to be undertaken in keeping with commercially reasonable commercial lending standards.

(c)No Borrower has any knowledge of any impairment of the validity or collectability of any of the Accounts. The Lead Borrower shall notify the Agent of any such impairment immediately after any Borrower becomes aware of any such impairment.

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(d)No Borrower shall post any bond to secure any Borrower's performance under any agreement to which any Borrower is a party nor cause any surety, guarantor, or other third party obligee to become liable to perform any obligation of any Borrower (other than to the Agent) in the event of any Borrower's failure so to perform.

6.5.Notification to Account Debtors. The Agent shall have the right (upon the occurrence and during the continuance of an Event of Default) to notify any of the Borrowers' Account Debtors to make payment directly to the Agent and to collect all amounts due on account of the Collateral.

Article 7 - Cash Management. Payment of Liabilities:

7.1.The Concentration, Blocked, and Operating Accounts.

(a)The following checking accounts have been or will be established (and are so referred to herein):

(i)The "Concentration Account" (so referred to herein): Established by the Agent with BOA.

(ii)The "Blocked Accounts" (so referred to herein): Established by the Lead Borrower with BOA.

(iii)The "Operating Account" (so referred to herein): Established by the Lead Borrower with BOA.

(b)The contents of each DDA (other than the Operating Account) and of the Blocked Accounts constitutes Collateral and Proceeds of Collateral. The contents of the Concentration Account constitutes the Agent's property.

(c)The Borrowers shall pay all fees and charges of, and maintain such impressed balances as may be required by the depository in which any account is opened as required hereby (even if such account is opened by and/or is the property of the Agent).

7.2.Proceeds and Collections.

(a)All Receipts and all cash proceeds of any sale or other disposition of any of each Borrower's assets:

(i)Constitute Collateral and proceeds of Collateral.

(ii)Shall be held in trust by the Borrowers for the Agent.

(iii)Shall not be commingled with any of any Borrower's other funds.

(iv)Shall be deposited and/or transferred only to the Blocked Accounts or the Concentration Account.

(b)The Lead Borrower shall cause the ACH or wire transfer to the Blocked Accounts or the Concentration Accounts, not less frequently than daily (except that the Agent may in its discretion agree that certain DDA’s related to individual stores may be swept not more often than weekly), and whether or not there is then an outstanding balance in the Loan Account, of the following:

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(i)The then contents of each DDA (other than any Exempt DDA), each such transfer to be net of any minimum balance, not to exceed $1,000.00, as may be required to be maintained in the subject DDA by the bank at which such DDA is maintained.

(ii)The proceeds of all credit card charges not otherwise provided for pursuant hereto.

(iii)Telephone advice (confirmed by written notice) shall be provided to the Agent on each Business Day on which any such transfer is made.

(c)Whether or not any Liabilities are then outstanding, the Lead Borrower shall cause the ACH or wire transfer to the Concentration Account, no less frequently than daily, of then entire ledger balance of the Blocked Accounts, net of such minimum balance, not to exceed $1,000.00 as may be required to be maintained in a Blocked Account by the depository which such Blocked Account is maintained.

(d)In the event that, notwithstanding the provisions of this Section 7.2, any Borrower receives or otherwise has dominion and control of any Receipts, or any proceeds or collections of any Collateral, such Receipts, proceeds, and collections shall be held in trust by that Borrower for the Agent and shall not be commingled with any of that Borrower's other funds or deposited in any account of any Borrower other than as instructed by the Agent.

7.3.Payment of Liabilities.

(a)On each Business Day, the Agent shall apply the then collected balance of the Concentration Account (net of fees charged, and of such impressed balances as may be required by the bank at which the Concentration Account is maintained) towards the unpaid balance of the Loan Account and all other Liabilities, provided, however, for purposes of the calculation of interest on the unpaid principal balance of the Loan Account, such payment shall be deemed to have been made one (1) Business Day after such transfer.

(b)The following rules shall apply to deposits and payments under and pursuant to this Section 7.3:

(i)Funds shall be deemed to have been deposited to the Concentration Account on the Business Day on which deposited, provided that notice of such deposit is available to the Agent by 2:00 p.m. on that Business Day.

(ii)Funds paid to the Agent, other than by deposit to the Concentration Account, shall be deemed to have been received on the Business Day when they are good and collected funds, provided that notice of such payment is available to the Agent by 2:00 p.m. on that Business Day.

(iii)If notice of a deposit to the Concentration Account (Section 7.3(b)(i) or payment (Section 7.3(b)(ii)) is not available to the Agent until after 2:00 p.m. on a Business Day, such deposit or payment shall be deemed to have been made at 9:00 a.m. on the then next Business Day.

(iv)All deposits to the Concentration Account and other payments to the Agent are subject to clearance and collection.

(c)The Agent shall transfer to the Operating Account any surplus in the Concentration Account remaining after the application towards the Liabilities referred to in Section 7.3(a), above (less those amount which are to be netted out, as provided therein) provided, however, in the event that

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(i)any Borrower is In Default; and

(ii)one or more L/C's are then outstanding,

then the Agent may establish a funded reserve of up to 110% of the aggregate Stated Amounts of such L/C's. Such funded reserve shall either be (i) returned to the Lead Borrower provided that no Borrower is In Default or (ii) applied towards the Liabilities following the occurrence of any Event of Default described in Section 10.11 or acceleration following the occurrence of any other Event of Default.

7.4.The Operating Account. Except as otherwise specifically provided in, or permitted by, this Agreement, all checks shall be drawn by the Lead Borrower upon, and other disbursements shall be made by the Lead Borrower solely from, the Operating Account.

7.5.Medicare and Medicaid Payments.The Borrowers shall cause all Medicare and Medicaid payments, and only Medicare and Medicaid payments, to be remitted to such post office lockbox address(es) as is provided in the Governmental Receivables Lockbox Account Agreement, and the remittances shall then be processed by BOA for deposit in the lockbox account established by Borrowers with BOA (the “Government Receivables Lockbox Account”). As provided in the Governmental Receivables Blocked Account Agreement, all amounts in the Governmental Receivables Lockbox Account shall be swept daily to the applicable blocked account at BOA (the “Government Receivables Blocked Account”). Borrowers shall not cause, or permit to occur, any modification to the Governmental Receivables Lockbox Account Agreement or Governmental Receivables Blocked Account Agreement, or to the flow of funds as contemplated by those agreements.

Article 8 - Grant of Security Interest:

8.1.Grant of Security Interest. To secure the Borrowers' prompt, punctual, and faithful performance of all and each of the Liabilities, each Borrower hereby grants to the Agent, for the ratable benefit of the Revolving Credit Lenders, a continuing security interest in and to, and assigns to the Agent, for the ratable benefit of the Revolving Credit Lenders, the following, and each item thereof, whether now owned or now due, or in which that Borrower has an interest, or hereafter acquired, arising, or to become due, or in which that Borrower obtains an interest, and all products, Proceeds, substitutions, and accessions of or to any of the following (all of which, together with any other property in which the Agent may in the future be granted a security interest, is referred to herein as the "Collateral"):

(a)All Accounts and accounts receivable.

(b)All Inventory.

(c)All General Intangibles.

(d)All Equipment.

(e)All Goods.

(f)All Fixtures.

(g)All Chattel Paper.

(h)All Health-Care-Insurance Receivables.

(i)All Letter-of-Credit Rights.

(j)All Payment Intangibles.

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(k)All Supporting Obligations.

(l)All books, records, and information relating to the Collateral and/or to the operation of each Borrowers' business, and all rights of access to such books, records, and information, and all property in which such books, records, and information are stored, recorded, and maintained.

(m)All Leasehold Interests.

(n)All Investment Property, Instruments, Documents, Deposit Accounts, money, policies and certificates of insurance, deposits, impressed accounts, compensating balances, cash, or other property.

(o)All insurance proceeds, refunds, and premium rebates, including, without limitation, proceeds of fire and credit insurance, whether any of such proceeds, refunds, and premium rebates arise out of any of the foregoing. (8.1(a)) through 8.1(n)) or otherwise.

(p)All liens, guaranties, rights, remedies, and privileges pertaining to any of the foregoing (8.1(a)) through 8.1(o)), including the right of stoppage in transit.

8.2.Extent and Duration of Security Interest.

(a)The security interest created and granted herein is in addition to, and supplemental of, any security interest previously granted by any Borrower to the Agent and shall continue in full force and effect applicable to all Liabilities until both

(i)all Liabilities have been paid and/or satisfied in full; and

(ii)the security interest created herein is specifically terminated in writing by a duly authorized officer of the Agent.

(b)It is intended that the Collateral Interests created herein extend to and cover all assets of each Borrower, other than those assets specifically excluded from the Collateral, as set forth on EXHIBIT 8.2(b), annexed hereto.

Article 9 - Agent As Borrowers' Attorney-In-Fact:

9.1.Appointment as Attorney-In-Fact. Each Borrower hereby irrevocably constitutes and appoints the Agent (acting through any officer of the Agent) as that Borrowers' true and lawful attorney, with full power of substitution, following the occurrence and during the continuance of an Event of Default, to convert the Collateral into cash at the sole risk, cost, and expense of that Borrower, but for the sole benefit of the Agent and the Revolving Credit Lenders. The rights and powers granted the Agent by this appointment include but are not limited to the right and power to:

(a)Prosecute, defend, compromise, or release any action relating to the Collateral.

(b)Sign change of address forms to change the address to which each Borrowers' mail is to be sent to such address as the Agent shall designate; receive and open each Borrowers' mail; remove any Receivables Collateral and Proceeds of Collateral therefrom and turn over the balance of such mail either to the Lead Borrower or to any trustee in bankruptcy or receiver of the Lead Borrower, or other legal representative of a Borrower whom the Agent determines to be the appropriate person to whom to so turn over such mail.

(c)Endorse the name of the relevant Borrower in favor of the Agent upon any and all checks, drafts, notes, acceptances, or other items or instruments; sign and endorse the name of the relevant Borrower on, and receive as secured party, any of the Collateral, any invoices, schedules of Collateral, freight or express receipts, or bills of lading, storage receipts, warehouse receipts, or other documents of title respectively relating to the Collateral.

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(d)Sign the name of the relevant Borrower on any notice to that Borrowers' Account Debtors or verification of the Receivables Collateral; sign the relevant Borrowers' name on any Proof of Claim in Bankruptcy against Account Debtors, and on notices of lien, claims of mechanic's liens, or assignments or releases of mechanic's liens securing the Accounts.

(e)Take all such action as may be necessary to obtain the payment of any letter of credit and/or banker's acceptance of which any Borrower is a beneficiary.

(f)Repair, manufacture, assemble, complete, package, deliver, alter or supply goods, if any, necessary to fulfill in whole or in part the purchase order of any customer of each Borrower.

(g)Use, license or transfer any or all General Intangibles of each Borrower.

9.2.No Obligation to Act. The Agent shall not be obligated to do any of the acts or to exercise any of the powers authorized by Section 9.1 herein, but if the Agent elects to do any such act or to exercise any of such powers, it shall not be accountable for more than it actually receives as a result of such exercise of power, and shall not be responsible to any Borrower for any act or omission to act except for any act or omission to act as to which there is a final determination made in a judicial proceeding (in which proceeding the Agent has had an opportunity to be heard) which determination includes a specific finding that the subject act or omission to act had been grossly negligent or in actual bad faith.

Article 10 - Events of Default:

The occurrence of any event described in this Article 10 - respectively shall constitute an "Event of Default" herein. The occurrence of any Event of Default shall also constitute, without notice or demand, a default under all other agreements between the Agent or any Revolving Credit Lender and any Borrower and instruments and papers heretofore, now, or hereafter given the Agent or any Revolving Credit Lender by any Borrower.

10.1.Failure to Pay the Revolving Credit. The failure by any Borrower to pay when due any principal of, interest on, or fees in respect of, the Revolving Credit.

10.2.Failure To Make Other Payments. The failure by any Borrower to pay within five (5) days of when due (or upon demand, if payable on demand), any payment Liability other than any payment liability on account of the principal of, or interest on, or fees in respect of, the Revolving Credit.

10.3.Failure to Perform Covenant or Liability (No Grace Period). The failure by any Borrower to promptly, punctually, faithfully and timely perform, discharge, or comply with any covenant or Liability included in any of the following provisions hereof:

Section	Relates to
4.6	Encumbrances
4.7	Indebtedness
4.19	Dividends. Investments. Other Corporate Actions
4.28	Pharmaceutical Laws
Article 7 -	Cash Management

10.4.Failure to Perform Covenant or Liability (Grace Period). The failure by the Borrowers to comply with (i) any covenant or Liability in Section 4.14 or Article 5 which failure continues without cure for a period of five (5) days following the earlier of the Borrowers’ knowledge of such breach or of the receipt by Lead Borrower of written notice from the Agent of such breach) or (ii) any covenant or Liability not described in Sections 10.1, 10.2, 10.3 or 10.4(i) which failure continues without cure for a period of thirty (30) days following the earlier of the Borrowers’ knowledge of such breach or receipt by Lead Borrower of written notice from the Lender of such breach).

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10.5.Misrepresentation. The determination by the Agent that any representation or warranty at any time made by any Borrower to the Agent or any Revolving Credit Lender was not true or complete in all material respects when given.

10.6.Acceleration of Other Debt. Breach of Lease. The occurrence of any event such that any Indebtedness of any Borrower to any creditor other than the Agent or any Revolving Credit Lender could be accelerated or, without the consent of any Borrower, any Lease could be terminated (whether or not the subject creditor or lessor takes any action on account of such occurrence).

10.7.Default Under Other Agreements. The occurrence of any breach of any covenant or Liability imposed by, or of any default under, any agreement (including any Loan Document) between the Agent or any Revolving Credit Lender and any Borrower or instrument given by any Borrower to the Agent or any Revolving Credit Lender and the expiry, without cure, of any applicable grace period (notwithstanding that the subject Agent or Revolving Credit Lender may not have exercised all or any of its rights on account of such breach or default).

10.8.Uninsured Casualty Loss. The occurrence of any uninsured loss, theft, damage, or destruction of or to any material portion of the Collateral.

10.9.Attachment. Judgment. Restraint of Business.

(a)The service of process upon the Agent or any Revolving Credit Lender or any Participant seeking to attach, by trustee, mesne, or other process, any funds of any Borrower on deposit with, or assets of any Borrower in the possession of, the Agent or that Revolving Credit or such Participant.

(b)The entry of any judgment against any Borrower, which judgment is not satisfied (if a money judgment) or appealed from (with execution or similar process stayed) within thirty (30) days of its entry.

(c)The entry of any order or the imposition of any other process having the force of law, the effect of which is to restrain in any material way the conduct by any Borrower of its business in the ordinary course.

10.10.Business Failure. Any act by, against, or relating to any Borrower, or its property or assets, which act constitutes the determination, by any Borrower, to initiate a program of partial or total self-liquidation; application for, consent to, or sufferance of the appointment of a receiver, trustee, or other person, pursuant to court action or otherwise, over all, or any part of any Borrower's property; the granting of any trust mortgage or execution of an assignment for the benefit of the creditors of any Borrower, or the occurrence of any other voluntary or involuntary liquidation or extension of debt agreement for any Borrower; the offering by or entering into by any Borrower of any composition, extension, or any other arrangement seeking relief from or extension of the debts of any Borrower; or the initiation of any judicial or non-judicial proceeding or agreement by, against, or including any Borrower which seeks or intends to accomplish a reorganization or arrangement with creditors; and/or the initiation by or on behalf of any Borrower of the liquidation or winding up of all or any part of any Borrower's business or operations.

10.11.Bankruptcy. The failure by any Borrower to generally pay the debts of that Borrower as they mature; adjudication of bankruptcy or insolvency relative to any Borrower; the entry of an order for relief or similar order with respect to any Borrower in any proceeding pursuant to the Bankruptcy Code or any other federal bankruptcy law; the filing of any complaint, application, or petition by any Borrower initiating any matter in which any Borrower is or may be granted any relief from the debts of that Borrower pursuant to the Bankruptcy Code or any other insolvency statute or procedure; the filing of any complaint, application, or petition against any Borrower initiating any matter in which that Borrower is or may be granted any relief from the debts of that Borrower pursuant to the Bankruptcy Code or any other insolvency statute or procedure, which complaint, application, or petition is not timely contested in good faith by that Borrower by appropriate proceedings or, if so contested, is not dismissed within thirty (30) days of when filed.

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10.12.Indictment - Forfeiture. The indictment of, or institution of any legal process or proceeding against, any Borrower, under any Applicable Law where the relief, penalties, or remedies sought or available include the forfeiture of any property of any Borrower and/or the imposition of any stay or other order, the effect of which would be reasonably likely to be a Material Adverse Change.

10.13.Guarantor's Default.The occurrence of any Guarantor's Default.

10.14.Termination of Guaranty. The termination or attempted termination of any guaranty by any guarantor of the Liabilities.

10.15.Challenge to Loan Documents.

(a)Any challenge by or on behalf of any Borrower to the validity of any Loan Document or the applicability or enforceability of any Loan Document strictly in accordance with the subject Loan Document's terms or which seeks to void, avoid, limit, or otherwise adversely affect any security interest created by or in any Loan Document or any payment made pursuant thereto.

(b)Any determination by any court or any other judicial or government authority that any Loan Document is not enforceable strictly in accordance with the subject Loan Document's terms or which voids, avoids, limits, or otherwise adversely affects any security interest created by any Loan Document or any payment made pursuant thereto.

10.16.Change in Control. Any Change in Control.

Article 11 - Rights and Remedies Upon Default:

11.1.Acceleration. Upon the occurrence of any Event of Default as described in Section 10.11, all Liabilities shall be immediately due and payable. Upon the occurrence of any Event of Default other than as described in Section 10.11, the Agent may (and on the issuance of Acceleration Notice(s) requisite to the causing of Acceleration, the Agent shall) declare all Liabilities to be immediately due and payable and may exercise all of the Agent's Rights and Remedies as the Agent from time to time thereafter determines as appropriate.

11.2.Rights of Enforcement. The Agent shall have all of the rights and remedies of a secured party upon default under the UCC, in addition to which the Agent shall have all and each of the following rights and remedies:

(a)To give notice to any bank at which any DDA or Blocked Account is maintained and in which Proceeds of Collateral are deposited, to turn over such Proceeds directly to the Agent.

(b)To give notice to any customs broker of any of the Borrowers to follow the instructions of the Agent as provided in any written agreement or undertaking of such broker in favor of the Agent.

(c)To collect the Receivables Collateral with or without the taking of possession of any of the Collateral.

(d)To take possession of all or any portion of the Collateral.

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(e)To sell, lease, or otherwise dispose of any or all of the Collateral, in its then condition or following such preparation or processing as the Agent deems advisable and with or without the taking of possession of any of the Collateral.

(f)To apply the Receivables Collateral or the Proceeds of the Collateral towards (but not necessarily in complete satisfaction of) the Liabilities.

(g)To exercise all or any of the rights, remedies, powers, privileges, and discretions under all or any of the Loan Documents.

11.3.Sale of Collateral.

(a)Any sale or other disposition of the Collateral may be at public or private sale upon such terms and in such manner as the Agent deems advisable, having due regard to compliance with any statute or regulation which might affect, limit, or apply to the Agent's disposition of the Collateral.

(b)Unless the Collateral is perishable or threatens to decline speedily in value, or is of a type customarily sold on a recognized market (in which event the Agent shall provide the Lead Borrower such notice as may be practicable under the circumstances), the Agent shall give the Lead Borrower at least ten (10) days prior notice, by authenticated record, of the date, time, and place of any proposed public sale, and of the date after which any private sale or other disposition of the Collateral may be made. Each Borrower agrees that such written notice shall satisfy all requirements for notice to that Borrower which are imposed under the UCC or other applicable law with respect to the exercise of the Agent's rights and remedies upon default.

(c)The Agent and any Revolving Credit Lender may purchase the Collateral, or any portion of it at any sale held under this Article.

(d)If any of the Collateral is sold, leased, or otherwise disposed of by the Agent on credit, the Liabilities shall not be deemed to have been reduced as a result thereof unless and until payment is finally received thereon by the Agent.

(e)The Agent shall apply the proceeds of the Agent's exercise of its rights and remedies upon default pursuant to this Article 11.

11.4.Occupation of Business Location. In connection with the Agent's exercise of the Agent's rights under this Article 11, the Agent may enter upon, occupy, and use any premises owned or occupied by each Borrower, and may exclude each Borrower from such premises or portion thereof as may have been so entered upon, occupied, or used by the Agent. The Agent shall not be required to remove any of the Collateral from any such premises upon the Agent's taking possession thereof, and may render any Collateral unusable to the Borrowers. In no event shall the Agent be liable to any Borrower for use or occupancy by the Agent of any premises pursuant to this Article 11, nor for any charge (such as wages for any Borrowers' employees and utilities) incurred in connection with the Agent's exercise of the Agent's Rights and Remedies.

11.5.Grant of Nonexclusive License. Each Borrower hereby grants to the Agent a royalty free nonexclusive irrevocable license to use, apply, and affix any trademark, trade name, logo, or the like in which any Borrower now or hereafter has rights, such license being with respect to the Agent's exercise of the rights hereunder including, without limitation, in connection with any completion of the manufacture of Inventory or sale or other disposition of Inventory.

11.6.Assembly of Collateral. The Agent may require any Borrower to assemble the Collateral and make it available to the Agent at the Borrowers' sole risk and expense at a place or places which are reasonably convenient to both the Agent and the Lead Borrower.

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11.7.Rights and Remedies. The rights, remedies, powers, privileges, and discretions of the Agent hereunder (herein, the “Agent’s Rights and Remedies") shall be cumulative and not exclusive of any rights or remedies which it would otherwise have. No delay or omission by the Agent in exercising or enforcing any of the Agent's Rights and Remedies shall operate as, or constitute, a waiver thereof. No waiver by the Agent of any Event of Default or of any default under any other agreement shall operate as a waiver of any other default hereunder or under any other agreement. No single or partial exercise of any of the Agent's Rights or Remedies, and no express or implied agreement or transaction of whatever nature entered into between the Agent and any person, at any time, shall preclude the other or further exercise of the Agent's Rights and Remedies. No waiver by the Agent of any of the Agent's Rights and Remedies on any one occasion shall be deemed a waiver on any subsequent occasion, nor shall it be deemed a continuing waiver. The Agent's Rights and Remedies may be exercised at such time or times and in such order of preference as the Agent may determine. The Agent's Rights and Remedies may be exercised without resort or regard to any other source of satisfaction of the Liabilities.

Article 12 - Revolving Credit Fundings and Distributions:

12.1.Revolving Credit Funding Procedures. Subject to Section 12.2:

(a)The Agent shall advise each Revolving Credit Lender, no later than 2:00 p.m. on a date on which any Revolving Credit Loan is to be made on that date. Such advice, in each instance, may be by telephone or facsimile transmission, provided that if such advice is by telephone, it shall be confirmed in writing. Advice of a Revolving Credit Loan shall include the amount of and interest rate applicable to the subject Revolving Credit Loan.

(b)Subject to that Revolving Credit Lender's Revolving Credit Dollar Commitment, each Revolving Credit Lender, by no later than the end of business on the day on which the subject Revolving Credit Loan is to be made, shall Transfer that Revolving Credit Lender's Revolving Credit Percentage Commitment of the subject Revolving Credit Loan to the Agent.

12.2.Agent's Covering of Fundings:

(a)Each Revolving Credit Lender shall make available to the Agent, as provided herein, that Revolving Credit Lender's Revolving Credit Percentage Commitment of the following:

(i)Each Revolving Credit Loan, up to the maximum amount of that Revolving Credit Lender's Revolving Credit Dollar Commitment of the Revolving Credit Loans.

(ii)Up to the maximum amount of that Revolving Credit Lender's Revolving Credit Dollar Commitment of each L/C Drawing (to the extent that such L/C Drawing is not "covered" by a Revolving Credit Loan as provided herein).

(b)In all circumstances, the Agent may:

(i)Assume that each Revolving Credit Lender, subject to Section 12.3(a), timely shall make available to the Agent that Revolving Credit Lender's Revolving Credit Percentage Commitment of each Revolving Credit Loan, notice of which is provided pursuant to Section 12.1 and shall make available, to the extent not "covered" by a Revolving Credit Loan, that Revolving Credit Lender's Revolving Credit Percentage Commitment of any honoring of an L/C.

(ii)In reliance upon such assumption, make available the corresponding amount to the Borrowers.

(iii)(Assume that each Revolving Credit Lender timely shall pay, and shall make available, to the Agent all other amounts which that Revolving Credit Lender is obligated to so pay and/or make available hereunder or under any of the Loan Documents.

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(c)In the event that, in reliance upon any of such assumptions, the Agent makes available, a Revolving Credit Lender's Revolving Credit Percentage Commitment of one or more Revolving Credit Loans, or any other amount to be made available hereunder or under any of the Loan Documents, which amount a Revolving Credit Lender (a "Delinquent Revolving Credit Lender") fails to provide to the Agent within One (1) Business Day of written notice of such failure, then:

(i)The amount which had been made available by the Agent is an "Agent's Cover" (and is so referred to herein).

(ii)All interest paid by the Borrowers on account of the Revolving Credit Loan or coverage of the subject L/C Drawing which consist of the Agent's Cover shall be retained by the Agent until the Agent's Cover, with interest, has been paid.

(iii)The Delinquent Revolving Credit Lender shall pay to the Agent, on demand, interest at a rate equal to the prevailing federal funds rate on any Agent's Cover in respect of that Delinquent Revolving Credit Lender

(iv)The Agent shall have succeeded to all rights to payment to which the Delinquent Revolving Credit Lender otherwise would have been entitled hereunder in respect of those amounts paid by or in respect of the Borrowers on account of the Agent's Cover together with interest until it is repaid. Such payments shall be deemed made first towards the amounts in respect of which the Agent's Cover was provided and only then towards amounts in which the Delinquent Revolving Credit Lender is then participating. For purposes of distributions to be made pursuant to Section 12.3(a) (which relates to ordinary course distributions) or Section 13.6 (which relates to distributions of proceeds of a Liquidation) below, amounts shall be deemed distributable to a Delinquent Revolving Credit Lender (and consequently, to the Agent to the extent to which the Agent is then entitled) at the highest level of distribution (if applicable) at which the Delinquent Revolving Credit Lender would otherwise have been entitled to a distribution.

(v)Subject to Subsection 12.2(c)(iv), the Delinquent Revolving Credit Lender shall be entitled to receive any payments from the Borrowers to which the Delinquent Revolving Credit Lender is then entitled, provided however there shall be deducted from such amount and retained by the Agent any interest to which the Agent is then entitled on account of Section 12.2(c)(ii), above.

(d)A Delinquent Revolving Credit Lender shall not be relieved of any obligation of such Delinquent Revolving Credit Lender hereunder (all and each of which shall constitute continuing obligations on the part of any Delinquent Revolving Credit Lender).

(e)A Delinquent Revolving Credit Lender may cure its status as a Delinquent Revolving Credit Lender by paying the Agent the aggregate of the following:

(i)The Agent's Cover (to the extent not previously repaid by the Borrowers and retained by the Agent in accordance with Subsection 12.2(c)(iv)), above) with respect to that Delinquent Revolving Credit Lender.

Plus

(ii)The aggregate of the amount payable under Subsection 12.2(c)(iii), above (which relates to interest to be paid by that Delinquent Revolving Credit Lender).

Plus

(iii)All such costs and expenses as may be incurred by the Agent in the enforcement of the Agent's rights against such Delinquent Revolving Credit Lender.

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12.3.Ordinary Course Distributions. (This Section 12.3 applies unless the provisions of Section 13.6 (which relates to distributions in the event of a Liquidation) becomes operative).

(a)On such day as may be set from time to time by the Agent (or more frequently at the Agent's option) the Agent and each Revolving Credit Lender shall settle up on amounts advanced under the Revolving Credit and collected funds received in the Concentration Account.

(b)The Agent shall distribute to each Revolving Credit Lender, such Person's respective pro-rata share of interest payments on the Revolving Credit Loans when actually received and collected by the Agent (excluding the Two (2) Business Days for settlement provided for in Section 7.3(a), which shall be for the account of the Agent only). For purposes of calculating interest due to a Revolving Credit Lender, that Revolving Credit Lender shall be entitled to receive interest on the actual amount contributed by that Revolving Credit Lender towards the principal balance of the Revolving Credit Loans outstanding during the applicable period covered by the interest payment made by the Borrowers. Any net principal reductions to the Revolving Credit Loans received by the Agent in accordance with the Loan Documents during such period shall not reduce such actual amount so contributed, for purposes of calculation of interest due to that Revolving Credit Lender, until the Agent has distributed to that Revolving Credit Lender its pro-rata share thereof.

(c)No Revolving Credit Lender shall have any interest in, or right to receive any part of any interest which reflects "float" as described in the proviso included in Section 7.3(a). Any such float shall be for the account of the Agent only.

(d)No Revolving Credit Lender shall have any interest in, or right to receive any part of, the any fees to be paid by the Borrowers to the Agent pursuant to the Fee Letter.

(e)Any amount received by the Agent as reimbursement for any cost or expense (including without limitation, attorneys' reasonable fees) shall be distributed by the Agent to that Person which is entitled to such reimbursement as provided in this Agreement (and if such Person(s) is (are) the Revolving Credit Lenders, pro-rata based upon their respective Revolving Credit Commitment Percentages at the date on which the expense, in respect of which such reimbursement is being made, was incurred).

(f)Each distribution pursuant to this Section 12.3 is subject to Section 12.2(c), above.

Article 13 - Acceleration and Liquidation:

13.1.Acceleration Notices

(a)The Agent may give the Revolving Credit Lenders an Acceleration Notice at any time following the occurrence of an Event of Default.

(b)The SuperMajority Lenders may give the Agent an Acceleration Notice at any time following the occurrence of an Event of Default. Such notice may be by multiple counterparts, provided that counterparts executed by the requisite Revolving Credit Lenders are received by the Agent within a period of five (5) consecutive Business Days.

13.2.Acceleration. Unless stayed by judicial or statutory process, the Agent shall Accelerate the Liabilities on account of the Revolving Credit within a commercially reasonable time following:

(a)The Agent's giving of an Acceleration Notice to the Revolving Credit Lenders as provided in Section 13.1(a).

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(b)The Agent's receipt of an Acceleration Notice from the SuperMajority Lenders, in compliance with Section 13.1(b).

13.3.Initiation of Liquidation. Unless stayed by judicial or statutory process, a Liquidation shall be initiated by the Agent within a commercially reasonable time following Acceleration of Liabilities on account of the Revolving Credit.

13.4.Actions At and Following Initiation of Liquidation

(a)At the initiation of a Liquidation the Agent and the Revolving Credit Lenders shall "net out" each Revolving Credit Lender's respective contributions towards the Revolving Credit Loans, so that each Revolving Credit Lender holds that Revolving Credit Lender's Revolving Credit Percentage Commitment of the Revolving Credit Loans and advances.

(b)Following the initiation of a Liquidation, each Revolving Credit Lender shall contribute, towards any L/C thereafter honored and not immediately reimbursed by the Borrowers, that Revolving Credit Lender's Revolving Credit Percentage Commitment of such honoring.

13.5.Agent's Conduct of Liquidation

(a)Any Liquidation shall be conducted by the Agent, with the advice and assistance of the Revolving Credit Lenders.

(b)The Agent may establish one or more Nominees to "bid in" or otherwise acquire ownership to any Post Foreclosure Asset.

(c)The Agent shall manage the Nominee and manage and dispose of any Post Foreclosure Assets with a view towards the realization of the economic benefits of the ownership of the Post Foreclosure Assets and in such regard, the Agent and/or the Nominee may operate, repair, manage, maintain, develop, and dispose of any Post Foreclosure Asset in such manner as the Agent determines as appropriate under the circumstances.

(d)The Agent may decline to undertake or to continue taking a course of action or to execute an action plan (whether proposed by the Agent or any Revolving Credit Lender) unless indemnified to the Agent's satisfaction by the Revolving Credit Lenders against any and all liability and expense which may be incurred by the Agent by reason of taking or continuing to take that course of action or action plan.

(e)Each Revolving Credit Lender shall execute all such instruments and documents not inconsistent with the provisions of this Agreement as the Agent and/or the Nominee reasonably may request with respect to the creation and governance of any Nominee, the conduct of the Liquidation, and the management and disposition of any Post Foreclosure Asset.

13.6.Distribution of Liquidation Proceeds:

(a)The Agent may establish one or more reasonably funded reserve accounts into which proceeds of the conduct of any Liquidation may be deposited in anticipation of future expenses which may be incurred by the Agent in the exercise of rights as a secured creditor of the Borrowers and prior claims which the Agent anticipates may need to be paid.

(b)The Agent shall distribute the net proceeds of Liquidation in accordance with the relative priorities set forth in Section 13.7.

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(c)Each Revolving Credit Lender, on the written request of the Agent and/or any Nominee, not more frequently than once each month, shall reimburse the Agent and/or any Nominee, pro-rata, for any cost or expense reasonably incurred by the Agent and/or the Nominee in the conduct of a Liquidation, which amount is not covered out of current proceeds of the Liquidation, which reimbursement shall be paid over to and distributed by the Agent.

13.7.Relative Priorities To Proceeds of Liquidation

(a)All distributions of proceeds of a Liquidation shall be net of payment over to the Agent as reimbursement for all reasonable third party costs and expenses incurred by the Agent and to Lenders' Special Counsel and to any funded reserve established pursuant to Section 13.6(a).

(b)The proceeds of a Liquidation, net of those amounts described in Section 12.2(c)(iv), shall be distributed based on the following priorities:

(i)To the Revolving Credit Lenders (other than any Delinquent Revolving Credit Lender), pro-rata, to the unpaid principal balance of the Revolving Credit; and then

(ii)To the Revolving Credit Lenders (other than any Delinquent Revolving Credit Lender), pro-rata, to accrued interest on the Revolving Credit; and then

(iii)To the Revolving Credit Lenders (other than any Delinquent Revolving Credit Lender), pro-rata, to those fees distributable hereunder to the Revolving Credit Lenders; and then

(iv)To any Delinquent Revolving Credit Lenders, pro-rata to amounts to which such Revolving Credit Lenders otherwise would have been entitled pursuant to Sections 13.7(b)(i), 13.7(b)(ii), 13.7(b)(iii); and then

(v)To the Revolving Credit Lenders, pro-rata, to the extent of the Revolving Credit Early Termination Fee; and then

(vi)To any other Liabilities.

Article 14 - The Agent:

14.1.Appointment of The Agent

(a)Each Lender appoints and designates Wells Fargo Retail Finance, LLC as the "Agent" hereunder and under the Loan Documents.

(b)Each Revolving Credit Lender authorizes the Agent:

(i)To execute those of the Loan Documents and all other instruments relating thereto to which the Agent is a party.

(ii)To take such action on behalf of the Revolving Credit Lenders and to exercise all such powers as are expressly delegated to the Agent hereunder and in the Loan Documents and all related documents, together with such other powers as are reasonably incident thereto.

14.2.Responsibilities of Agent

(a)The Agent shall not have any duties or responsibilities to, or any fiduciary relationship with, any Revolving Credit Lender except for those expressly set forth in this Agreement.

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(b)Neither the Agent nor any of its Affiliates shall be responsible to any Revolving Credit Lender for any of the following:

(i)Any recitals, statements, representations or warranties made by any Borrower or any other Person.

(ii)Any appraisals or other assessments of the assets of any Borrower or of any other Person responsible for or on account of the Liabilities.

(iii)The value, validity, effectiveness, genuineness, enforceability, or sufficiency of the Loan Agreement, the Loan Documents or any other document referred to or provided for therein.

(iv)Any failure by any Borrower or any other Person (other than the Agent) to perform its obligations under the Loan Documents.

(c)The Agent may employ attorneys, accountants, and other professionals and agents and attorneys-in-fact and shall not be responsible for the negligence or misconduct of any such attorneys, accountants, and other professionals or agents or attorneys-in-fact selected by the Agent with reasonable care. No such attorney, accountant, other professional, agent, or attorney-in-fact shall be responsible for any action taken or omitted to be taken by any other such Person.

(d)Neither the Agent, nor any of its directors, officers, or employees shall be responsible for any action taken or omitted to be taken or omitted to be taken by any other of them in connection herewith in reliance upon advice of its counsel nor, in any other event except for any action taken or omitted to be taken as to which a final judicial determination has been or is made (in a proceeding in which such Person has had an opportunity to be heard) that such Person had acted in a grossly negligent manner, in actual bad faith, or in willful misconduct.

(e)The Agent shall not have any responsibility in any event for more funds than the Agent actually receives and collects.

(f)The Agent, in its separate capacity as a Lender, shall have the same rights and powers hereunder as any other Lender.

14.3.Concerning Distributions By the Agent

(a)The Agent in the Agent's reasonable discretion based upon the Agent's determination of the likelihood that additional payments will be received, expenses incurred, and/or claims made by third parties to all or a portion of such proceeds, may delay the distribution of any payment received on account of the Liabilities.

(b)The Agent may disburse funds prior to determining that the sums which the Agent expects to receive have been finally and unconditionally paid to the Agent. If and to the extent that the Agent does disburse funds and it later becomes apparent that the Agent did not then receive a payment in an amount equal to the sum paid out, then any Revolving Credit Lender to whom the Agent made the funds available, on demand from the Agent, shall refund to the Agent the sum paid to that person.

(c)If, in the opinion of the Agent, the distribution of any amount received by the Agent might involve the Agent in liability, or might be prohibited hereby, or might be questioned by any Person, then the Agent may refrain from making distribution until the Agent's right to make distribution has been adjudicated by a court of competent jurisdiction.

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(d)The proceeds of any Revolving Credit Lender's exercise of any right of, or in the nature of, set-off shall be deemed, First, to the extent that a Revolving Credit Lender is entitled to any distribution hereunder, to constitute such distribution and Second, shall be shared with the other Revolving Credit Lenders as if distributed pursuant to (and shall be deemed as distributions under) Section 13.7.

(e)Each Revolving Credit Lender recognizes that the crediting of the Borrowers with the "proceeds" of any transaction in which a Post Foreclosure Asset is acquired is a non-cash transaction and that, in consequence, no distribution of such "proceeds" will be made by the Agent to any Lender.

(f)In the event that (x) a court of competent jurisdiction shall adjudge that any amount received and distributed by the Agent is to be repaid or disgorged or (y) those Lenders adversely affected thereby determine to effect such repayment or disgorgement, then each Revolving Credit Lender to which any such distribution shall have been made shall repay, to the Agent which had made such distribution, that Revolving Credit Lender's pro-rata share of the amount so adjudged or determined to be repaid or disgorged.

14.4.Dispute Resolution. Any dispute among the Revolving Credit Lenders and/or the Agent concerning the interpretation, administration, or enforcement of the financing arrangements contemplated by this or any other Loan Document or the interpretation or administration of this or any other Loan Document which cannot be resolved amicably shall be resolved in the United States District Court for the District of Massachusetts, sitting in Boston or in the Superior Court of Suffolk County, Massachusetts, to the jurisdiction of which courts each Revolving Credit Lender hereto hereby submits.

14.5.Distributions of Notices and Other Documents. The Agent will forward to each Revolving Credit Lender, promptly after the Agent's receipt thereof, a copy of each notice or other document furnished to the Agent pursuant to this Agreement, including monthly, quarterly, and annual financial statements received from the Lead Borrower pursuant to Article 4.28 of this Agreement, other than any of the following:

(a)Routine communications associated with requests for Revolving Credit Loans and/or the issuance of L/C's.

(b)Routine or nonmaterial communications.

(c)Any notice or document required by any of the Loan Documents to be furnished to the Revolving Credit Lenders by the Lead Borrower.

(d)Any notice or document of which the Agent has knowledge that such notice or document had been forwarded to the Revolving Credit Lenders other than by the Agent.

14.6.Confidential Information

(a)Each Revolving Credit Lender will maintain, as confidential, all of the following:

(i)Proprietary approaches, techniques, and methods of analysis which are applied by the Agent in the administration of the credit facility contemplated by this Agreement.

(ii)Proprietary forms and formats utilized by the Agent in providing reports to the Revolving Credit Lenders pursuant hereto, which forms or formats are not of general currency.

(iii)The results of financial examinations, reviews, inventories, analysis, appraisals, and other information concerning, relating to, or in respect of any Borrower and prepared by or at the request of, or furnished to any of, the Revolving Credit Lenders by or on behalf of the Agent.

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(b)Nothing included herein shall prohibit the disclosure of any such information as may be required to be provided by judicial process or by regulatory authorities having jurisdiction over any party to this Agreement.

14.7.Reliance by Agent.The Agent shall be entitled to rely upon any certificate, notice or other document (including any cable, telegram, telex, or facsimile) reasonably believed by the Agent to be genuine and correct and to have been signed or sent by or on behalf of the proper person or persons, and upon advice and statements of attorneys, accountants and other experts selected by the Agent. As to any matters not expressly provided for in this Agreement, any Loan Document, or in any other document referred to therein, the Agent shall in all events be fully protected in acting, or in refraining from acting, in accordance with the applicable Consent required by this Agreement. Instructions given with the requisite Consent shall be binding on all Revolving Credit Lenders.

14.8.Non-Reliance on Agent and Other Revolving Credit Lenders

(a)Each Revolving Credit Lender represents to all other Revolving Credit Lenders and to the Agent that such Revolving Credit Lender:

(i)Independently and without reliance on any representation or act by Agent or by any other Revolving Credit Lender, and based on such documents and information as that Revolving Credit Lender has deemed appropriate, has made such Revolving Credit Lender's own appraisal of the financial condition and affairs of the Borrowers and decision to enter into this Agreement.

(ii)Has relied upon that Revolving Credit Lender's review of the Loan Documents by that Revolving Credit Lender and by counsel to that Revolving Credit Lender as that Revolving Credit Lender deemed appropriate under the circumstances.

(b)Each Revolving Credit Lender agrees that such Revolving Credit Lender, independently and without reliance upon Agent or any other Revolving Credit Lender, and based upon such documents and information as such Revolving Credit Lender shall deem appropriate at the time, will continue to make such Revolving Credit Lender's own appraisals of the financial condition and affairs of the Borrowers when determining whether to take or not to take any discretionary action under this Agreement.

(c)The Agent, in the discharge of that Agent's duties hereunder, shall not

(i)Be required to make inquiry of, or to inspect the properties or books of, any Person.

(ii)Have any responsibility for the accuracy or completeness of any financial examination, review, inventory, analysis, appraisal, and other information concerning, relating to, or in respect of any Borrower and prepared by or at the request of, or furnished to any of, the Revolving Credit Lenders by or on behalf of the Agent.

(d)Except for notices, reports, and other documents and information expressly required to be furnished to the Revolving Credit Lenders by the Agent hereunder (as to which, see Section 14.5), the Agent shall not have any affirmative duty or responsibility to provide any Lender with any credit or other information concerning any Person, which information may come into the possession of Agent or any Affiliate of the Agent.

(e)Each Revolving Credit Lender, at such Revolving Credit Lender's request, shall have reasonable access to all nonprivileged documents in the possession of the Agent, which documents relate to the Agent's performance of its duties hereunder.

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14.9.Indemnification. Without limiting the liabilities of the Borrowers under any this or any of the other Loan Documents, each Revolving Credit Lender shall indemnify the Agent, pro-rata, for any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever (including attorneys' reasonable fees and expenses and other out-of-pocket expenditures) which may at any time be imposed on, incurred by, or asserted against the Agent and in any way relating to or arising out of this Agreement or any other Loan Document or any documents contemplated by or referred to therein or the transactions contemplated thereby or the enforcement of any of terms hereof or thereof or of any such other documents, provided, however, no Revolving Credit Lender shall be liable for any of the foregoing to the extent that any of the foregoing arises from any action taken or omitted to be taken by the Agent as to which a final judicial determination has been or is made (in a proceeding in which the Agent has had an opportunity to be heard) that the Agent had acted in a grossly negligent manner, in actual bad faith, or in willful misconduct.

14.10.Resignation of Agent.

(a)The Agent may resign at any time by giving 60 days prior written notice thereof to the Revolving Credit Lenders. Upon receipt of any such notice of resignation, the SuperMajority Lenders shall have the right to appoint a successor to such Agent (and if no Event of Default has occurred, with the consent of the Lead Borrower, not to be unreasonably withheld and, in any event, deemed given by the Lead Borrower if no written objection is provided by the Lead Borrower to the (resigning) Agent within seven (7) Business Days notice of such proposed appointment). If a successor Agent shall not have been so appointed and accepted such appointment within 30 days after the giving of notice by the resigning Agent, then the resigning Agent may appoint a successor Agent, with the consent of the Lead Borrower (so long as no Event of Default shall have occurred and be continuing), such consent not to be unreasonably withheld or delayed, which shall be a financial institution having a combined capital and surplus in excess of $250,000,000.00. The consent of the Lead Borrower otherwise required by this Section 14.10(a) shall not be required if an Event of Default has occurred.

(b)Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor shall thereupon succeed to, and become vested with, all the rights, powers, privileges, and duties of the (resigning) Agent so replaced, and the (resigning) Agent shall be discharged from the (resigning) Agent's duties and obligations hereunder, other than on account of any responsibility for any action taken or omitted to be taken by the (resigning) Agent as to which a final judicial determination has been or is made (in a proceeding in which the (resigning) Person has had an opportunity to be heard) that such Person had acted in a grossly negligent manner or in bad faith.

(c)After any retiring Agent's resignation, the provisions of this Agreement and of all other Loan Documents shall continue in effect for the retiring Person's benefit in respect of any actions taken or omitted to be taken by it while it was acting as Agent.

Article 15 - Action By Agent - Consents - Amendments - Waivers:

15.1.Administration of Credit Facilities.

(a)Except as otherwise specifically provided in this Agreement, the Agent may take any action with respect to the credit facility contemplated by the Loan Documents as the Agent determines to be appropriate , provided, however, the Agent is not under any affirmative obligation to take any action which it is not required by this Agreement or the Loan Documents specifically to so take.

(b)Except as specifically provided in the following Sections of this Agreement, whenever a Loan Document or this Agreement provides that action may be taken or omitted to be taken in an Agent's discretion, the Agent shall have the sole right to take, or refrain from taking, such action without, and notwithstanding, any vote of the Revolving Credit Lender:

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Actions Described in Section	Type of Consent Required
15.2	Majority Lenders
15.3	SuperMajority Lenders
15.4	Certain Consent
15.5	Unanimous Consent
15.6	Consent of the Agent

(c)The rights granted to the Revolving Credit Lenders in those sections referenced in Section 15.1(b) shall not otherwise limit or impair the Agent's exercise of its discretion under the Loan Documents.

15.2.Actions Requiring or On Direction of Majority Lenders. Except as otherwise provided in this Agreement, the Consent or direction of the Majority Lenders is required for any amendment, waiver, or modification of any Loan Document.

15.3.Actions Requiring or On Direction of SuperMajority Lenders. The Consent or direction of the SuperMajority Lenders is required as follows:

(a)The SuperMajority Lenders may direct the Agent to require the prompt repayment of Protective OverAdvances have been outstanding for more than 45 consecutive Business Days or more than twice in any twelve month period (the Revolving Credit Lenders recognizing that, except as described in this Section 15.3(a), any loan or advance under the Revolving Credit which results in a Protective OverAdvance may be made by the Agent in its discretion without the Consent of the Revolving Credit Lenders and that each Revolving Credit Lender shall be bound thereby.

(b)The SuperMajority Lenders may direct the Agent to suspend the Revolving Credit (including the making of any Protective OverAdvances), if any Borrower is then In Default, following which direction, and for as long as a Borrower is In Default, the only Revolving Credit Loans which may be made are the following:

(i)Protective OverAdvances not otherwise terminated as provided in 15.3(a).

(ii)Revolving Credit Loans made to "cover" the honoring of L/C's.

(iii)Revolving Credit Loans made with Consent of the SuperMajority Lenders.

(c)The SuperMajority Lenders may undertake the following if an Event of Default has occurred and not been duly waived, :

(i)Give the Agent an Acceleration Notice in accordance with Section 13.1(b).

(ii)Direct the Agent to increase the rate of interest to the default rate of interest as provided in, and to the extent permitted by, this Agreement.

(d)The Consent of the SuperMajority Lenders shall be required to authorize the Agent to affirmatively subordinate the Liabilities to any material obligation of any Borrower, unless such subordination is otherwise required pursuant to this or is permitted by this Agreement.

15.4.Action Requiring Certain Consent. The Consent or direction of the following is required for the following actions:

(a)Any forgiveness of all or any portion of any payment Liability: All Lenders whose payment Liability is being so forgiven: (other than any Delinquent Revolving Credit Lender).

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(b)Any decrease in any interest rate or fee payable under any of the Loan Documents (other than any fee payable to the Agent (for which the consent of the Agent shall be required): A Lenders adversely affected thereby (other than any Delinquent Revolving Credit Lender).

(c)Any waiver, amendment, or modification which has the effect of increasing any Revolving Credit Dollar Commitment or Revolving Credit Percentage Commitment shall be subject to the Consent of all Revolving Credit Lenders (other than any Delinquent Revolving Credit Lender) except that no Consent shall be required for any such increase which is the result of the application of the following Sections of this Agreement:

(i)Section 15.9 (which relates to NonConsenting Revolving Credit Lenders).

(ii)Section 16.1 (which relates to assignments and assumptions).

(d)Volitional Disgorgement as described in 14.3(f):Each Lender (other than any Delinquent Revolving Credit Lender) which is adversely affected thereby.

15.5.Actions Requiring or Directed By Unanimous Consent. None of the following may take place except with Unanimous Consent:

(a)Any release of a material portion of the Collateral, but such Consent to such release is not required if any of the following conditions is satisfied:

(i)Such release is otherwise required or provided for in the Loan Documents.

(ii)Such release is being made to facilitate a Liquidation.

(iii)No OverLoan exists immediately after giving effect to the application to the Loan Account of the net proceeds received on account of the transaction in which such release is made but only where any of the following conditions is not satisfied:

(b)Any amendment of the Definitions of "Borrowing Base" or "Availability" or of any Definition of any component thereof, such that more credit would be available to the Borrowers, based on the same assets, as would have been available to the Borrowers immediately prior to such amendment , it being understood, however, that:

(i)The foregoing shall not limit the adjustment by the Agent of any Reserve in the Agent's administration of the Revolving Credit as otherwise permitted by this Agreement.

(ii)The foregoing shall not prevent the Agent, in its administration of the Revolving Credit, from restoring any component of Borrowing Base which had been lowered by the Agent back to the value of such component, as stated in this Agreement or to an intermediate value.

(iii)The amendment of any financial performance covenant to which direct or indirect reference is made in the Definition of "Availability" or "Borrowing Base" or in the Definition of any component thereof shall be subject to amendment as otherwise provided in this Agreement (and by Consent of the Majority Lenders if not subject to any other specific provision of this Agreement).

(c)Any release of any Person obligated on account of the Liabilities.

(d)The making of any Revolving Credit Loan which, when made, exceeds Availability and is not a Protective OverAdvance, subject, however, to the following:

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(i)No Consent is required in connection with the making of any Revolving Credit Loan to "cover" any honoring of a drawing under any L/C.

(ii)Each Lender recognizes that subsequent to the making of a Revolving Credit Loan which does not constitute a Protective OverAdvance, the unpaid principal balance of the Loan Account may exceed Borrowing Base on account of changed circumstances beyond the control of the Agent (such as a drop in collateral value).

(e)Any amendment which has the effect of limiting the Agent's right or ability to make Protective OverAdvances.

(f)The waiver of the obligation of the Borrowers to reduce the unpaid principal balance of loans under the Revolving Credit to an amount so that no OverLoan (other than a Protective OverAdvance) is outstanding.

(g)Any amendment of this Article 15 - .

(h)Amendment of any of the following Definitions:

"Majority Lender"

"Protective OverAdvance"

"SuperMajority Lenders

"Unanimous Consent"

15.6.Actions Requiring Agent's Consent.

(a)No action, amendment, or waiver of compliance with, any provision of the Loan Documents or of this Agreement which affects the Agent in its capacity as Agent may be undertaken without the written consent of the Agent.

(b)No action referenced herein which affects the rights, duties, obligations, or liabilities of the Agent shall be effective without the written consent of the Agent.

15.7.Miscellaneous Actions

(a)Notwithstanding any other provision of this Agreement, no single Revolving Credit Lender independently may exercise any right of action or enforcement against or with respect to any Borrower.

(b)The Agent shall be fully justified in failing or refusing to take action under this Agreement or any Loan Document on behalf of any Revolving Credit Lender unless the Agent shall first

(i)receive such clear, unambiguous, written instructions as the Agent deems appropriate; and

(ii)be indemnified to the Agent's satisfaction by the Revolving Credit Lenders against any and all liability and expense which may be incurred by the Agent by reason of taking or continuing to take any such action, unless such action had been grossly negligent, in willful misconduct, or in bad faith.

(c)The Agent may establish reasonable procedures for the providing of direction and instructions from the Revolving Credit Lenders to the Agent, including its reliance on multiple counterparts, facsimile transmissions, and time limits within which such direction and instructions must be received in order to be included in a determination of whether the requisite Lenders have provided their direction, Consent, or instructions.

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15.8.Actions Requiring Lead Borrower's Consent. The Lead Borrower's consent is required for any amendment of this Agreement, except that each of the following Articles of this Agreement may be amended without the consent of the Lead Borrower:

Article	Title of Article
12	Revolving Credit Fundings and Distributions
13	Acceleration and Liquidation
14	The Agent
15	Action By Agents - Consents - Amendments - Waivers
16	Assignments and Participations

15.9.NonConsenting Revolving Credit Lender

(a)In the event that a Revolving Credit Lender (in this Section 15.9, a "NonConsenting Revolving Credit Lender") does not provide its Consent to a proposal by the Agent to take action which requires consent under this Article 15, then one or more Revolving Credit Lenders who provided Consent to such action may require the assignment, without recourse and in accordance with the procedures outlined in Section 16.1, below, of the NonConsenting Revolving Credit Lender's commitment hereunder on fifteen (15) days written notice to the Agent and to the NonConsenting Revolving Credit Lender.

(b)At the end of such fifteen (15) days, and provided that the NonConsenting Revolving Credit Lender delivers the Revolving Credit Note held by the NonConsenting Revolving Credit Lender to the Agent, the Revolving Credit Lenders who have given such written notice shall Transfer the following to the NonConsenting Revolving Credit Lender:

(i)Such NonConsenting Revolving Credit Lender's pro-rata share of the principal and interest of the Revolving Credit Loans to the date of such assignment.

(ii)All fees distributable hereunder to the NonConsenting Revolving Credit Lender to the date of such assignment.

(iii)Any out-of-pocket costs and expenses for which the NonConsenting Revolving Credit Lender is entitled to reimbursement from the Borrowers.

(c)In the event that the NonConsenting Revolving Credit Lender fails to deliver to the Agent the Revolving Credit Note held by the NonConsenting Revolving Credit Lender as provided in Section 15.9(b), then:

(i)The amount otherwise to be Transferred to the NonConsenting Revolving Credit Lender shall be Transferred to the Agent and held by the Agent, without interest, to be turned over to the NonConsenting Revolving Credit Lender upon delivery of the Revolving Credit Note held by that NonConsenting Revolving Credit Lender.

(ii)The Revolving Credit Note held by the NonConsenting Revolving Credit Lender shall have no force or effect whatsoever.

(iii)The NonConsenting Revolving Credit Lender shall cease to be a "Revolving Credit Lender".

(iv)The Revolving Credit Lender(s) which have Transferred the amount to the Agent as described above shall have succeeded to all rights and become subject to all of the obligations of the NonConsenting Revolving Credit Lender as "Revolving Credit Lender".

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(d)In the event that more than One (1) Revolving Credit Lender wishes to require such assignment, the NonConsenting Revolving Credit Lender's commitment hereunder shall be divided among such Revolving Credit Lenders, pro-rata based upon their respective Revolving Credit Percentage Commitments, with the Agent coordinating such transaction.

(e)The Agent shall coordinate the retirement of the Revolving Credit Note held by the NonConsenting Revolving Credit Lender and the issuance of Revolving Credit Notes to those Revolving Credit Lenders which "take-out" such NonConsenting Revolving Credit Lender, provided, however, no processing fee otherwise to be paid as provided in Section 16.2(b) shall be due under such circumstances.

Article 16 - Assignments By Revolving Credit Lenders:

16.1.Assignments and Assumptions:

(a)Except as provided herein, each Revolving Credit Lender (in this Section 16.1(a), an "Assigning Revolving Credit Lender") may assign to one or more Eligible Assignees (in this Section 16.1(a), each an "Assignee Revolving Credit Lender") all or a portion of that Revolving Credit Lender's interests, rights and obligations under this Agreement and the Loan Documents (including all or a portion of its Commitment) and the same portion of the Revolving Credit Loans at the time owing to it, and of the Revolving Credit Note held by the Assigning Revolving Credit Lender, provided that:

(i)The Agent shall have given its prior written consent to such assignment, which consent shall not be unreasonably withheld, but need not be given if the proposed assignment would result in any resulting Revolving Credit Lender's having a Dollar Commitment of less than the "minimum hold" amount specified in Section 16.1(a)(iii) or if there would be more than Three (3) Revolving Credit Lenders.

(ii)Each such assignment shall be of a constant, and not a varying, percentage of all the Assigning Revolving Credit Lender's rights and obligations under this Agreement.

(iii)Following the effectiveness of such assignment, the Assigning Revolving Credit Lender's Dollar Commitment (if not an assignment of all of the Assigning Revolving Credit Lender's Commitment) shall not be less than $5,000,000.00.

16.2.Assignment Procedures. (This Section 16.2 describes the procedures to be followed in connection with an assignment effected pursuant to this Article 16 - and permitted by Section 16.1).

(a)The parties to such an assignment shall execute and deliver to the Agent, for recording in the Register, an Assignment and Acceptance substantially in the form of EXHIBIT 16.2, annexed hereto.

(b)The Assigning Revolving Credit Lender shall deliver to the Agent, with such Assignment and Acceptance, the Revolving Credit Note held by the subject Assigning Revolving Credit Lender and the Agent's processing fee of $2,500.00, provided, however, no such processing fee shall be due where the Assigning Revolving Credit Lender is one of the Revolving Credit Lenders at the initial execution of this Agreement.

(c)The Agent shall maintain a copy of each Assignment and Acceptance delivered to it and a register or similar list (the "Register") for the recordation of the names and addresses of the Revolving Credit Lenders and of the Revolving Credit Percentage Commitment and Revolving Credit Percentage Commitment of each Revolving Credit Lender. The Register shall be available for inspection by the Revolving Credit Lenders at any reasonable time and from time to time upon reasonable prior notice. In the absence of manifest error, the entries in the Register shall be conclusive and binding on all Revolving Credit Lenders. The Agent and the Revolving Credit Lenders may treat each Person whose name is recorded in the Register as a "Revolving Credit Lender" hereunder for all purposes of this Agreement.

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(d)The Assigning Revolving Credit Lender and Assignee Revolving Credit Lender, directly between themselves, shall make all appropriate adjustments in payments for periods prior to the effective date of an Assignment and Assumption.

16.3.Effect of Assignment.

(a)From and after the effective date specified in an Assignment and Acceptance which has been executed, delivered, and recorded (which effective date the Agent may delay by up to Five (5) Business Days after the delivery of such Assignment and Acceptance):

(i)The Assignee Revolving Credit Lender:

(A)Shall be a party to this Agreement and the Loan Documents (and to any amendments thereof) as fully as if the Assignee Revolving Credit Lender had executed each.

(B)Shall have the rights of a Revolving Credit Lender hereunder to the extent of the Revolving Credit Percentage Commitment and Revolving Credit Percentage Commitment assigned by such Assignment and Acceptance.

(ii)The Assigning Revolving Credit Lender shall be released from the Assigning Revolving Credit Lender's obligations under this Agreement and the Loan Documents to the extent of the Commitment assigned by such Assignment and Acceptance.

(iii)The Agent shall undertake to obtain and distribute replacement Revolving Credit Notes to the subject Assigning Revolving Credit Lender and Assignee Revolving Credit Lender.

(b)By executing and delivering an Assignment and Acceptance, the parties thereto confirm to and agree with each other and with all parties to this Agreement as to those matters which are set forth in the subject Assignment and Acceptance.

Article 17 - Notices:

17.1.Notice Addresses. All notices, demands, and other communications made in respect of any Loan Document (other than a request for a loan or advance or other financial accommodation under the Revolving Credit) shall be made to the following addresses, each of which may be changed upon seven (7) days written notice to all others given by certified mail, return receipt requested:

If to the Agent:

Wells Fargo Retail Finance, LLC

One Boston Place - - 18^th Floor

Boston, Massachusetts 02108

Attention:David Molinario, Vice President

Fax:             617-523-4032

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With a copy to:

Riemer & Braunstein LLP

Three Center Plaza

Boston, Massachusetts 02108

Attention:Donald E. Rothman, Esquire

Fax: 617-880-3456

If to the Lead Borrower and all Borrowers:

DrugMax, Inc.

312 Farmington Avenue

Farmington, Connecticut 06032

Attention:Edgardo A. Mercadante

Fax: 860- 679-9337

With a copy to:

Robinson & Cole LLP

280 Trumbull Street

Hartford, Connecticut 06103-3597

Attention:John B. Lynch, Esquire

Fax: 860-275-8299

17.2.Notice Given.

(a)Except as otherwise specifically provided herein, notices shall be deemed made and correspondence received, as follows (all times being local to the place of delivery or receipt):

(i)By mail: the sooner of when actually received or Three (3) days following deposit in the United States mail, postage prepaid.

(ii)By recognized overnight express delivery: the Business Day following the day when sent.

(iii)By Hand: If delivered on a Business Day after 9:00 AM and no later than Three (3) hours prior to the close of customary business hours of the recipient, when delivered. Otherwise, at the opening of the then next Business Day.

(iv)By Facsimile transmission (which must include a header on which the party sending such transmission is indicated): If sent on a Business Day after 9:00 AM and no later than Three (3) hours prior to the close of customary business hours of the recipient, one (1) hour after being sent. Otherwise, at the opening of the then next Business Day.

(b)Rejection or refusal to accept delivery and inability to deliver because of a changed address or Facsimile Number for which no due notice was given shall each be deemed receipt of the notice sent.

17.3.Wire Instructions. Notice Given. Subject to change in the same manner that a notice address may be changed (as to which, see Section 17.1), wire transfers to the Agent shall be made in accordance with the following wire instructions:

Wells Fargo Bank

San Francisco, CA

ABA Number: # 121-000-248

Account Name: Wells Fargo Retail Finance, LLC

Account Number: 4945088607:

Reference: DrugMax, Inc.

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Article 18 - Term:

18.1.Termination of Revolving Credit. The Revolving Credit shall remain in effect (subject to suspension as provided in Section 2.6) until the Termination Date.

18.2.Actions On Termination.

(a)On the Termination Date, the Borrowers shall pay the Agent (whether or not then due), in immediately available funds, all then Liabilities including, without limitation: the following:

(i)The entire balance of the Loan Account (including the unpaid principal balance of the Revolving Credit Loans).

(ii)Any payments due on account of the indemnification obligations included in Section 2.10(e).

(iii)Any accrued and unpaid Unused Line Fee.

(iv)Any applicable Revolving Credit Early Termination Fee.

(v)Any remaining installment of any fees owed to the Agent under the Fee Letter.

(vi)All unreimbursed costs and expenses of the Agent and of Lenders' Special Counsel for which each Borrower is responsible.

(vii)All other Liabilities.

(b)On the Termination Date, the Borrowers shall also shall make such arrangements concerning any L/C's then outstanding, any Bank Products and Bank Product Obligations, and with respect to any other continuing Liabilities (such as the Borrower's continuing Liability to reimburse the Lender as set forth in Section 19.9) and continuing indemnification Liability set forth in Section 19.13 as are reasonably satisfactory to the Agent.

(c)Until such payment (Section 18.2(a))) and arrangements concerning L/C's, Bank Products, and Bank Product Obligations (Section 18.2(b)), all provisions of this Agreement, other than those included in Article 2 which place any obligation on the Agent or any Revolving Credit Lender to make any loans or advances or to provide any financial accommodations to any Borrower shall remain in full force and effect until all Liabilities shall have been paid in full.

(d)The release by the Agent of the Collateral Interests granted the Agent by the Borrowers hereunder may be upon such conditions and indemnifications as the Agent may require.

Article 19 - General:

19.1.Protection of Collateral. The Agent has no duty as to the collection or protection of the Collateral beyond the safe custody of such of the Collateral as may come into the possession of the Agent.

19.2.Publicity. The Agent may issue a "tombstone" notice of the establishment of the credit facility contemplated by this Agreement and may make reference to each Borrower (and may utilize any logo or other distinctive symbol associated with each Borrower) in connection with any advertising, promotion, or marketing (including reference in any "case study" of the creditor facility contemplated hereby) undertaken by the Agent.

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19.3.Successors and Assigns. This Agreement shall be binding upon the Borrowers and their respective representatives, successors, and assigns and shall inure to the benefit of the Agent and each Revolving Credit Lender and their respective successors and assigns, provided, however, no trustee or other fiduciary appointed with respect to any Borrower shall have any rights hereunder. In the event that the Agent or any Revolving Credit Lender assigns or transfers its rights under this Agreement, the assignee shall thereupon succeed to and become vested with all rights, powers, privileges, and duties of such assignor hereunder and such assignor shall thereupon be discharged and relieved from its duties and obligations hereunder.

19.4.Severability. Any determination that any provision of this Agreement or any application thereof is invalid, illegal, or unenforceable in any respect in any instance shall not affect the validity, legality, or enforceability of such provision in any other instance, or the validity, legality, or enforceability of any other provision of this Agreement.

19.5.Amendments. Course of Dealing.

(a)This Agreement and the other Loan Documents incorporate all discussions and negotiations between each Borrower and the Agent and each Revolving Credit Lender, either express or implied, concerning the matters included herein and in such other instruments, any custom, usage, or course of dealings to the contrary notwithstanding. No such discussions, negotiations, custom, usage, or course of dealings shall limit, modify, or otherwise affect the provisions thereof. No failure by the Agent or any Revolving Credit Lender to give notice to the Lead Borrower of any Borrower's having failed to observe and comply with any warranty or covenant included in any Loan Document shall constitute a waiver of such warranty or covenant or the amendment of the subject Loan Document. No change made by the Agent to the manner by which Borrowing Base is determined shall obligate the Agent to continue to determine Borrowing Base in that manner.

(b)Each Borrower may undertake any action otherwise prohibited hereby, and may omit to take any action otherwise required hereby, upon and with the express prior written consent of the Agent. Subject to Article 15, no consent, modification, amendment, or waiver of any provision of any Loan Document shall be effective unless executed in writing by or on behalf of the party to be charged with such modification, amendment, or waiver (and if such party is the Agent then by a duly authorized officer thereof). Any modification, amendment, or waiver provided by the Agent shall be in reliance upon all representations and warranties theretofore made to the Agent by or on behalf of the Borrowers (and any guarantor, endorser, or surety of the Liabilities) and consequently may be rescinded in the event that any of such representations or warranties was not true and complete in all material respects when given.

19.6.Power of Attorney. In connection with all powers of attorney included in this Agreement, each Borrower hereby grants unto the Agent (acting through any of its officers) full power to do any and all things necessary or appropriate in connection with the exercise of such powers as fully and effectually as that Borrower might or could do, hereby ratifying all that said attorney shall do or cause to be done by virtue of this Agreement. No power of attorney set forth in this Agreement shall be affected by any disability or incapacity suffered by any Borrower and each shall survive the same. All powers conferred upon the Agent by this Agreement, being coupled with an interest, shall be irrevocable until this Agreement is terminated by a written instrument executed by a duly authorized officer of the Agent.

19.7.Application of Proceeds. The proceeds of any collection, sale, or disposition of the Collateral, or of any other payments received hereunder, shall be applied towards the Liabilities in such order and manner as the Agent determines in its sole discretion, consistent, however, with Sections 13.6 and 13.7 and any other applicable provisions of this Agreement. The Borrowers shall remain liable for any deficiency remaining following such application.

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19.8.Increased Costs. If, as a result of any Requirement of Law, or of the interpretation or application thereof by any court or by any governmental or other authority or entity charged with the administration thereof, whether or not having the force of law, which:

(a)subjects any Revolving Credit Lender to any taxes or changes the basis of taxation, or increases any existing taxes, on payments of principal, interest or other amounts payable by any Borrower to the Agent or any Revolving Credit Lender under this Agreement (except for taxes on the Agent or any Revolving Credit Lender based on net income or capital imposed by the jurisdiction in which the principal or lending offices of the Agent or that Revolving Credit Lender are located);

(b)imposes, modifies or deems applicable any reserve, cash margin, special deposit or similar requirements against assets held by, or deposits in or for the account of or loans by or any other acquisition of funds by the relevant funding office of any Revolving Credit Lender;

(c)imposes on any Revolving Credit Lender any other condition with respect to any Loan Document; or

(d)imposes on any Revolving Credit Lender a requirement to maintain or allocate capital in relation to the Liabilities;

and the result of any of the foregoing, in such Revolving Credit Lender's reasonable opinion, is to increase the cost to that Revolving Credit Lender of making or maintaining any loan, advance or financial accommodation or to reduce the income receivable by that Revolving Credit Lender in respect of any loan, advance or financial accommodation by an amount which that Revolving Credit Lender deems to be material, then upon written notice from the Agent, from time to time, to the Lead Borrower (such notice to set out in reasonable detail the facts giving rise to and a summary calculation of such increased cost or reduced income), the Borrowers shall forthwith pay to the Agent, for the benefit of the subject Revolving Credit Lender, upon receipt of such notice, that amount which shall compensate the subject Revolving Credit Lender for such additional cost or reduction in income.

19.9.Costs and Expenses of the Agent.

(a)The Borrowers shall pay from time to time on demand all Costs of Collection and all reasonable costs, expenses, and disbursements (including attorneys' reasonable fees and expenses) which are incurred by the Agent in connection with the preparation, negotiation, execution, and delivery of this Agreement and of any other Loan Documents, and all other reasonable costs, expenses, and disbursements which may be incurred in connection with or in respect to the credit facility contemplated hereby or which otherwise are incurred with respect to the Liabilities.

(b)The Borrowers shall pay from time to time on demand all reasonable costs and expenses (including attorneys' reasonable fees and expenses) incurred, following the occurrence of any Event of Default, by the Revolving Credit Lenders to Lenders' Special Counsel.

(c)Each Borrower authorizes the Agent to pay all such fees and expenses and in the Agent's discretion, to add such fees and expenses to the Loan Account, provided that notice of such payment shall be given to Lead Borrower.

(d)The undertaking on the part of each Borrower in this Section 19.9 shall survive payment of the Liabilities and/or any termination, release, or discharge executed by the Agent in favor of any Borrower, other than a termination, release, or discharge which makes specific reference to this Section 19.9.

19.10.Copies and Facsimiles. Each Loan Document and all documents and papers which relates thereto which have been or may be hereinafter furnished the Agent or any Revolving Credit Lender may be reproduced by that Revolving Credit Lender or by the Agent by any photographic, microfilm, xerographic, digital imaging, or other process, and such Person making such reproduction may destroy any document so reproduced. Any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding (whether or not the original is in existence and whether or not such reproduction was made in the regular course of business). Any facsimile which bears proof of transmission shall be binding on the party which or on whose behalf such transmission was initiated and likewise shall be so admissible in evidence as if the original of such facsimile had been delivered to the party which or on whose behalf such transmission was received.

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19.11.Massachusetts Law. This Agreement and all rights and obligations hereunder, including matters of construction, validity, and performance, shall be governed by the law of The Commonwealth of Massachusetts.

19.12.Consent to Jurisdiction.

(a)Each Borrower agrees that any legal action, proceeding, case, or controversy against any Borrower with respect to any Loan Document may be brought in the Superior Court of Suffolk County Massachusetts or in the United States District Court, District of Massachusetts, sitting in Boston, Massachusetts, as the Agent may elect in the Agent's sole discretion. By execution and delivery of this Agreement, each Borrower, for itself and in respect of its property, accepts, submits, and consents generally and unconditionally, to the jurisdiction of the aforesaid courts.

(b)Each Borrower WAIVES personal service of any and all process upon it, and irrevocably consents to the service of process out of any of the aforementioned courts in any such action or proceeding by the mailing of copies thereof by certified mail, postage prepaid, to the Lead Borrower at the Lead Borrower's address for notices as specified herein, such service to become effective five (5) Business Days after such mailing.

(c)Each Borrower WAIVES any objection based on forum non conveniens and any objection to venue of any action or proceeding instituted under any of the Loan Documents and consents to the granting of such legal or equitable remedy as is deemed appropriate by the Court.

(d)Nothing herein shall affect the right of the Agent to bring legal actions or proceedings in any other competent jurisdiction.

(e)Each Borrower agrees that any action commenced by any Borrower asserting any claim arising under or in connection with this Agreement or any other Loan Document shall be brought solely in the Superior Court of Suffolk County Massachusetts or in the United States District Court, District of Massachusetts, sitting in Boston, Massachusetts, and that such Courts shall have exclusive jurisdiction with respect to any such action.

19.13.Indemnification. Each Borrower shall indemnify, defend, and hold the Agent and each Revolving Credit Lender and any Participant and any of their respective employees, officers, or agents (each, an "Indemnified Person") harmless of and from any claim brought or threatened against any Indemnified Person by any Borrower, any guarantor or endorser of the Liabilities, or any other Person (as well as from attorneys' reasonable fees, expenses, and disbursements in connection therewith) on account of the relationship of the Borrowers or of any other guarantor or endorser of the Liabilities, including all costs, expenses, liabilities, and damages as may be suffered by any Indemnified Person in connection with (x) the Collateral; (y) the occurrence of any Event of Default; or (z) the exercise of any rights or remedies under any of the Loan Documents (each of such claims which may be defended, compromised, settled, or pursued by the Indemnified Person with counsel of the Lender's selection, but at the expense of the Borrowers) other than any claim as to which a final determination is made in a judicial proceeding (in which the Agent and any other Indemnified Person has had an opportunity to be heard), which determination includes a specific finding that the Indemnified Person seeking indemnification had acted in a grossly negligent manner or in actual bad faith. This indemnification shall survive payment of the Liabilities and/or any termination, release, or discharge executed by the Agent in favor of the Borrowers, other than a termination, release, or discharge duly executed on behalf of the Agent which makes specific reference to this Section 19.13.

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19.14.Rules of Construction. The following rules of construction shall be applied in the interpretation, construction, and enforcement of this Agreement and of the other Loan Documents:

(a)Unless otherwise specifically provided for herein (and then only to the extent so provided), interest and any fee or charge which is stated as a per annum percentage shall be calculated based on a 360 day year and actual days elapsed.

(b)Words in the singular include the plural and words in the plural include the singular.

(c)Unless otherwise specifically provided for herein or in a specific Loan Document (and then only to the extent so provided), as between the parties hereto or to any Loan Document, the definitions of the following terms, as included in the UCC, are deemed to be as follows for purposes of the performance of obligations arising under or in respect of any Loan Document:

(i)"Authenticate" means "signed".

(ii)"Record" means written information in a tangible form.

(d)Cross references to Sections in this Agreement begin with the Article in which that Section appears, and then the Section to which reference is made.

(e)Titles, headings (indicated by being underlined or shown in Small Capitals) and any Table of Contents are solely for convenience of reference; do not constitute a part of the instrument in which included; and do not affect such instrument's meaning, construction, or effect.

(f)The words "includes" and "including" are not limiting.

(g)Text which follows the words "including, without limitation" (or similar words) is illustrative and not limitational.

(h)Text which is shown in italics (except for parenthesized italicized text), shown in bold, shown IN ALL CAPITAL LETTERS, or in any combination of the foregoing, shall be deemed to be conspicuous.

(i)The words "may not" are prohibitive and not permissive.

(j)Any reference to a Person's "knowledge" (or words of similar import) are to such Person's knowledge assuming that such Person has undertaken reasonable and diligent investigation with respect to the subject of such "knowledge" (whether or not such investigation has actually been undertaken).

(k)Terms which are defined in one section of any Loan Document are used with such definition throughout the instrument in which so defined.

(l)The term "Dollars" and the symbol "$" each refers to United States Dollars.

(m)Unless limited by reference to a particular Section or provision, any reference to "herein", "hereof", or "within" is to the entire Loan Document in which such reference is made.

(n)References to "this Agreement" or to any other Loan Document is to the subject instrument as amended to the date on which application of such reference is being made.

(o)Except as otherwise specifically provided, all references to time are to Boston, Massachusetts, time.

(p)In the determination of any notice, grace, or other period of time prescribed or allowed hereunder:

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(i)Unless otherwise provided (I) the day of the act, event, or default from which the designated period of time begins to run shall not be included and the last day of the period so computed shall be included unless such last day is not a Business Day, in which event the last day of the relevant period shall be the then next Business Day and (II) the period so computed shall end at 5:00 PM on the relevant Business Day.

(ii)The word "from" means "from and including".

(iii)The words "to" and "until" each mean "to, but excluding".

(iv)The word "through" means "to and including".

(q)The Loan Documents shall be construed and interpreted in a harmonious manner and in keeping with the intentions set forth in Section 19.15, provided, however, in the event of any inconsistency between the provisions of this Agreement and any other Loan Document, the provisions of this Agreement shall govern and control.

19.15.Intent. It is intended that:

(a)This Agreement take effect as a sealed instrument.

(b)The scope of all Collateral Interests created by any Borrower to secure the Liabilities be broadly construed in favor of the Agent and that they cover all assets of each Borrower.

(c)All Collateral Interests created in favor of the Agent at any time and from time to time secure all Liabilities, whether now existing or contemplated or hereafter arising.

(d)All reasonable costs, expenses, and disbursements incurred by the Agent and, to the extent provided in Section 19.9 each Revolving Credit Lender, in connection with such Person's relationship(s) with any Borrower shall be borne by the Borrowers.

(e)Unless otherwise explicitly provided herein, the Agent's consent to any action of any Borrower which is prohibited unless such consent is given may be given or refused by the Agent in its sole discretion and without reference to Section 2.17(a).

19.16.Right of Set-Off. Any and all deposits or other sums at any time credited by or due to any Borrower from the Agent or any Revolving Credit Lender or any Participant or from any Affiliate of any of the foregoing, and any cash, securities, instruments or other property of any Borrower in the possession of any of the foregoing, whether for safekeeping or otherwise (regardless of the reason such Person had received the same) shall at all times constitute security for all Liabilities and for any and all obligations of each Borrower to the Agent and such Revolving Credit Lender or any Participant or such Affiliate and may be applied or set off against the Liabilities and against such obligations at any time following the occurrence and during the continuance of an Event of Default, whether or not such are then due and whether or not other collateral is then available to the Agent or that Revolving Credit Lender.

19.17.Pledges To Federal Reserve Banks. Nothing included in this Agreement shall prevent or limit any Revolving Credit Lender, to the extent that such Revolving Credit Lender is subject to any of the twelve Federal Reserve Banks organized under §4 of the Federal Reserve Act (12 U.S.C. §341) from pledging all or any portion of that Lender's interest and rights under this Agreement, provided, however, neither such pledge nor the enforcement thereof shall release the pledging Revolving Credit Lender from any of its obligations hereunder or under any of the Loan Documents.

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19.18.Maximum Interest Rate. Regardless of any provision of any Loan Document, neither the Agent nor any Revolving Credit Lender shall be entitled to contract for, charge, receive, collect, or apply as interest on any Liability, any amount in excess of the maximum rate imposed by Applicable Law. Any payment which is made which, if treated as interest on a Liability would result in such interest's exceeding such maximum rate shall be held, to the extent of such excess, as additional collateral for the Liabilities as if such excess were "Collateral."

19.19.Waivers.

(a)Each Borrower (and all guarantors, endorsers, and sureties of the Liabilities) make each of the waivers included in Section 19.19(b), below, knowingly, voluntarily, and intentionally, and understands that Agent and each Revolving Credit Lender, in establishing the facilities contemplated hereby and in providing loans and other financial accommodations to or for the account of the Borrowers as provided herein, whether not or in the future, is relying on such waivers.

(b)EACH BORROWER, AND EACH SUCH GUARANTOR, ENDORSER, AND SURETY RESPECTIVELY WAIVES THE FOLLOWING:

(i)Except as otherwise specifically required hereby, notice of non-payment, demand, presentment, protest and all forms of demand and notice, both with respect to the Liabilities and the Collateral.

(ii)Except as otherwise specifically required hereby, the right to notice and/or hearing prior to the Agent's exercising of the Agent's rights upon default.

(iii)THE RIGHT TO A JURY IN ANY TRIAL OF ANY CASE OR CONTROVERSY IN WHICH THE AGENT OR ANY REVOLVING CREDIT LENDER IS OR BECOMES A PARTY (WHETHER SUCH CASE OR CONTROVERSY IS INITIATED BY OR AGAINST THE AGENT OR ANY REVOLVING CREDIT LENDER OR IN WHICH THE AGENT OR ANY REVOLVING CREDIT LENDER IS JOINED AS A PARTY LITIGANT), WHICH CASE OR CONTROVERSY ARISES OUT OF OR IS IN RESPECT OF, ANY RELATIONSHIP AMONGST OR BETWEEN ANY BORROWER OR ANY OTHER PERSON AND THE AGENT AND EACH REVOLVING CREDIT LENDER LIKEWISE WAIVES THE RIGHT TO A JURY IN ANY TRIAL OF ANY SUCH CASE OR CONTROVERSY).

(iv)The benefits or availability of any stay, limitation, hindrance, delay, or restriction (including, without limitation, any automatic stay which otherwise might be imposed pursuant to Section 362 of the Bankruptcy Code) with respect to any action which the Agent may or may become entitled to take hereunder.

(v)Any defense, counterclaim, set-off, recoupment, or other basis on which the amount of any Liability, as stated on the books and records of the Agent, could be reduced or claimed to be paid otherwise than in accordance with the tenor of and written terms of such Liability.

(vi)Any claim to consequential, special, or punitive damages.

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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as a sealed instrument as of the day and year first above written.

LEAD BORROWER

DRUGMAX, INC., a Nevada corporation

By:_________________________________

Print Name:__________________________

Title:_______________________________

BORROWERS

VALLEY DRUG COMPANY, an Ohio corporation

By:_________________________________

Print Name:__________________________

Title: _______________________________

VALLEY DRUG COMPANY SOUTH, a Louisiana corporation

By:_________________________________

Print Name:__________________________

Title: _______________________________

FAMILYMEDS, INC., a Connecticut corporation

By:_________________________________

Print Name:__________________________

Title: _______________________________

S/1

AGENT

WELLS FARGO RETAIL FINANCE, LLC

By_________________________________

Print Name:__________________________

Title:_______________________________

REVOLVING CREDIT LENDERS

WELLS FARGO RETAIL FINANCE, LLC

By:________________________________

Print Name:_________________________

Title:_______________________________

S/2

EX-23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the use in this Registration Statement on Form S-1 of our report dated April 15, 2005, except with respect to the matters discussed in Note 17, as to which the date is November 1, 2005, relating to the consolidated financial statements and consolidated financial statement schedule of DrugMax, Inc. (which report expresses an unqualified opinion and includes explanatory paragraphs concerning (i) uncertainty regarding the Company’s ability to continue as a going concern and (ii) the changes in the methods of accounting for negative goodwill, goodwill and other intangible assets to conform to Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”) appearing in the Prospectus, which is part of this Registration Statement.

We also consent to the reference to us under the heading “Experts” in such Prospectus.

/s/ Deloitte & Touche LLP

Hartford, Connecticut

November 1, 2005