10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED MARCH 31, 2004

or

[  ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Commission File No. 1-15445

DRUGMAX, INC.,

(Name of registrant as specified in its charter)

STATE OF NEVADA	34-1755390
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
25400 US Highway 19 North, Suite 137, Clearwater, FL	33763
(Address of Principal Executive Officers)	(Zip Code)

Issuer’s telephone number: (727) 533-0431

Securities registered pursuant to Section 12(b) of the Exchange Act:  None.

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

Common stock, Par value $.001 per share

(Title of Class)

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

        Indicate by check mark if no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [X]

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b2 of the Act).  Yes  [  ]  No  [X]

        The aggregate market value of the Common Stock, $.001 par value, held by non-affiliates of the Registrant based upon the last price at which the common stock was sold as of the last business day of the Registrant’s most recently completed second fiscal quarter, September 30, 2003, as reported on the NASDAQ Stock Market was approximately $11,931,611. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

        The number of shares outstanding of common stock as of July 2, 2004 was 8,193,152.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement to be used in connection with the Registrant’s 2004 Annual Meeting of Stockholders, which will be filed on or before July 29, 2004, are incorporated by reference in Part III, Items 10-14 of this Form 10-K. Except with respect to information specifically incorporated by reference in this Form 10-K, the Proxy Statement is not deemed to be filed as a part hereof.

CAUTIONARY STATEMENTS

Certain oral statements made by management from time to time and certain statements contained in press releases and periodic reports issued by DrugMax, Inc. (the “Company”), including those contained herein, that are not historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Because such statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements, including those in Management’s Discussion and Analysis of Financial Condition and Results of Operations, are statements regarding the intent, belief or current expectations, estimates or projections of the Company, its Directors or its Officers about the Company and the industry in which it operates, and assumptions made by management, and include among other items, (a) the Company’s strategies regarding growth and business expansion, including its strategy of focusing on higher-margin products while reducing costs and the Company’s proposed merger with Familymeds Group, Inc. and other potential future acquisitions; (b) the Company’s financing plans, including its intent to enter into a new credit facility in connection with the proposed merger with Familymeds Group, Inc.; (c) trends affecting the Company’s financial condition or results of operations; (d) the Company’s ability to continue to control costs and to meet its liquidity and other financing needs; (e) the Company’s ability to improve and maintain effective disclosure and internal controls and (f) the Company’s ability to respond to changes in customer demand and regulations. Although the Company believes that its expectations are based on reasonable assumptions, it can give no assurance that the anticipated results will occur. When used in this report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are generally intended to identify forward-looking statements.

Important factors that could cause the actual results to differ materially from those in the forward-looking statements include, among other items, (i) changes in the regulatory and general economic environment related to the health care and pharmaceutical industries, including possible changes in reimbursement for healthcare products and in manufacturers’ pricing or distribution policies; (ii) conditions in the capital markets, including the interest rate environment and the availability of capital; (iii) changes in the competitive marketplace that could affect the Company’s revenue and/or cost bases, such as increased competition, lack of qualified marketing, management or other personnel, and increased labor and inventory costs; (iv) changes in technology or customer requirements, (v) changes regarding the availability and pricing of the products which the Company distributes, as well as the loss of one or more key suppliers for which alternative sources may not be available, (vi) the Company’s ability to integrate recently acquired businesses and (vii) the factors set forth in “Risk Factors” contained in this Annual Report on Form 10-K. Further information relating to factors that could cause actual results to differ from those anticipated is included but not limited to information under the headings “Business,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K. The Company disclaims any intention or obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise.

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TABLE OF CONTENTS

ITEM		PAGE
	PART I
1.	Business	4
2.	Properties	25
3.	Legal Proceedings	25
4.	Submission of Matters to a Vote of Security Holders	27
	PART II
5.	Market for Registrant’s Common Equity and Related Stockholder Matters	28
6.	Selected Financial Data	29
7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
7A.	Quantitative and Qualitative Disclosures About Market Risks	43
8.	Financial Statements and Supplementary Data	44
9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	75
9A.	Controls and Procedures	76
	PART III
10.	Directors and Executive Officers of the Registrant	78
11.	Executive Compensation	78
12.	Security Ownership of Certain Beneficial Owners and Management	78
13.	Certain Relationships and Related Transactions	78
14.	Principal Accountant Fees and Services	78
	PART IV
15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	78
	Signatures	84

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PART I

Item 1.  BUSINESS.

General

DrugMax, Inc. (Nasdaq: DMAX) is a full-line, wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products, nutritional supplements and other related products. The Company is headquartered in Clearwater, Florida and maintains distribution centers in Pennsylvania and Louisiana. The Company distributes its products primarily to independent pharmacies in the continental United States, and secondarily to small and medium-sized pharmacy chains, alternative care facilities and other wholesalers. While the Company ships to all 50 states and Puerto Rico, its sales tend to be concentrated around its distribution centers in Pennsylvania and Louisiana and largely populated states such as New York, California, Texas and Florida. The Company maintains an inventory in excess of 20,000 stock keeping units (“SKU”s) from leading manufacturers and holds licenses to ship to all 50 states and Puerto Rico. Each SKU represents an individual type of product sold by the Company. See “Business – Purchasing.”

History

The Company was founded in 1993 under the name NuMED Surgical, Inc. as a subsidiary of NuMED Home Health Care, Inc., a publicly traded company. The Company was created to complete the distribution of certain assets and liabilities associated with NuMED Home Health Care’s surgical/medical products division to its stockholders. NuMED Home Health Care, Inc. contributed all of those assets and liabilities to the Company, and then distributed all of the shares of the Company’s common stock to its stockholders. In connection with the spin off, the Company’s common stock was registered under the Securities Exchange Act of 1934, and the Company began trading as a separate public company.

In April 1997, the Company sold its major product line and subsequently disposed of its operating assets because of continued losses caused by increased competition and the loss of exclusivity of its products. The sale of the Company’s major product line and assets was completed by March 31, 1998, and, accordingly, from April 1, 1998, to September 8, 1998, the Company used a liquidation basis of accounting.

On March 17, 1999, the Company acquired all of the outstanding common stock of Nutriceuticals.com Corporation (“Nutriceuticals”), a Florida corporation formed in September 1998 to engage in the online retailing of natural products over the Internet. For accounting purposes, this acquisition was treated as an acquisition of the Company by Nutriceuticals and a recapitalization of Nutriceuticals. Although the Company was incorporated in Nevada on October 18, 1993, the Company’s date of inception is September 8, 1998 for accounting purposes. After the Company acquired Nutriceuticals, the Company changed its corporate name to Nutriceuticals.com Corporation.

In November 1999, the Company acquired all of the outstanding shares of common stock of Becan Distributors, Inc. (“Becan”), and its wholly owned subsidiary Discount Rx, Inc. (“Discount”), a wholesale distributor primarily of pharmaceuticals and, to a lesser extent, over-the-counter and health and beauty care products which had been in business since 1997. Following the acquisition of Becan, the Company changed its name to DrugMax.com, Inc. With the acquisition of Becan, the Company changed its primary focus from that of an online business-to-consumer retailer of vitamins and other health products to that of an e-commerce business-to-business wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products and nutritional supplements. In March 2000, Becan was merged into the Company.

In March 2000, the Company diversified its operations by acquiring all of the issued and outstanding shares of common stock of Desktop Corporation, a Texas corporation located in Dallas, Texas. In addition, in May 2000, the Company formed Desktop Media Group, Inc. (“Desktop Media”) a Florida corporation, to develop web based and Internet software for the Company. On September 15, 2000, Desktop Corporation and Desktop Media

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executed Articles of Merger whereby Desktop Corporation was merged into Desktop Media, with Desktop Media Group, Inc. (“Desktop”) being the surviving entity. Desktop, in addition to being a designer and developer of customized internet solutions, owned, at the time of acquisition, 50% of the outstanding shares of common stock of VetMall, LLC (later converted to a newly formed Florida corporation VetMall, Inc.) (“VetMall”), with the remaining shares being owned by W.A. Butler & Company (“Butler”), one of the nation’s largest veterinary products distributors. Concurrent with the acquisition of Desktop, the Company acquired an additional 20% interest in VetMall from Butler. In April 2003, Butler and the Company executed an agreement (the “April 2003 Agreement”) whereby Butler transferred its remaining 30% ownership in VetMall to the Company; accordingly, the Company now owns 100% of VetMall stock. The April 2003 Agreement was negotiated due to the fact that VetMall had no current or anticipated operations; therefore, Butler desired to be relieved of any possible future business activities and financial liability of VetMall. Neither VetMall nor Desktop currently have any operations, and management anticipates the dissolution of these entities.

On April 19, 2000, the Company acquired Valley Drug Company (“Valley”), a full-line, primary wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products and general merchandise. This acquisition helped the Company expand its customer base, product line and market share, and provided the Company with the additional ability to serve its customers as a primary, full-line wholesale distributor, and offer them the convenience of one-stop shopping. Valley has been in operation since 1950. In January 2004 Valley relocated its offices from Youngstown, Ohio to New Castle, Pennsylvania. See “Acquisitions.”

In September 2001, the Company changed its name to DrugMax, Inc. to more appropriately reflect the Company’s business model.

On October 25, 2001, the Company’s wholly-owned subsidiary, Discount Rx, Inc., a Louisiana corporation, purchased substantially all of the net assets of Penner & Welsch, Inc. (“Penner”), a wholesale distributor of pharmaceuticals based in Louisiana, pursuant to an Agreement for the Purchase and Sale of Assets dated October 12, 2001. Penner was a Chapter 11 debtor which had voluntarily filed for Chapter 11 protection in the US Bankruptcy Court Eastern Division of Louisiana. Prior to its acquisition, commencing in September 2000, the Company managed the day-to-day operations of Penner, in exchange for a management fee equal to a percentage of the gross revenues of Penner each month. During such management period, the Company provided Penner with a collateralized revolving line of credit for the sole purpose of purchasing inventory from the Company. Penner has been in operation since 1963. The Company operates the acquired business in St. Rose, Louisiana under Valley Drug Company South, Inc. See “Acquisitions.”

On May 14, 2003, Discount Rx, Inc., a Nevada corporation and a wholly owned subsidiary of the Company, purchased substantially all of the assets, subject to certain liabilities, of Avery Pharmaceuticals, Inc., Avery Wholesale Pharmaceuticals, Inc., also known as Texas Vet Supply (jointly “Avery”), and Infinity Custom Plastics, Inc. (“Infinity”), wholesale distributors of pharmaceuticals and respiratory products based in Texas, pursuant to an Asset Purchase Agreement dated May 14, 2003 (the “Avery Agreement”). In October 2003, the Company relocated the operations of Avery to St. Rose, Louisiana, and currently operates the acquired business under Valley Drug Company South. See “Acquisitions.”

Industry Overview

Wholesale pharmaceutical distributors serve pharmacies and other healthcare providers by providing access to a single source for pharmaceutical and healthcare products from hundreds of different manufacturers. Wholesale pharmaceutical distributors lower customer inventory costs, provide efficient and timely product delivery, and provide valuable inventory and purchasing information. Customers also benefit from value-added programs developed by wholesale pharmaceutical distributors to reduce costs and to increase operating efficiencies for the customer, including packaging, stockless inventory, and pharmacy computer systems.

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Wholesale distributors are critical links in the pharmaceutical supply chain, helping fuel the majority of the $216.4 billion in total prescription drug sales to retailers and institutions in 2003. The United States’ prescription drug sales increased approximately 11.5% from $192.2 billion in 2002 to approximately $216.4 billion in 2003. Prescription drug sales are expected to grow at an annual compound rate of 8% to 12% through 2007 according to IMS Health. The principal factors contributing to this historical and expected growth are the following:

• Aging of Population. According to the US Census Bureau, there were 35.9 million citizens at least 65 years old in 2003. The aging population’s therapy needs will be in predictable categories that require continued treatment for diabetes, high cholesterol, heart disease and other health problems. This demographic group represents the largest percentage of new prescriptions filled and obtains more prescriptions per capita annually than any other age group.

• Importance of the Wholesale Distribution Channel. Over the past decade, as the cost and complexity of maintaining inventories and arranging for delivery of pharmaceutical products has risen, manufacturers of pharmaceuticals have significantly increased the distribution of their products through wholesalers. Drug wholesalers are generally able to offer their customers more efficient distribution and inventory management than pharmaceutical manufacturers. According to the Healthcare Distribution Management Association (“HDMA”), this channel saves healthcare systems billions each year by maximizing economies of scale, creating efficiencies, lowering expenses, and simplifying distribution.

• Rising Pharmaceutical Costs. From 1990 to 2000, the average retail price of a prescription increased from $22.06 to $45.79. The Company believes that price increases for branded pharmaceutical products by manufacturers will continue to equal or exceed the overall increases in the Consumer Price Index (“CPI”). In 2003, actual pharmaceutical prices increased 8.3%, with the CPI increase of 2.5%. According to the National Association of Chain Drugstores, the average retail prescription price increased from approximately $54.73 in 2002 to approximately $59.30 in 2003.

• Increased Drug Utilization. In recent years, a number of factors have contributed to the increased utilization of drug-based therapies to prevent and to treat disease. New drug offerings continue to grow, with 119 new drug approvals in 2003 compared to 109 new drug approvals in 2002.

The Company’s products function within the structure of the healthcare financing and reimbursement system of the United States. As a result of a wide variety of political, economic and regulatory influences, this system is currently under intense scrutiny and subject to fundamental changes. In recent years, the system has changed significantly in an effort to reduce costs. These changes include increased use of managed care, cuts in Medicare, consolidation of pharmaceutical and medical-surgical supply distributors, and the development of large, sophisticated purchasing groups. As a result, the Company’s profit margins have been negatively impacted, particularly with regard to branded pharmaceuticals. The Company expects that these forces will continue to negatively impact profit margins, including as a result of:

• the highly-competitive nature of the pharmaceutical wholesale business;

• drug manufacturers’ reduction of wholesale buying opportunities; and

• continuing efforts by drug manufacturers and others to eliminate forward buying by wholesalers.

Buying opportunities occur when manufacturers announce that wholesalers with whom they conduct business may purchase inventory at favorable prices if they are willing to purchase more than their usual inventory of product. Forward buying is a speculative purchasing strategy employed in the industry to purchase inventory in advance of expected price increases.

Objectives and Strategy

The Company’s primary business objective is to become a leading full-line wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products, nutritional supplements and other

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related products, with a focus on sales of higher-margin products primarily to independent pharmacies and secondarily to small and medium-sized pharmacy chains and alternative care facilities. Accordingly, while the Company continues to distribute brand products as requested by its customers, beginning in fiscal 2003 it began to focus its efforts on higher-margin products, including generic and over-the-counter products. Additionally, from time-to-time, DrugMax seeks to acquire additional complementary product lines, as it did with its acquisition of Avery, that enhance its ability to provide higher-margin products.

Historically, the Company has primarily grown its business through strategic acquisitions. In the future, the Company intends to continue to:

• provide quality products and efficient service at competitive prices;

• focus on the sale of higher-margin products;

• undertake beneficial strategic acquisitions;

• market its name, products and services to create brand recognition and generate and capture traffic on its web site;

• develop strategic relationships that increase the Company’s product offerings, particularly with regard to higher-margin products;

• maintain technology focus and expertise to improve efficiency and ease of use of its web site; and

• attract and retain exceptional employees.

Sales and Marketing, Customer Service and Support

The Company is a full-line, wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products, nutritional supplements and other related products. The majority of the Company’s sales are in the pharmaceutical product line. The Company’s pharmaceutical products are divided into generic and brand products. In general, brand products offer smaller margins than generic products or the other products offered by the Company. Accordingly, while the Company continues to distribute brand products as requested by its customers, it is currently focusing its efforts on growing its generic pharmaceutical, over-the-counter and other products lines.

The Company distributes its products primarily to independent pharmacies in the continental United States, and secondarily to small and medium-sized pharmacy chains, alternative care facilities and other wholesalers. The Company’s products are sold both through traditional wholesale distribution lines and the Company’s web site, www.drugmax.com. Since the early December 1999 launch of its web site, over 9,000 independent pharmacies, small regional pharmacy chains, wholesalers and distributors have registered to purchase products through the Company’s web site. Although the Company expects that it will continue to derive a significant portion of its revenue from its traditional “brick and mortar” full-line wholesale distribution business, the Company believes its e-commerce, business-to-business model will allow the Company to leverage its existing wholesale distribution business, thus increasing its ability to effectively market and distribute its products.

The Company uses a variety of programs to stimulate demand for its products and increase traffic to its web site, including the following:

Direct Sales.    The Company maintains employees to act as its direct sales force to target organizations that buy and sell the products it carries.

Telemarketing.    The Company maintains an in-house telemarketing group for use in customer prospecting, lead generation and lead follow-up.

Advertising.    The Company advertises in trade journals, at trade shows and engages in co-branding arrangements. In addition to strategic agreements and traditional advertising, the Company also uses many online sales and marketing techniques.

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Customer Service and Support.    The Company believes that it can establish and maintain long-term relationships with its customers and encourage repeat visits if, among other things, the Company has excellent customer support and service. The Company currently offers information regarding its products and services and answers customer questions about the ordering process, and investigates the status of orders, shipments and payments. A customer can access the Company by fax or e-mail by following prompts located on its web site or by calling the Company’s toll-free telephone line.

In addition, the Company is promoting, advertising and increasing recognition of its web site through a variety of marketing and promotional techniques, including:

• enhancing online content and ease of use of the Company web site;

• enhancing customer service and technical support; and

• advertising in trade journals and at industry trade shows.

During the fiscal years ended March 31, 2004, 2003, and 2002, the Company’s 10 largest customers accounted for approximately 40%, 44%, and 37%, respectively, of the Company’s net sales. The Company’s two largest customers during fiscal 2004 and 2003, Supreme Distributors and QK Healthcare, accounted for approximately 10% each of net sales in fiscal 2004, and 17% and 11% of net sales in fiscal 2003, respectively. In fiscal 2002, the Company’s largest customer, QK Healthcare, accounted for approximately 13% of net sales. In fiscal 2004, QK Healthcare, Inc. sued the Company and ceased doing business with the Company. The suit has now been settled and QK Healthcare, Inc. has indicated its willingness to resume business with the Company. See “Legal Proceedings.”

Distribution

The Company’s wholesale distribution business is supported by three distribution centers located in Pittsburgh, Pennsylvania; New Castle, Pennsylvania; and St. Rose, Louisiana. These locations enable the Company to deliver approximately 95% of its products to its customers via next day delivery. The remaining product is distributed by its delivery vans in regions of eastern Ohio and western Pennsylvania, or by common carrier to more distant customers. While the Company ships to all 50 states and Puerto Rico, its sales tend to be concentrated around its distribution centers in Pennsylvania and Louisiana and largely populated states such as New York, California, Texas and Florida.

Purchasing

The Company purchases over 20,000 individual inventory items, which are designated as individual stock keeping units (“SKU”) primarily from manufacturers and secondarily from other wholesalers and distributors. Each SKU has a separate electronic bar code. The Company utilizes sophisticated inventory control and purchasing software to track inventory, to analyze demand history and to project future demand. The system is designed to enhance profit margins by eliminating the manual ordering process, allowing for automatic inventory replenishment and identifying inventory buying opportunities. In addition, the Company’s purchasing department constantly monitors the market to take advantage of periodic volume discounts, market discounts and pricing changes.

The Company purchases products from approximately 400 vendors, such as AmerisourceBergen Corp., Pfizer, Inc., Eli Lilly and Company, Merck and others. The Company initiates purchase orders with vendors through its information system. During fiscal years 2004, 2003, and 2002, the Company’s 10 largest vendors accounted for approximately 89%, 60%, and 40%, respectively, (by dollar volume) of the Company’s purchases for each year. In fiscal 2004 and 2003, the Company’s largest vendor, AmerisourceBergen Corp. accounted for approximately 24% and 45%, respectively, of total purchases of the Company. The next largest vendor was less than 8% for each fiscal 2004 and 2003. Substantially all of the Company’s supplier agreements are terminable at will by

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either party or upon short notice and without penalty. Historically, the Company has not experienced difficulty in purchasing desired products from suppliers. The Company believes that its relationships with its suppliers are good.

Competition

The wholesale distribution of pharmaceuticals, health and beauty aids, and other healthcare products is highly competitive. The Company faces strong competition both in price and service from national, regional and local full-line, short-line and specialty wholesalers, service merchandisers, self-warehousing chains and from manufacturers engaged in direct distribution. In Pittsburgh, for example, where the Company maintains a distribution facility, there are a number of suppliers that provide branded pharmaceuticals and other products to independent pharmacies, Internet pharmacies, clinics and other licensed outlets. These competitors compete primarily on the basis of service and price. Other competitive factors include delivery service, credit terms, breadth of product line, customer support, merchandising and marketing programs. Certain of the Company’s competitors, including McKesson HBOC, Inc., AmerisourceBergen Corporation, and Cardinal Health Inc., have significantly greater financial and marketing resources, longer operating histories and larger customer bases than the Company does. In addition, many of the Company’s competitors have greater brand recognition and significantly greater financial, marketing and other resources, and may be able to:

• secure merchandise from vendors on more favorable terms;

• devote greater resources to marketing and promotional campaigns; and

• adopt more aggressive pricing or inventory availability policies.

In addition, certain of the Company’s competitors, such as McKesson HBOC, Inc., AmerisourceBergen Corp., and Cardinal Health, Inc. have developed or may be able to develop e-commerce operations that compete with the Company’s e-commerce operations, and may be able to devote substantially more resources to web site development and systems development than the Company. The online commerce market is rapidly evolving and intensely competitive. The Company expects 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

The manufacturing, packaging, labeling, advertising, promotion, distribution and sale of most of the Company’s products are subject to regulation by numerous governmental agencies, including the United States Food and Drug Administration, which regulates most of its products under the Federal Food, Drug and Cosmetic Act. The Company’s products are also subject to regulation by, among other regulatory agencies, the Consumer Product Safety Commission, the United States Department of Agriculture and the United States Department of Environmental Regulation. Furthermore, the Company and/or its customers are subject to extensive licensing requirements and comprehensive regulation governing various aspects of the healthcare delivery system, including the so called “fraud and abuse” laws. The fraud and abuse laws and regulations are broad in scope and are subject to frequent modification and varied interpretations.

The Company’s advertising is also subject to regulation by the Federal Trade Commission under the Federal Trade Commission Act, in addition to state and local regulation. The Federal Trade Commission Act prohibits unfair methods of competition and unfair or deceptive acts or practices in or affecting commerce. The Federal Trade Commission Act also provides that the dissemination or the causing to be disseminated of any false advertisement pertaining to drugs or foods is an unfair or deceptive act or practice. Under the Federal Trade Commission’s Substantiation Doctrine, an advertiser is required to have a “reasonable basis” for all objective product claims before the claims are made. Failure to adequately substantiate claims may be considered either deceptive or unfair practices.

In addition, the Company’s products function within the structure of the healthcare financing and reimbursement system of the United States. As a result of a wide variety of political, economic and regulatory influences, this

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system is currently under intense scrutiny and subject to fundamental changes. In recent years, the system has changed significantly in an effort to reduce costs. These changes include increased use of managed care, cuts in Medicare, consolidation of pharmaceutical and medical-surgical supply distributors, and the development of large, sophisticated purchasing groups. In addition, a variety of new approaches have been proposed to continue to reduce cost. Because of uncertainty regarding the ultimate features of reform initiatives and their enactment and implementation, the Company cannot predict which, if any, of such reform proposals will be adopted, when they may be adopted, or what impact they may have on the Company. While the Company uses its best efforts to adhere to the regulatory and licensing requirements, as well as any other requirements affecting the Company’s products, compliance with these often requires subjective legislative interpretation. Consequently, the Company cannot assure that its compliance efforts will be deemed sufficient by regulatory agencies and commissions enforcing these requirements. Violation of these regulations may result in civil and criminal penalties. See “Risk Factors.”

Intellectual Property

The principal trademarks and service marks of the Company include DRUGMAX^® and DRUGMAX.COM^®. The marks are registered in the United States. The United States federal registrations of these trademarks and service marks have ten-year terms and are subject to unlimited renewals. The Company believes that protecting its trademarks and registered domain names is important to its business strategy of building strong brand name recognition and that such trademarks have significant value in the marketing of the Company’s products. To protect its proprietary rights, the Company relies on copyright, trademark and trade secret laws, confidentiality agreements with employees and third parties, and license agreements with consultants, vendors and customers. Despite such protections, however, the Company may be unable to fully protect its intellectual property. See “Risk Factors.”

Employees

At March 31, 2004, the Company employed 80 persons, 72 of which represented full-time employees. Labor unions do not represent any of these employees. The Company considers its employee relations to be good.

Employees are permitted to participate in employee benefit plans of the Company that may be in effect from time to time, to the extent eligible. Each of the employees is eligible for stock option grants in accordance with the provisions of the Company’s 1999 Stock Option Plan, and eligible to receive restricted stock in accordance with the provisions of the Company’s 2003 Restricted Stock Plan, as determined by the Administrator of the Plan. The purpose of the 1999 Stock Option Plan and the 2003 Restricted Stock Plan is to enable the Company to attract and retain top-quality executive employees, officers, directors and consultants and to provide such executive employees, officers, directors and consultants with an incentive to enhance stockholder return.

Acquisitions

The Company made the following acquisitions during the last three fiscal years:

Penner and Welsch, Inc.

On October 25, 2001, Discount, a wholly-owned subsidiary of the Company, purchased substantially all of the net assets of Penner & Welsch, Inc. (“Penner”), a wholesale distributor of pharmaceuticals based in Louisiana, pursuant to an Agreement for the Purchase and Sale of Assets dated October 12, 2001 (“the Agreement”). As previously reported by the Company, Penner was a Chapter 11 debtor which had voluntarily filed for Chapter 11 protection in the US Bankruptcy Court Eastern Division of Louisiana. Prior to this acquisition, commencing in September 2000, the Company managed the day-to-day operations of Penner, in exchange for a management fee equal to a percentage of the gross revenues of Penner each month. During the management period, the Company provided Penner with a collateralized revolving line of credit for the sole purpose of purchasing inventory from

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the Company. Pursuant to the Agreement, Penner received an aggregate of 125,418 shares of restricted common stock of the Company, valued at $5.98 per share, cash in the amount of $488,619, and forgiveness of $1,604,793 in trade accounts payable and management fees owed to Discount. The source of the funds used to acquire Penner’s assets was the working capital of the Company. The Agreement, including the nature and amount of the consideration paid to Penner, was negotiated between the parties and, on October 15, 2001, was approved by the US Bankruptcy Court, Eastern Division of Louisiana. The Company operates the acquired business under Valley South, its wholly owned subsidiary.

Avery Pharmaceuticals, Inc.

On May 14, 2003, Discount Rx, Inc., a Nevada corporation and a wholly owned subsidiary of the Company, purchased substantially all of the assets, and assumed certain liabilities, of Avery Pharmaceuticals, Inc., Avery Wholesale Pharmaceuticals, Inc., also known as Texas Vet Supply (jointly “Avery Pharmaceuticals”), and Infinity Custom Plastics, Inc. (“Infinity”), wholesale distributors of pharmaceuticals and respiratory products based in Texas, pursuant to an Asset Purchase Agreement dated May 14, 2003 (the “Avery Agreement”).

Pursuant to the Avery Agreement, the Company acquired accounts receivable, inventory, equipment, furniture, the trade name and a patent pending for the process of the manufacture of vials for the respiratory therapy industry, totaling approximately $789,000. The liabilities assumed, which were comprised principally of trade payables, amounted to approximately $646,000, in addition to the forgiveness of debt owed to the Company of approximately $53,000. In addition, the Company executed a promissory note in the amount of $318,000 to the predecessor company’s 50% shareholder (“Sankary”), as additional consideration (the “Sankary Note”). The Sankary Note included a right of set off for accounts payable in excess of an agreed upon amount assumed at closing The Company and Avery specifically contemplated that the Company 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 Agreement permit the Company to “set off” payments due under the Sankary Note against payments made in excess of the assumed liabilities. The Company believes that it has paid Avery’s obligations well in excess of the assumed liabilities. Therefore, all other payments under the Sankary Note are offset such that nothing more is due and payable there under in excess of the $90,000.

Sankary filed a lawsuit against the Company, in the 342^nd Judicial District Court of Tarrant County, Texas (“Sankary Suit”). The complaint alleges that the Company defaulted under the Sankary Note as a result of the Company’s failure to make payments when due to Sankary.

The Company has paid to Sankary the minimum amount due under the Sankary Note (approximately $90,000) and has paid liabilities of Avery in excess of its obligations under the agreement, such that it is entitled to offset any further liability under the Sankary Note. The Company 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. See Litigation.

Additionally, the Avery Agreement contains a provision whereby based on earnings of the acquired business, the note may be increased to the original amount of $318,000 which would be treated as an addition to the purchase price. The operations of the acquired business have produced a net loss for the Company; therefore, no adjustment to the note was made based upon performance. Also, the Company executed a Consulting and Non-Competition Agreement (“Consulting Agreement”) with John VerVynck (“VerVynck”) an officer and shareholder of Avery Pharmaceuticals and Infinity. The Consulting Agreement provided for the payment to VerVynck of $39,360, payable bi-monthly, over the six-month term of the Consulting Agreement. Upon completion of the Consulting Agreement in December 2003 VerVynck’s employment with the Company was terminated. The Consulting Agreement prohibits VerVynck from competing for one year following his termination and the six-month term of the consulting agreement. In October 2003, the Company relocated the operations of Avery to the St. Rose Louisiana location. The Company operates the acquired business through its wholly owned subsidiary Valley South.

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Recent Developments: Private Placement and Proposed Merger with Familymeds, Inc.

On March 18, 2004, the Company sold 1,000,000 shares of its common stock in a private placement to accredited investors for $3.21 million. The expenses related to this offering approximated $500,000. Maxim Group LLC, a New York-based investment firm, acted as the placement agent for the Company in the private placement. Net proceeds will be used for working capital and general corporate purposes. The private placement was made under an exemption from the registration requirements of the Securities Act of 1933, as amended, 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. The Company has filed a registration statement on Form S-3 with the Securities and Exchange Commission, which as of June 28, 2004 had not yet been declared effective by the Securities and Exchange Commission, to register the resale of the shares sold in the private placement, as is required by the subscription agreements between the investors and the Company.

On March 19, 2004, the Company entered into an Agreement and Plan of Merger with Familymeds Group, Inc., a Connecticut Company (“FMG”), as amended on July 1, 2004, pursuant to which FMG will be merged with and into the Company, with the Company being the surviving company. FMG is a pharmacy chain with a strategy of locating pharmacies at or near a patient’s point of medical care. FMG operates more than 76 pharmacies in 14 states. Many of these pharmacies are located at or near the point of care between physicians and patients, many times inside or near medical office buildings. Across these distribution channels, FMG annually services over 400,000 acute and chronically ill patients, many with complex specialty and medical product needs. The principal executive offices of FMG are located at 312 Farmington Avenue, Farmington, CT 06032. If the merger is consummated, the Company expects that the current Company stockholders will, as a group, own approximately 40%, and FMG stockholders, employees and directors will, as a group, own approximately 60%, of the issued and outstanding shares of the Company immediately after the merger, assuming the vesting of all restricted shares issued in connection with the merger. In addition, at the closing of the merger, the Company will issue warrants to the FMG stockholders and certain FMG warrant holders and note holders entitling them to purchase certain additional shares of the Company common stock.

The Company’s annual meeting of stockholders, at which its stockholders will note on the merger, currently is scheduled to be held in August 2004, although this date is subject to change based upon various factors. The Company has filed a preliminary Proxy Statement on Schedule 14A with the Securities and Exchange Commission relating to the merger and other matters to be voted upon at the annual meeting of stockholders. However, the merger is subject to various closing conditions, including the approval of the merger by the stockholders of the Company and FMG and the obtainment of adequate financing, and there can be no assurance that the merger will be consummated. If the merger is consummated, the Company will be subject to various risk associated with the merger and Familymeds Group, Inc. See, “Risk Factors” below.

RISK FACTORS

In addition to the other information in this Form 10-K, the following should be considered in evaluating the Company’s business and prospects:

Risk Factors Relating to DrugMax, Inc.

The Company’s business could be adversely affected if relations with any of its significant suppliers are terminated.

The Company’s ability to purchase pharmaceuticals, or to expand the scope of pharmaceuticals purchased, from a particular supplier is largely dependent upon such supplier’s assessment of the Company’s creditworthiness and

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the Company’s ability to resell the products it purchases. The Company is also dependent upon its suppliers’ continuing need for, and willingness to utilize, the Company’s services to help them manage their inventories. If the Company ceases to be able to purchase pharmaceuticals from any of its significant suppliers, such occurrence could have a material adverse effect on the Company’s business, results of operations and financial condition because many suppliers own exclusive patent rights and are the sole manufacturers of certain pharmaceuticals. If the Company becomes unable to purchase patented products from any such supplier, it could be required to purchase such products from other distributors on less favorable terms, and the Company’s profit margin on the sale of such products could be reduced or eliminated. Substantially all of the Company’s agreements with suppliers are terminable by either party at will on short notice and without penalty. See “Business.”

The Company’s industry has experienced declining margin percentages in recent years and, if this trend continues, the Company’s business could be adversely affected.

Over the past decade, participants in the wholesale pharmaceutical distribution industry have experienced declining gross and operating margin percentages. Industry sources estimate that the average gross margin percentage of companies in the industry has decreased from approximately 7.35% in 1990 to approximately 4.25% in 2002. The profitability of wholesale distributors, including the Company, is largely dependent upon earning volume incentives, cash discounts and rebates from pharmaceutical manufacturers. The Company’s profitability is also increasingly dependent on its ability to purchase inventory in advance of anticipated or known manufacturer price increases. Although investment buying opportunities may enable the Company to increase its gross margin percentage when manufacturers increase prices, such buying requires subjective assessments of future price changes as well as significant working capital. If the Company’s gross margin percentages decline significantly, or if the Company’s assessments of future price changes are incorrect, or if the Company does not have the necessary working capital to take advantage of buying opportunities, the Company’s profitability could be materially adversely affected. To increase its margins, while the Company continues to distribute brand products as requested by its customers, it is currently focusing its efforts on growing its generic pharmaceutical, over-the-counter and other products lines. Additionally, from time to time the Company seeks to acquire additional complimentary product lines, as it did with its acquisition of Avery and Infinity. As a result, the company’s profit margins have stabilized. The Company’s gross margin percentage was approximately 2.6%, 2.8% and 2.8% for fiscal 2004, 2003 and 2002, respectively, as the Company continues to concentrate its sales efforts towards the higher margin generic and over-the-counter products. See “Acquisitions.” However, there can be no assurances that the Company will be successful in continuing to stabilize or increase its margins. Growth in higher-margin products requires significant marketing and sales efforts, which may not be successful. Low demand for higher-margin products could prevent the Company from increasing its sales of these products, and increased competition in higher-margin products could reduce the margins on these products. The proposed merger with FMG will also impact the Company’s margins. See “Risk Factors Relating to the Proposed Merger with FMG.”

The loss of one or more of the Company’s largest customers or a significant decline in the level of purchases made by one or more of the Company’s largest customers could hurt the Company’s business by reducing the Company’s revenues and earnings.

As is customary in the Company’s industry, the Company’s customers are generally permitted to terminate the Company’s relationship or reduce purchasing levels on relatively short notice and without penalty. Termination of a relationship by a significant customer or a significant decline in the level of purchases made by a significant customer could have a material adverse effect on the Company’s business, results of operations and financial condition. Additionally, an adverse change in the financial condition of a significant customer, including an adverse change as a result of a change in governmental or private reimbursement programs, could have a material adverse effect on the Company’s ability to collect its receivables from the customer and the volume of its sales to the customer.

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The Company’s markets are highly competitive and it may be unable to compete effectively.

The pharmaceutical and over-the-counter product industries are intensely competitive. To strategically respond to changes in the competitive environment, the Company may sometimes make pricing, service or marketing decisions or acquisitions that could materially hurt its business. The Company cannot guarantee that it can compete successfully against current and future competitors. Management believes that the Company’s business is not seasonal; however, significant promotional activities can have a direct impact on sales volumes in any given quarter. See “Business—Competition.”

The Company’s business could be adversely affected if it lost any of its key personnel.

The Company is dependent on the services of the Company’s senior management and on the relationships between the Company’s key personnel and the Company’s significant customers and suppliers. The Company has entered into employment agreements or non-competition agreements with the key members of the Company’s management team. The loss of certain members of the Company’s senior management or of key purchasing or sales personnel, particularly the Company’s Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer, could have a material adverse effect on the Company’s business, results of operations and financial condition. The Company generally does not carry life insurance policies on the lives of the Company’s key senior managers or key purchasing or sales personnel. As is generally true in the industry, if any of the Company’s senior management or key personnel with an established reputation within the industry were to leave the Company’s employment, there can be no assurance that the Company’s customers or suppliers who have relationships with such person would not purchase products from such person’s new employer, rather than from the Company. The Company historically has not had significant difficulty attracting and retaining needed employees.

Changes in the healthcare industry could adversely affect the Company.

The healthcare industry has undergone significant change in recent years as a result of various efforts to reduce costs, including proposed national healthcare reform, trends toward managed care, spending cuts in Medicare, consolidation of pharmaceutical and medical/surgery supply distributors, the development of large, sophisticated purchasing groups and efforts by traditional third party payers to contain or reduce healthcare costs. The Company cannot predict whether these trends will continue or whether any other healthcare reform efforts will be enacted and what effect any such reforms may have on the Company’s practices and products or the Company’s customers and suppliers. Any future changes in the healthcare industry, including a reduction in governmental financial support of healthcare services, adverse changes in legislation or regulations governing the delivery or pricing of prescription drugs, healthcare services or mandated benefits may cause healthcare industry participants to significantly reduce the amount of the Company’s products and services they purchase or the price they are willing to pay for the Company’s products and services. Changes in pharmaceutical manufacturers’ pricing or distribution policies could also significantly and adversely affect the Company’s revenues, margins and profitability. See “Business.”

The Company could be adversely affected if there are changes in the regulations affecting the healthcare industry or if it fails to comply with current regulations applicable to the Company’s business.

The healthcare industry is more heavily regulated than many other industries. As a distributor of certain controlled substances and prescription pharmaceuticals, the Company is required to register with and obtain licenses and permits from certain federal and state agencies and must comply with operating and security measures prescribed by those agencies. The Company is also subject to various regulations including the 1987 Prescription Drug Marketing Act, an amendment to the federal Food, Drug and Cosmetic Act, which regulates

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the purchase, storage, security and distribution of prescription pharmaceuticals. The Company’s compliance with these regulations is monitored through periodic site inspections conducted by various governmental agencies. Any failure to comply with these regulations or to respond to changes in these regulations could result in penalties on the Company such as fines, restrictions on the Company’s operations or a temporary or permanent closure of the Company’s facilities. These penalties could harm the Company’s operating results. The Company cannot assure that future changes in applicable laws or regulations will not materially increase the costs of conducting business or otherwise have a material adverse effect on the Company’s business, results of operations and financial condition. See “Business.”

A disruption in the Company’s information systems could adversely affect its business.

The Company is dependent on the Company’s information systems to receive and process customer orders, initiate orders with product suppliers, distribute products to the Company’s customers in a timely and cost-effective manner, track and secure inventory and maintain compliance with federal and state regulations. Any disruption in the Company’s information systems could thus have a material adverse effect on the Company’s business, results of operations and financial condition. The Company has its own certificate server from Microsoft that encrypts the registration session to protect the customer information. In addition, the Company has taken steps to protect the registration information residing in its servers by using firewalls, backups and other preventive measures designed to protect the privacy of its customers. The Company maintains off-site copies of all the data and programs utilized by the Company locations. The Company restricts access to customer personal and financial data to those authorized employees who have a need for these records. The Company does not release information about its customers to third parties without the prior written consent of its customers unless otherwise required by law. Notwithstanding these precautions, the Company cannot assure that the security mechanisms will prevent security breaches or service breakdowns. Despite the network security measures the Company has implemented, its servers may be vulnerable to computer viruses, physical or electronic break-ins or other similar disruptions. Such a disruption could lead to interruptions or delays in its service, loss of data, or its inability to accept and fulfill customer orders. Any of these events could materially affect the Company’s business.

The Company is subject to capacity constraint system development risks which may result in its inability to service its customers and meet its growth expectations.

A key element of its strategy is to generate a high volume of traffic on, and use of, the Company’s web site. Accordingly, the Company’s web site transaction processing systems and network infrastructure performance, reliability and availability are critical to its operating results. These factors are also critical to its reputation and its ability to attract and retain customers and maintain adequate customer service levels. The volume of goods it sells and the attractiveness of its product and service offerings will decrease if there are any systems interruptions that affect the availability of its web site or its ability to fulfill orders. The Company expects to continually enhance and expand its technology and transaction processing systems, and network infrastructure and other technologies, to accommodate increases in the volume of traffic on its web site. The Company may also fail timely to expand and upgrade its systems and infrastructure to accommodate increases in the volume of traffic on the web site.

The Company has a history of violating certain of its debt covenants.

The Company’s credit facilities require the Company’s compliance with certain restrictive covenants, including but not limited to minimum EBITDA, maximum capital expenditures and minimum net worth. During fiscal years 2003 and 2004, the Company was not in compliance with certain of these restrictive covenants. However, these violations were waived by Standard Federal National Bank and Congress Financial, respectively. There can be no assurance that Congress Financial will continue to waive these deficiencies in the future. If not so waived, failure to meet these covenants will cause the Company to be in default under the credit facility and will allow

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Congress Financial to accelerate the obligations under the facility. If Congress Financial accelerates the obligations and the Company cannot secure an alternate credit facility, the Company may not be able to continue as a going concern.

The Company’s disclosure controls and procedures are not adequately effective.

The Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2004, the Company’s disclosure controls and procedures needed improvement and were not adequately effective. If the disclosure controls and procedures are not improved and made more effective, then information required to be disclosed in the Company’s financial statements may not be recorded, processed, summarized or reported within the appropriate time periods and may periodically result in a misstatement of the financial statements, and possibly such information will not be accumulated and communicated to the Company’s management to allow for timely decisions.

Risk Factors Relating to the Proposed Merger with FMG

The merger may not be consummated or may be delayed.

The proposed merger with FMG is subject to various closing conditions, including stockholder approval, regulatory consents and financing, and there can be no assurance that the merger will be consummated. The Company’s annual meeting of stockholders currently is scheduled to be held in August, but this date is subject to change based upon various factors. The merger may be delayed past the expected closing date. See “Business – Recent Developments.”

The combined company may fail to realize all of the anticipated benefits of the merger.

The value of the combined company following the merger and the benefits of the merger principally depend on the successful integration of the two companies and the implementation of their business plan. The Company believes merging the two companies, and thus vertically integrating the Company’s wholesale operations with FMG’s retail operations, will reduce the aggregate expenses for the combined company while increasing the Company’s revenues and margins. The expense reductions are expected to be achieved through purchasing efficiencies and by eliminating certain redundant costs. The increases in revenues and margins are expected to be achieved through, among other factors:

• increased purchasing power that, among other things, will allow the combined company to purchase products at discounted rates through special buy-in programs offered by manufacturers;

• an expanded customer base;

• the integration of the two companies’ broad sales and distributions channels, including FMG’s retail (mail order, call center and Internet) channels, with the Company’s wholesale (mail order, call center and Internet) channels, allowing the combined company to expand distribution directly to the growing managed care and alternate site markets; and

• increased sales, in an amount greater than either company individually had, to the higher-margin specialty prescription and generic pharmaceutical markets as a result of the combination of FMG’s retail model, which focuses on providing a wide variety of prescription and non-prescription healthcare-related diagnostic products used for the treatment of chronic diseases through pharmacies located at or near the point of care between physicians and patients, with the Company’s supply capabilities. The specialty prescription market includes products used to treat chronic, high cost, or rare diseases; which products are often administered via a non-oral route in a non-hospital setting.

Management has experience integrating the businesses and assets that the Company has acquired, in connection with the acquisitions of Becan Distributors, Valley Drug Company, Penner & Welch, Inc. and most recently Avery Pharmaceuticals Inc. Management has experienced some delays and unexpected obstacles in these past integrations, none of which, however, it believes have been material. Further, when appropriate, management has decided to discontinue acquired divisions for business reasons, such as the businesses of Desktop Media Group, Inc. and VetMall, Inc.

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However, there is little business precedent for the integration of a pharmaceutical wholesaler, such as the Company, and a retail pharmacy chain, such as FMG, and therefore, while management believes there are significant benefits to the merger, the Company’s ability to capitalize on these opportunities is uncertain. The combined company may fail to realize some or all of the anticipated revenue opportunities, cost savings and other benefits of the transaction as a result of, among other things, vendor constraints, unanticipated costs, deterioration in the U.S. economy and other factors. For example, FMG currently has a wholesale supply agreement requiring it to purchase 90% of its pharmaceuticals from AmerisourceBergen Corp. The Company also purchases pharmaceuticals from AmerisourceBergen Corp. but it does not have any minimum purchase requirements. Although the company believes that it will be able to reach a satisfactory agreement with AmerisourceBergen Corp., failure to do so could result in a delay and/or reduction in the expected benefit from purchasing synergies of the merger. In addition, the integration of FMG’s business and operations with those of the Company, including systems conversions, may take longer than anticipated, may be more costly than anticipated and may have unanticipated adverse results relating to FMG’s or the Company’s existing businesses or customer base. There can be no assurance that management will be able to successfully integrate FMG and the Company. If the post-merger management fails to achieve its business plan or is delayed in doing so, the Company’s results of operations and financial condition following the merger would be materially adversely affected.

Current holders of the Company’s common stock will experience substantial dilution of their percentage ownership interest of the Company common stock.

If the merger is consummated, the Company expects that the current Company stockholders will, as a group, own approximately 40%, and FMG stockholders, employees and directors will, as a group, own approximately 60%, of issued and outstanding shares of the Company immediately after the merger, assuming the vesting of all shares of restricted stock issued in connection with the merger. In addition, at the closing of the merger, the Company will issue warrants to the FMG stockholders, the FMG warrant holders and the FMG note holders entitling them to purchase certain additional shares of the Company’s common stock. As a result, after the merger, each share of the Company common stock that the Company’s stockholders currently own will represent a smaller percentage ownership interest in the combined company than they currently own, and, accordingly the current stockholders of the Company, will have less control over matters on which stockholders vote, including the election of directors.

A portion of the merger consideration is subject to the market value of the Company common stock and may expose the current Company stockholders to added dilution.

The aggregate number of shares of the Company’s common stock to be paid in the merger is fixed and is not subject to adjustment for changes in the market price of the Company’s common stock. However, as stated above, at the closing, the Company also is issuing warrants to purchase the Company’s common stock to the FMG stockholders, to certain FMG warrant holders and the to certain FMG note holders. The number of warrants to be so issued, and the exercise price of those warrants, is based upon the weighted-average stock price of the Company’s common stock during the ten trading days immediately preceding the closing. The lower the ten-day weighted-average stock price, the greater the number of warrants to be issued, the lower the exercise price of those warrants and the greater the potential dilution to existing Company stockholders should the warrants be exercised. Assuming a ten-day weighted-average stock price of $4.85 at the closing, the Company’s stock price on June 10, 2004, the Company will issue warrants to purchase a total of 3,047,446 shares of the Company common stock at the closing. The exercise of any of these warrants will necessarily dilute the relative percentage ownership of the current Company stockholders. Once again assuming a ten-day weighted-average stock price of $4.85 at the closing, if immediately after the closing all of the warrants issued at closing are exercised, but the currently outstanding options to purchase common stock of the Company are not, the Company expects that the current Company stockholders will at such time, as a group, own approximately 35%, and FMG stockholders, employees and directors will, as a group, own approximately 65%, of issued and outstanding shares of the Company.

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The Company’s stock price may remain volatile.

As recently as January 16, 2004, approximately two months prior to the date the companies announced the execution of the merger agreement, the Company common stock traded below $2.00. By the time the execution of the merger agreement was announced on March 22, 2004, the price had risen to over $4.50. Between March 22, 2004 and July 7, 2004, the stock price has remained over $4.00. There can be no assurance that the Company’s stock price will remain near its recent highs, especially if the merger is not consummated. The Company’s ability to integrate FMG’s business, announcement of developments related to the Company’s business after the merger, announcements by competitors, quarterly fluctuations in the Company’s financial results and general economic conditions in the highly-competitive pharmaceutical industry in which the Company will compete could cause the price of the Company common stock to continue to fluctuate, perhaps substantially. In addition, the Company has agreed to register the resale of 1,000,000 shares recently sold in a private placement, all of the shares to be issued in connection with or at the closing of the merger, and the shares of the Company owned by Messrs. Taneja and LaGamba. As a result of such registration, the holders of such shares may use such registrations to sell the shares publicly or privately, resulting in further downward pressure on the stock price. These factors and fluctuations could have a significantly harmful effect on the market price of the Company common stock after the merger.

The fairness opinion obtained by the Company from Sanders Morris Harris, Inc. will not reflect changes in circumstances between the signing of the agreement and the merger.

In connection with the merger, the Company has received a fairness opinion from its financial advisor, Sanders Morris Harris, Inc., dated March 26, 2004. The Company has not obtained an updated opinion from Sanders Morris Harris, Inc. Changes in the operations and prospects of the Company or FMG, general market and economic conditions and other factors which may be beyond the control of the Company and FMG, and on which the fairness opinion was based, may alter the value of the Company or FMG or the prices of shares of the Company common stock and shares of FMG common stock by the time the merger is completed. The opinion does not speak as of the time the merger will be completed or as of any date other than the date of the opinion. The Company is not aware of any events that have occurred since the date of the opinion that are likely to alter Sanders Morris Harris, Inc.’s determination that the merger is fair to the shareholders of the Company from a financial point of view.

If not managed efficiently, the combined company’s rapid growth may divert management’s attention from the operation of its business, which could hinder its ability to operate successfully.

The Company’s growth has placed, and its anticipated continued growth (including as a result of the merger) will continue to place, significant demands on its managerial and operational resources. The combined company’s failure to manage its growth efficiently may divert management’s attention from the operation of its business and render it unable to keep pace with its customers’ demands.

The combined company’s working capital and credit facilities may be insufficient.

To complete the merger, the merger agreement requires that the Company shall have obtained a new credit facility. The Company has received proposals for a $65 million credit facility. The new credit facility will be used to repay certain existing indebtedness of the Company and FMG. While the Company has obtained these proposals, there can be no assurance that the loan, or any other acceptable credit facility, will be available to us prior to the scheduled closing of the merger.

Further, even if such a credit facility is obtained prior to closing, it may be insufficient to fund the Company’s credit needs. Management presently believes that the new credit facility proposed by Congress will be sufficient to allow the surviving company to integrate the businesses of FMG and the Company and to fund its business plan for the next 12 months. However, if the Company fails to realize some or all of the anticipated revenue

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opportunities or cost savings and other benefits of the merger, or if the costs of the merger or the integration of the companies exceeds what is anticipated, the Company may need to seek alternate or additional financing. The Company and FMG require substantial working capital to fund their operations. The Company’s future capital requirements will depend upon many factors, including, but not limited to:

• the cost of the merger and of integrating the businesses of the Company and FMG;

• whether the Company makes future acquisitions;

• whether the Company hires additional personnel; and

• whether the Company expands the services that it offers.

While the Company does not currently have any immediate plans to make future acquisitions, hire personnel or expand its services (other than as a result of the FMG merger), the Company regularly considers acquisitions and growth opportunities. As a result of the foregoing factors, the surviving company’s actual revenues and costs are uncertain and may vary considerably. These variations may significantly affect its future need for capital. The actual amount and timing of the Company’s future capital requirements may differ materially from its estimates. In particular, the Company’s estimates may be inaccurate as a result of changes and fluctuations in its revenues, operating costs and development expenses. The Company’s actual financing needs will depend on the amount of post-merger operating losses, development expenses, working capital needs and other factors. Adequate funds may not be available when needed or may not be available on favorable terms. If adequate financing is not raised, the Company may not be able to execute its business plan and the post-merger financial condition and results of operations of the combined company may be materially adversely affected.

The Company’s business plan to improve its profit margins by increasing sales of higher-margin products, which the merger is intended to promote, may be unsuccessful.

Over the past decade, participants in the wholesale pharmaceutical distribution industry have experienced declining gross and operating margin percentages. In addition, brand name drug manufacturers recently have started to require drug wholesalers to reduce or eliminate forward buying, a strategy pursuant to which wholesalers purchase products in anticipation of expected price increases. Further, brand manufacturers are reducing the number of buy-in programs that they are offering. Buy-in programs are special opportunities provided by manufacturers to purchase greater-than-normal quantities at reduced prices. Both of these trends may result in further downward pressure on the Company’s gross margins.

As a result of these pressures, although the Company continues to distribute brand products as requested by its customers, beginning in fiscal 2003 it began to focus its efforts on higher-margin products, including generic and over-the-counter products. As part of this strategy, from time-to-time, the Company seeks to acquire additional complementary higher-margin product lines, as it did through its acquisition of Avery.

The merger with FMG compliments and is expected to further the Company’s business strategy of focusing on higher-margin products. However, as stated above, while management believes there are significant benefits to the merger, the Company’s ability to capitalize on these opportunities is uncertain. Further, there can be no assurance that the Company will be able to maintain or increase revenues and margins even if it implements the merger. Growth in higher-margin products requires significant marketing and sales efforts, which may not be successful, as well as working capital to capitalize on opportunities to purchase product at reduced prices, which may not be available. Low demand for higher-margin products could prevent the Company from increasing its sales of these products, and increased competition in higher-margin products could reduce the margins on those products. Further, the cost of the merger may exceed what is anticipated and the Company may not achieve the benefits of the merger, both of which may negatively impact its working capital and, thus, its opportunities to participate in buy-in opportunities, which will negatively impact its margins and profitability. In general, the profitability of wholesale distributors, including the Company, is largely dependent upon earning volume incentives, cash discounts and rebates from pharmaceutical manufacturers, and there can be no assurance that the Company will be able to stabilize or increase its profit margins.

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The merger agreement limits the Company’s and FMG’s ability to pursue alternatives to the merger.

The merger agreement contains “no shop” provisions that, subject to limited exceptions, limit the Company’s and FMG’s ability to discuss, facilitate or commit to competing third-party proposals to acquire all or a significant part of the Company. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of the Company from considering or proposing an acquisition even if it were prepared to pay more consideration than that proposed in the merger, or might result in a potential competing acquirer proposing to pay a lower per share price to acquire the Company than it might otherwise have proposed to pay.

The implementation of the combined company’s business plan is dependent upon the continued employment of its management team and attracting and retaining qualified pharmacists.

The combined company’s success will depend to a large extent on its executive management team, key employees and pharmacists. After the merger, it is expected that Edgardo A. Mercadante (the current Chief Executive Officer of FMG) will become the Company’s Co-Chairman and Chief Executive Officer, Dale Ribaudo (the current Chief Financial Officer of FMG) will become the Company’s Chief Financial Officer, Jugal K. Taneja will remain as Co-Chairman of the Company, William L. LaGamba will remain as President and Chief Operating Officer of the Company and Ronald Patrick will remain as Chief Financial Officer of Valley. The Company historically has not had significant difficulty attracting and retaining needed employees. However, the merger agreement requires that each of Messrs. Taneja, LaGamba, Mercadante, and Ribaudo enter into new employment agreements with the combined company after the merger upon terms acceptable to them and the combined company’s compensation committee. There can be no assurance that the parties will reach agreements on mutually acceptable employment terms. The loss of any of these individuals, as well as certain other key employees and pharmacists, could have a material adverse effect on the combined company’s ability to implement its business plan and business, results of operations and financial condition. The Company generally does not carry life insurance policies on the lives of its key senior managers or key purchasing or sales personnel. With the exception of Mr. Mercadante, FMG does not have “key person” life insurance covering any of FMG’s employees. As is generally true in the industry, if any of the Company’s senior management or key personnel with an established reputation within the industry were to leave the Company’s employment, there can be no assurance that the Company’s customers or suppliers who have relationships with such person would not purchase products from such person’s new employer, rather than from the Company. There is currently a national shortage of pharmacists. As a result, the combined company may not be able to attract and retain an adequate number of pharmacists required in order to maintain FMG’s existing level of customer service.

Risk Factors Relating to FMG

If the merger is completed, FMG will merge with and into the Company. Accordingly, the surviving company will inherit the risks of FMG’s business, operations and industry.

FMG has a history of losses and negative cash flow; FMG’s auditor has issued a going concern opinion.

FMG has incurred significant losses and negative cash flow in the past. Further, unless restructured in connection with the merger, FMG’s senior collateralized revolving credit facility with General Electric Capital Corporation (“General Electric”), and its debt under that facility will mature on August 31, 2004. As of May 22, 2004, the amount outstanding under the General Electric facility was approximately $27.7 million. These facts raise doubt about FMG’s ability to continue as a going concern. FMG’s auditor has issued a going concern opinion, in part as a result of its credit facility having a maturity date of less than one year.

While management believes that the merger offers the combined company a greater opportunity than either company individually would have to improve its financial position, for the reasons discussed above, there can be no assurance that management will be able to integrate the two companies or that the anticipated benefits of the

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merger will be realized. If the Company and FMG fail to integrate the companies, achieve its business plan, realize some or all of the anticipated revenue opportunities or cost savings and other benefits of the merger, or if the costs of the merger or the integration of the companies exceeds what is anticipated, the combined company’s working capital and financial condition will be materially negatively impacted.

Further, as stated above, at the closing of the merger, the combined company expects to obtain a new credit facility to replace the General Electric facility. While this will eliminate the immediate need for FMG to use its assets to repay the General Electric loan, and while the Company and FMG presently believe the new credit facility will be sufficient to allow the combined company to integrate the businesses of FMG and the Company and to fund its business plan for the next 12 months, there can be no assurance that the new company will have sufficient financing to operate the business after the closing of the merger.

As stated above, if the Company fails to realize some or all of the anticipated revenue opportunities or cost savings and other benefits of the merger, or if the costs of the merger or the integration of the companies exceeds what is anticipated, the surviving company may need to seek alternate or additional financing. The surviving company’s actual revenues and costs are uncertain and may vary considerably. These variations may significantly affect its future need for capital. The actual amount and timing of the surviving company’s future capital requirements may differ materially from its estimates. Adequate funds may not be available when needed or may not be available on favorable terms. If adequate financing is not raised, the surviving company may not be able to execute its business plan and the post-merger financial condition and results of operations of the combined company may be materially adversely affected.

Further, it is anticipated that as part of its new credit facility, the Company and FMG will be required to pledge all of their assets to the new lender to secure the entire credit facility, including that portion that was used to repay FMG’s obligations. If Familymeds, Inc., the operating company of FMG that will become a wholly-owned subsidiary of the Company after the merger, is unable to continue as a going concern or to meet its obligations to the new lender under the new credit facility after the merger, it is unlikely that the Company, on its own, will be able to satisfy the obligations. If FMG is unable to continue as a going concern, the Company will be unable to obtain the benefits of the merger and its working capital and financial condition will be materially negatively impacted and it may itself be unable to continue as a going concern. After the merger, the Company’s assets will be exposed to FMG’s and Familymeds Inc.’s creditors.

FMG has a history of violating certain of its debt covenants.

FMG’s current $31 million credit facility with General Electric matures on August 31, 2004. Available credit under the facility is based on eligible receivables, inventory and prescription files. The facility requires compliance with certain restrictive covenants including, but not limited to, minimum EBITDA, maximum capital expenditures, minimum net worth, minimum prescriptions filled, minimum inventory turnover, maximum trade receivable days sales outstanding and limitations on additional indebtedness. During 2003 and 2004, FMG was not in compliance with certain of these restrictive covenants; however, these violations were subsequently waived by General Electric. Although there can be no assurance, FMG does not expect that these past covenant violations will have a negative impact on its ability to enter into a new credit facility or have any impact on the merger.

FMG’s success is dependent upon entering into and maintaining contracts with health insurers, managed care organizations and pharmacy benefit managers.

FMG derives a majority of its revenue from health insurers, managed care organizations and pharmacy benefit managers. FMG’s contracts with these organizations enable it to obtain reimbursement on behalf of FMG’s customers for the prescription products that they purchase at FMG’s pharmacies. However, we do not know if FMG will be successful in maintaining these contracts. In the past, FMG has been prevented from participating in certain plans because of the plan’s decision to restrict participation as a cost saving initiative, or because the

21

reimbursement rate offered by the plan was less than FMG’s cost of goods sold. If it is unable to maintain existing contracts or obtain additional contracts, FMG’s customers may not be able to obtain reimbursement for prescription products purchased at FMG’s retail, mail order and online pharmacies, which would decrease the demand for FMG’s services and products and impair FMG’s ability to retain and expand its customer base. These plans include state Medicaid plans, Express Scripts, PCS, and paid prescription plans. Under the terms of these agreements, FMG is required to dispense prescription drugs to its customers in return for a contracted reimbursement rate from the individual plan.

Competition in the pharmacy markets in which FMG competes is intense and could have a negative effect on the combined company’s earnings.

FMG, like the Company, conducts business in competitive markets, and expects competition to intensify in the future. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could harm the combined company’s earnings. FMG’s competitors, many of which have significantly greater financial, technical, marketing and other resources than FMG, 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; and

• Specialty medication providers including Accredo Health and Priority Healthcare.

In addition, FMG faces competition from online pharmacies outside the United States.

The demand for FMG’s services and products is affected by regulatory and other changes in the health care industry.

As with the Company, FMG’s revenues from prescription drug sales may be affected by health care reform initiatives of federal and state governments, including proposals designed to significantly reduce spending on Medicare, Medicaid and other government programs. The demand for its services and products may also be affected by changes in programs providing for reimbursement for the cost of prescription drugs by third party plans and regulatory changes relating to the approval process for prescription drugs. These initiatives could lead to the enactment of federal and state regulations that may adversely impact our prescription drug sales and, accordingly, our results of operations.

Managed care organizations are increasingly challenging the price and cost-effectiveness of medical products and services. While FMG may be successful in continuing its contracts for insurance reimbursement, the efforts of managed care organizations to contain costs will likely place downward pressures on its gross margins from sales of prescription drugs. FMG cannot be certain that its products and services will be considered cost effective or that adequate managed care organization reimbursement will be available to enable it to maintain price levels sufficient to realize adequate profit margins on prescription drugs. FMG’s failure to realize and maintain adequate profit margins on prescription drugs would adversely affect its operating results.

FMG’s operations are subject to extensive regulations and failure to comply with those regulations could result in severe penalties and damage to FMG’s brand.

FMG, as with the Company, is subject to extensive federal, state and local licensing and registration laws and regulations with respect to its business, including its pharmacy and franchise operations and the pharmacists it employs. Regulations in these areas often involve subjective interpretation and FMG does not know if its attempts to comply with these regulations will be deemed sufficient by the appropriate regulatory agencies. FMG believes it has satisfied its licensing and registration requirements and continues to actively monitor its

22

compliance with these requirements. However, violations of any of these regulations could result in various penalties, including suspension or revocation of FMG’s licenses or registrations, and seizure of FMG’s inventory or monetary fines, any of which could adversely affect FMG’s operations and damage FMG’s brand.

FMG, like the Company, also is 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 FMG’s 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. FMG also is required to comply with the Dietary Supplement Health and Education Act when selling dietary supplements and vitamins.

In addition, FMG’s pharmacy compounding services are subject to Food and Drug Administration regulation. The Food and Drug Administration also regulates drug advertising and promotion, including direct-to-patient advertising, done by or on behalf of manufacturers and marketers. If FMG expands its product and service offerings, more of FMG’s 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. FMG also is 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). It also is 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 has 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 FMG, any of its personnel, or any of its significant customers or business partners, will not become subject to sanctions that could have a material adverse effect on FMG’s business, financial condition and results of operations. Additionally, the sanctioning or exclusion of a manufacturer or recipient of FMG’s products or services, even for activities unrelated to FMG, could also have a material adverse effect on FMG’s 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, FMG’s pharmacists are required to offer counseling to FMG’s 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 FMG’s pharmacists. In the event that FMG’s pharmacists or FMG’s mail order and online pharmacies provide erroneous or misleading information to its customers, FMG may be subject to liability or negative publicity that could have an adverse impact on its business. Although FMG carries general, professional and product liability insurance, FMG’s insurance may not cover potential claims of this type or may not be adequate to protect FMG from all liability that may be imposed.

The Health Insurance Portability and Accountability Act of 1996, and regulations promulgated there under (collectively “HIPAA”), require health care providers such as FMG 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 FMG does not offer franchises for sale at this time, in the case of renewing franchisees, FMG is 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 FMG’s existing franchisees, it also may be subject to certain state laws regulating the

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franchisor-franchisee relationship. Failure to comply with these regulations could result in substantial financial penalties. Currently, FMG only holds franchise agreements for seven stores and is not materially dependent on these agreements.

FMG also is subject to laws governing its 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 FMG’s results of operations. Other legislation being considered at the federal and state level could affect FMG’s business including state legislation related to the regulation of nonresident pharmacies.

FMG believes it is currently in material compliance with the state and federal laws and regulations governing its business.

The demand for FMG’s services and products at many of its retail pharmacies is dependent upon the continued operation of medical groups to which they are proximate.

A significant element of FMG’s business plan is operating retail pharmacies in or near medical buildings occupied by medical groups such as HMOs. Some of those buildings are occupied by only one medical group. In the event these medical groups or a significant number of physicians cease to operate in these locations, the demand for FMG’s services at these locations will likely decrease and may result in the closing of one or more of FMG’s pharmacies.

FMG may experience significant fluctuations in its operating results and rate of growth.

FMG’s revenue and operating profit growth depend on the continued growth of demand for its products and services. In addition, FMG’s business is affected by general economic and business conditions. A decrease in demand may result in decreased revenue or growth. FMG’s revenues and operating results may vary significantly from quarter to quarter due to a number of factors, including:

• Its ability to retain and increase sales to existing customers;

• the quantity and mix of products FMG’s customers purchase;

• the extent to which FMG offers delivery, shipping or other promotional discounts to its customers;

• disruptions in service by FMG’s vendors;

• timing and costs of upgrades and developments in FMG’s systems and infrastructure to support future growth;

Any errors in filling prescription drugs may expose FMG to liability and negative publicity.

Errors relating to prescriptions may produce liability for FMG that its insurance may not cover. FMG’s pharmacists are required by law to offer counseling, without additional charge, to FMG’s customers about medication, dosage, common side effects and other information deemed significant by the pharmacists. FMG’s pharmacists may have a duty to warn customers regarding any potential adverse effects of a prescription drug if the warning could reduce or negate such effects. Providing information on pharmaceutical and other products creates the potential for claims to be made against FMG for negligence, personal injury, wrongful death, product liability, malpractice, invasion of privacy or other legal theories based on FMG’s product or service offerings. FMG’s general liability, product liability and professional liability insurance may not cover potential claims of this type or may not be adequate to protect FMG from all liabilities that may be imposed if any such claims were to be successful. In the past, FMG has not been held liable for any material claims of this nature and its liability insurance has fully covered all actual and threatened claims of this type.

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FMG may be subject to product liability claims if people or property are harmed by the products it sells.

Like the Company, some of the products FMG sells may expose it to product liability claims relating to personal injury, death or property damage caused by such products and may require FMG to take actions such as product recalls. Any such product liability claim or product recall may result in adverse publicity regarding FMG and the products it sells. If FMG is found liable under product liability claims, it could be required to pay substantial monetary damages. Further, it could be forced to spend a substantial amount of money in litigation expenses, management, time and other resources to defend against these claims. As a result of these claims, whether or not FMG successfully defends them, its reputation could suffer, any of which could harm FMG’s business. Any imposition of product liability that is not covered by manufacturer indemnification or FMG’s insurance could harm FMG’s business, financial condition and operating results. In the past, FMG has not been held liable for any material claims of this nature and its liability insurance has fully covered all actual and threatened claims of this type.

Item 2.  PROPERTIES.

The Company does not own or hold any legal or equitable interest in any real estate. The Company leases its principal administrative, marketing and customer service facility containing approximately 5,216 square feet of air-conditioned 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. The Valley facility was relocated from Youngstown, Ohio to New Castle, Pennsylvania in the fourth quarter of 2004. The Company now leases for Valley a facility located at 209 Green Ridge Road, New Castle, Pennsylvania 16105, from Becan Development LLC, a related party (see Note 13 of the consolidated financial statements). The new 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 fifteen (15) years expiring December 30, 2018, with an initial monthly lease payment of $17,000. The Company leases for its Pittsburgh facility, 1,424 square feet of office and 1,176 square feet of warehouse space located at 203 Parkway West Industrial Park, Pittsburgh, Pennsylvania 15205. The term of the lease for the Pittsburgh facility is for three years expiring February 28, 2006, with a monthly lease payment of $1,658. The Company exercised its option within the lease for the Pittsburgh facility and provided the landlord with the Company’s intent to vacate. The Company plans to relocate the Pittsburgh distribution facility to New Castle, Pennsylvania to combine the operations of Pittsburgh and Valley. The Company leases for its subsidiary, Valley South, a building located at 10016 River Road, St. Rose, Louisiana, 70087, from River Road Real Estate LLC, a related party (see Note 13 of the consolidated financial statements.) 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.

Item 3.  LEGAL PROCEEDINGS.

From time to time, the Company may become involved in litigation arising in the ordinary course of its business. The Company is not presently subject to any material legal proceedings other than as set forth below.

In March 2000, the Company 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. (the “Reorganization Agreement”). On February 7, 2002, Messrs. Miller and Fagala filed a complaint against the Company in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, Florida, alleging, among other things, that the Company had breached the Reorganization Agreement by failing to pay 38,809 shares of the Company’s common stock to plaintiffs. The complaint also includes a count of conversion and further alleges that the Company breached its employment agreements with Messrs. Miller and Fagala, for which the plaintiffs seek monetary damages. On March 11, 2002, the Company filed its answer, affirmative defenses and counterclaim against plaintiffs and HCT Capital Corp. (“HCT”), in which it alleged, among other things, that plaintiffs had

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breached the Reorganization Agreement by misrepresenting the state of the acquired business, that the Company was entitled to set off its 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 the Company and cross-claim against the plaintiffs. In December 2003, a Settlement Agreement and Release (the “Release”) was executed by HCT and the Company whereby HCT and 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. There has been little activity by Messrs. Miller and Fagala with regard to this matter, and the Company is currently considering how to proceed in light of this inactivity. The Company intends to vigorously defend the actions filed against it and to pursue its counterclaim. The Company cannot reasonably estimate any possible future loss or recovery as a result of this matter; therefore, the Company has made no provision in the accompanying consolidated financial statements for resolution of this matter.

On May 1, 2002, the Company filed suit against an established customer of the Company’s Pittsburgh distribution center for collection of past due accounts receivable. The customer accounted for approximately $4.1 million, or 1.5%, of the gross revenue of the Company in the fiscal year ended March 31, 2002. The Company has an unconditional personal guaranty signed by the customer’s owner. On May 23, 2002, the customer filed a voluntary petition in bankruptcy in the U.S. Bankruptcy Court, under Chapter Eleven of the United States Bankruptcy Act, subsequent to which the customer failed to file the proper financial data with the court, causing the voluntary bankruptcy filing to be withdrawn. Management is continuing to pursue its claim for payment through the courts. The Company currently has recorded an allowance account representing 100% of the account balance.

On October 2, 2003, QK Healthcare, Inc. (“QK”) filed a complaint against Valley in the United States District Court of the Eastern District of New York, which included several counts with regard to the sale of twenty bottles of Lipitor by Valley to QK, including breach of contract, violations of the implied warranty of merchantability and fraud. The complaint demands actual damages, punitive damages and legal fees and expenses. On January 9, 2004, the Company filed an answer and counterclaim against QK, in which the Company seeks to recover from QK losses caused when QK refused to pay for pharmaceuticals ordered from the Company. The Parties reached a settlement on May 14, 2004, pursuant to which the case will be dismissed. The settlement agreement requires the Company to pay QK $218,000, calls for the parties to resume their business relationship, with the Company giving QK certain price reductions in the products QK purchases from the Company for one year, and provides for the mutual release of both parties. The Company has recorded $218,000 to operating expense and $32,000 to legal expense in the fourth quarter of fiscal 2004 relative to this matter.

On November 12, 2003, Phil & Kathy’s, Inc. d/b/a Alliance Wholesale Distributors (“Alliance”) served a complaint against the Company seeking to recover the non-payment of open invoices approximating $2,000,535, 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 purchase of twenty bottles of Lipitor from Alliance, which the Company later sold to QK. The Company intends to vigorously defend Alliance’s breach of contract action and prosecute the counterclaim. 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 the lawsuit against Valley by QK in New York. At March 31, 2004, the amount that the Company recorded as a trade payable balance due Alliance on the above was approximately $1.5 million. While the Company has recorded the foregoing trade payable, it continues to assess the extent of its full damages and cannot at this time reasonably estimate the total future possible loss that it will sustain as a result of the Alliance complaint or the possible recovery through the Company’s counterclaim or Valley’s consolidated action.

On May 14, 2003, Discount Rx, Inc., a Nevada corporation and a wholly owned subsidiary of the Company (“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

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in excess of the Assumed Liabilities. Discount believes that it has paid Avery’s obligations well in excess of the Assumed Liabilities. Therefore, all other payments under the Sankary Note are offset such that nothing more is due and payable thereunder.

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) and has paid liabilities of Avery in excess of its obligations under the agreement, such that it is entitled to offset any further liability under the Sankary Note. 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.

Additionally, since the closing of the Avery transaction, various creditors and other third parties owed money by Avery have threatened to file lawsuits against Discount. To date, Discount has not been sued by any of these creditors or other third parties and their claims remain unliquidated. The Company intends to vigorously defend any actions filed against Discount. In the unlikely event that Discount is not permitted to offset liabilities paid against the obligation under the Sankary Note, the total amount that remains payable under the Sankary Note as of June 25, 2004, is $228,000. However, because the Company believes that it is entitled to offset any further liability under the Sankary Note, the Company has made no provision in the accompanying consolidated financial statements for resolution of the Sankary Suit. Similarly, because no other lawsuits have been filed nor any threatened to be filed, the Company has made no provision in the accompanying consolidated financial statements for resolution of any other claims against Discount.

Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.

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PART II

Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The Company’s common stock is traded on the Nasdaq SmallCap Market under the symbol “DMAX.” The following table sets forth the closing high and low bid prices for the Company’s common stock on the Nasdaq SmallCap Market for each calendar quarter during the Company’s last two fiscal years, 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	$	4.20	$	1.96
	Second Quarter	$	2.60	$	1.10
	Third Quarter	$	1.58	$	0.85
	Fourth Quarter	$	1.45	$	0.97
2004	First Quarter	$	2.00	$	0.97
	Second Quarter	$	2.89	$	1.20
	Third Quarter	$	2.80	$	1.75
	Fourth Quarter	$	6.00	$	1.85
2005	First Quarter	$	5.05	$	3.78

As of July 2, 2004, there were approximately 781 shareholders of record of the Company’s common stock.

Historically, the Company has not declared or paid any cash dividends on its common stock. It currently intends to retain any future earnings to fund the development and growth of its business. Any future determination to pay dividends on the common stock will depend upon the Company’s 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 the Company’s Board of Directors. The Company’s current credit facility prohibits the payment of dividends.

Equity Compensation Plan Information

The following table sets forth certain information regarding the Company’s equity compensation plan as of March 31, 2004:

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))
	(a)	(b)		(c)
Equity compensation plan approved by securities holders (1)	2,000,000	$	3.69	-
Equity compensation plan not approved by security holders (2)	220,479	$	3.28	-
Equity compensation plan not approved by security holders (3)	150,000	$	16.50	-
Total	2,370,479			-

1. Reflects options to purchase shares of the Company’s common stock under the Company’s 1999 Stock Option Plan.

2. Reflects options to purchase shares of the Company’s common stock issued to a non-management employee.

3. Represents a warrant to purchase 150,000 shares of common stock at an exercise price of $16.50 granted to the Company’s underwriters in connection with its 1999 public offering. See Note 12 to the consolidated financial statements.

Please see Note 12 to the Company’s Consolidated Financial Statements for a description of the 1999 Stock Option Plan.

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Item 6.  SELECTED FINANCIAL DATA.

The following selected financial data should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report. The statement of operations data for the years ended March 31, 2004, 2003, and 2002 and the balance sheet data as of March 31, 2004 and 2003, are derived from, and are qualified by reference to our audited Consolidated Financial Statements included elsewhere in this Annual Report. The statement of operations data for the years ended March 31, 2001 and 2000 and the balance sheet data as of March 31, 2002, 2001 and 2000 are derived from the Company’s audited Consolidated Financial Statements which are not included in this Annual Report. When appropriate, certain amounts have been reclassified to conform with the presentation for fiscal year ended March 31, 2004. Historical results are not necessarily indicative of results which may be expected for any future period. Amounts shown in thousands except per share data.

	Fiscal year ended March 31,
	2004(a)			2003(b)			2002(c)		2001(d)			2000(e)
Net revenue	$	213,789		$	291,752		$	271,288	$	177,713		$	21,051
Gross profit		5,629			8,105			7,513		5,531			144
Selling, general and administrative		10,008			7,762			5,389		5,163			1,557
Depreciation and amortization		211			325			260		2,798			520
Goodwill, intangible asset and asset impairment loss		-			12,468			-		4,440			-
Operating (loss) income		(4,590	)		(12,450	)		1,864		(6,870	)		(1,933	)
(Loss) income before extraordinary item, equity earnings from unconsolidated subsidiary and income tax benefit (expense)		(5,623	)		(13,162	)		904		(8,734	)		(2,124	)
Net (loss) income		(7,039	)		(13,162	)		2,007		(9,306	)		(2,124	)
(Loss) earnings per share - basic		(0.98	)		(1.85	)		0.29		(1.45	)		(0.55	)
(Loss) earnings per share - diluted		(0.98	)		(1.85	)		0.28		(1.45	)		(0.55	)
Balance Sheet:
Cash and cash equivalents and restricted cash	$	2,788		$	2,161		$	2,167	$	2,436		$	6,020
Accounts receivable - net		11,696			11,340			14,002		14,864			4,106
Inventory		16,371			19,459			20,682		10,694			1,416
Property and equipment - net		1,410			768			990		505			693
Goodwill		13,105			13,105			25,314		25,179			26,081
Total assets		47,858			50,274			66,303		54,631			40,003
Accounts payable		14,340			14,619			13,845		11,448			3,171
Credit line payable		17,251			15,944			18,930		11,944			2,391
Stockholders’ equity		14,063			18,284			31,447		26,578			33,482
Total liabilities and stockholders’ equity		47,858			50,274			66,303		54,631			40,003

(a) Includes $1.4 million as a charge to income tax expense as a result of the reversal of the net deferred tax asset recorded in the fourth quarter of fiscal 2004.

(b) Includes $12.5 million of goodwill and intangible asset impairment loss, and $.3 million deferred income tax benefit.

(c) Includes $1.1 million deferred income tax benefit, net of $.4 million deferred income tax expense.

(d) Includes $4.4 million goodwill and asset impairment loss, and amortization of goodwill of $2.5 million.

(e) Fiscal 2000 includes sales from only the Pittsburgh facility, which was acquired by the Company in November 1999.

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The Company primarily has historically grown its business through strategic acquisitions. In November 1999, the Company acquired Becan (and its subsidiary, Discount) in Pittsburgh Pennsylvania; in April 2000, the Company acquired Valley in Youngstown, Ohio; in October 2001, the Company acquired Penner in St. Rose, Louisiana, and in May 2003, the Company acquired Avery. The Company currently has three distribution centers. Fiscal year 2004 includes the full-year sales for the three distribution centers and approximately 10 months of sales from Avery. Fiscal years 2003 and 2002 include full-year sales for the three distribution centers, and the fiscal year 2001 consists of full-year sales for the Pennsylvania distribution center, but only approximately eleven months of sales for the Ohio distribution center, and approximately seven months of sales for the Louisiana distribution center (which is the period of time the Company managed Penner prior to the Company’s acquisition of Penner in October 2001). See “Acquisitions.”

Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following management discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto presented in this Form 10-K.

Overview

DrugMax, Inc. (Nasdaq: DMAX) is a full-line, wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products, nutritional supplements and related products. The Company is headquartered in Clearwater, Florida and maintains distribution centers in Pennsylvania and Louisiana. The Company distributes its products primarily to independent pharmacies in the continental United States, and secondarily to small and medium-sized pharmacy chains, alternative care facilities and other wholesalers. The Company maintains an inventory in excess of 20,000 stock keeping units, (each “SKU” represents an individual type of item) from leading manufacturers and holds licenses to ship to all 50 states and Puerto Rico. While the Company ships to all 50 states and Puerto Rico, its sales tend to be concentrated around its distribution centers in Pennsylvania and Louisiana and largely populated states such as New York, California, Texas and Florida.

The Company’s products function within the structure of the healthcare financing and reimbursement system of the United States. As a result of a wide variety of political, economic and regulatory influences, this system is currently under intense scrutiny and subject to fundamental changes. In recent years, the system has changed significantly in an effort to reduce costs. These changes include increased use of managed care, cuts in Medicare, consolidation of pharmaceutical and medical-surgical supply distributors, and the development of large, sophisticated purchasing groups. As a result, the Company’s profit margins have been negatively impacted, particularly with regard to branded pharmaceuticals. In response, the Company has implemented a strategy aimed at increasing its margins while reducing costs by focusing on higher-margin products. The Company implemented this strategy by focusing on its core business of servicing independent pharmacies, hospitals and small chain stores, and de-emphasizing sales to warehouse customers, which generate high-volume revenue, but nominal gross profit. The Company’s focus on higher margin-products, and corresponding de-emphasis on lower-margin products, resulted in a decrease of sales of branded pharmaceuticals. During the latter part of the fiscal year, and especially during the fourth quarter 2004, the Company incurred the following operational issues resulting in a negative financial performance.

1) Increase of $2.2 million reserve to the allowance for doubtful accounts receivable and notes receivable, primarily as a result of its continuing evaluation of the collectibility of its accounts and trade notes receivable, noting an increase in the filing of bankruptcy of its customer base.

2) Determination that the deferred tax assets, amounting to $1.4 million, required a full reserve. Management believes it is more likely than not that the deferred income tax assets would not be able to be utilized;

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3) Settlement of a customer lawsuit, QK Healthcare, Inc., amounting to approximately $250,000 including legal costs;

4) Gross profit earned was minimized as a result of:

A) the overall decline in total revenue

B) the decline in volume of higher profit generic and OTC sales

C) the loss of “buy-in” opportunities and incentives from manufacturers, thus increasing the cost of purchased goods, as a result of the reduced purchasing levels caused by the loss of the QK Healthcare business

D) the loss of primary customer base, which carries a higher gross profit, due to credit issues, including bankruptcy filings as noted above;

5) Merger costs incurred for professional services associated therewith in the amount of approximately $150,000.

The Company also believes its margins and profitability will be improved by its proposed merger with with FMG, although there can be no assurances in this regard. See, “Business,” “Risk Factors,” and “Results of Operations.”

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, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company 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 period. On an on-going basis, the Company evaluates its estimates and judgments, including those related to customer incentives, product returns, bad debts, inventories, intangible assets, income taxes, and contingencies and litigation. The Company bases its estimates and judgments on historical experience and on various other factors 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.

The Company’s significant accounting policies are more fully described in Note 2 to its consolidated financial statements. Management believes the following critical accounting policies, among others, affect the Company’s more significant judgments and estimates used in the preparation of its consolidated financial statements.

Allowance for Doubtful Accounts

Receivables are stated net of allowances for doubtful accounts of approximately $2.6 million and $1.3 million at March 31, 2004 and 2003, respectively. On a regular basis, the Company evaluates its receivables and establishes the allowance for doubtful accounts based on a combination of specific customer circumstances and historical write-off experience. Credit is extended to customers based upon an evaluation of their financial position. Generally, advance payment is not required.

At March 31, 2004, the Company recorded an increase of approximately $2.2 million reserve to the allowance for doubtful accounts receivable and notes receivable, primarily as a result of its continuing evaluation of the collectibility of its accounts receivable. Recently, as a result of market conditions, the Company has witnessed an increase in the filing of bankruptcy by its customers. See, “Legal Proceedings.” In deciding how to account for these filings, the Company, which is an unsecured creditor in the bankruptcy proceedings, monitors the

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proceedings and evaluates the collectibility of the accounts in light of the bankruptcy through information and advice it receives from counsel and the bankruptcy trustee. As a result of its continuing experience in this area, in the fourth quarter, the Company increased its allowance to approximately 100% of the total amount of the accounts in bankruptcy. Of the approximately $2.2 million increase in the reserve to the allowance for doubtful accounts recorded in the fourth quarter, the accounts which were in bankruptcy accounted for over $1.5 million and a reserve that the Company established for other customers accounted for approximately $400,000. This additional reserve was established as a result of the Company’s continuing experience with the management of its accounts receivable, including its experience with accounts in bankruptcy and the Company’s annualized history of losses, which approximates 3% of total accounts receivable.

The Company feels its allowance for doubtful accounts at March 31, 2004 is adequately stated in relationship to its accounts receivable.

Inventory Valuation

Inventory is stated at the lower of cost or market. Cost is determined using the first-in, first-out basis of accounting. Inventories consist of brand and generic drugs, over-the-counter products, health and beauty aids, and nutritional supplements for resale. The inventories of the Company’s three distribution centers are constantly monitored for out of date or damaged products, which if exist, are reclassed and physically relocated out of saleable inventory to a holding area, referred to as the “morgue” inventory, for return to and credit from the manufacturer. It is important that the Company continually monitor the morgue inventory to assure that merchandise is returnable to the manufacturer in accordance with the vendors’ return policy. Improper management of the morgue inventory could result in write-downs of the morgue inventory and result in a charge to cost of sales. In addition, if market acceptance of the Company’s existing products or the successful introduction of new products should significantly decrease, inventory write-downs could be required. As of March 31, 2004, 2003, and 2002, no inventory valuation allowances were necessary,

Goodwill and Intangible Assets

The Company has completed several acquisitions which have generated significant amounts of goodwill and intangible assets and related amortization. The values assigned to goodwill and intangibles, as well as their related useful lives, are subject to judgment and estimation by the Company. In addition, upon adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), the Company ceased amortization of goodwill effective April 2001, and reviews goodwill annually for impairment. Goodwill and intangibles related to acquisitions are determined based on purchase price allocations. Valuation of intangible assets is generally based on the estimated cash flows related to those assets, while the initial value assigned to goodwill is the residual of the purchase price over the fair value of all identifiable assets acquired and liabilities assumed. Thereafter, the value of goodwill cannot be greater than the excess of the fair value of the Company’s reportable unit over the fair value of identifiable assets and liabilities, and the quoted market prices of the Company’s common stock, based on the annual impairment test. Downward movement in the Company’s common stock could have a material effect on the fair value of goodwill in future measurement periods. Useful lives 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. If the carrying amount of goodwill exceeds its fair value, then an indication exists that the Company’s goodwill may be impaired. As of March 31, 2004, the Company had unamortized goodwill in the amount of $13,105,000.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment when events or circumstances indicate that a diminution in value may have occurred, based on a comparison of undiscounted future cash flows to the carrying amount of the long-lived asset. Periodically, the Company evaluates the recoverability of the net carrying value of its property and equipment, by comparing the carrying values to the estimated future undiscounted cash flows. A deficiency in these cash flows relative to the carrying amounts is an indication of the need for a write-down due to impairment. The impairment write-down would be the difference between the carrying amounts and the fair value of these

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assets. Losses on impairments are recognized by a charge to earnings. As of March 31, 2004, management’s analysis did not indicate an impairment to the Company’s long-lived assets.

Allowance for Deferred Income Tax Asset

The Company had a deferred income tax asset and valuation allowance at March 31, 2001, which primarily represented the potential future tax benefit associated with its operating losses through the fiscal year ended March 31, 2001. In assessing the realizability of deferred income tax assets, management considered whether it is more likely than not that some portion or all of the deferred income tax assets would not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management evaluated the scheduled reversal of deferred income tax liability, the Company’s profitability for the year ended March 31, 2002, reviewed the Company’s business model, and future earnings projections, and believed the evidence indicated that the Company will be able to generate sufficient taxable income to utilize the deferred income tax asset. Based upon the evaluations made, management concluded that realization of the deferred income tax asset was more likely than not; therefore, the valuation allowance was reversed in fiscal 2002. During the fiscal year ended March 31, 2003, the Company recorded a deferred income tax benefit of approximately $.3 million related to losses reported for the fiscal year, and recorded a valuation allowance of $.6 million for a portion of deferred tax assets which management concluded that their realization was not more likely than not. Based upon management’s analysis and discussion in fiscal 2004, the Company reserved the net deferred tax asset at March 31, 2004, as it appears to be more likely than not that the Company will not be able to utilize the deferred income tax asset of approximately $1.4 million. Therefore, the Company recorded the $1.4 million as a charge to income tax expense in the fourth quarter of fiscal 2004.

Revenue Recognition

The Company recognizes revenue when goods are shipped and title or risk of loss resides with unaffiliated customers, and at which time the appropriate provisions are recorded for estimated contractual chargeback credits from the manufacturers based on the Company’s contract with the manufacturer. Rebates and allowances are recorded as a component of cost of sales 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. Detailed accounting, internal auditing and reconciliations are necessary for the Company to maintain accurate records for the rebates, allowances and chargebacks. The Company’s failure to properly record, audit and submit timely reports to vendors could result in the loss of revenue related to the rebates, allowances and chargebacks.

The Company accepts return of product from its customers for product which is saleable, in unopened containers and carries a current date. Generally, product returns are received via the Company’s own delivery vehicles, thereby eliminating a direct shipping cost from being incurred by the customer or the Company. Depending on the length of time the customer has held the product, the Company may charge a handling and restocking fee. Failure to process returns correctly could result in the Company accepting outdated or damaged merchandise from customers. The Company reviews all requests for return of product to assure that the Company accepts returned merchandise in saleable condition. Overall, the percentage of the return of product to the Company is extremely low. The Company has no sales incentive or rebate programs with its customers.

Recent Accounting Pronouncements

In April 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 145. SFAS No. 145 will rescind SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax benefit. As a result of SFAS No. 145, the criteria in APB No. 30 will be used to classify those gains and losses. The provisions of SFAS No. 145 related to of the rescission of FASB No. 13 shall be applied in fiscal years beginning after May 15, 2002. Early application of the provisions of SFAS No. 145 related to the rescission of FSAB No. 13 is encouraged. The components of

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SFAS No. 145 adopted in fiscal 2003, resulted in the Company recording forgiveness of debt to other income in the fiscal year ended March 31, 2004.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”), which replaces Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. SFAS No. 146 requires that liabilities associated with exit or disposal activities be recognized when they are incurred. Under EITF Issue No. 94-3, a liability for exit costs is recognized at the date of a commitment to an exit plan. SFAS No. 146 also requires that the liability be measured and recorded at fair value. Accordingly, the adoption of this standard may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The Company adopted the provisions of SFAS No. 146 for any restructuring activities initiated after December 31, 2002. As of March 31, 2004, the Company had not undertaken any such restructuring activities.

In November 2002, the FASB issued FASB Interpretation Number (“FIN”) 45, Guarantors’ Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also requires that at all times a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company will apply the provisions of FIN 45 to any guarantees issued after December 31, 2002. As of March 31, 2004, the Company did not have any guarantees outstanding.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (“SFAS No. 148”) which addresses financial accounting and reporting for recording expenses for the fair value of stock options. SFAS No. 148 provides alternative methods of transition for a voluntary change to fair value-based method of accounting for stock-based employee compensation. Additionally, SFAS No. 148 requires more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002, with early application permitted in certain circumstances. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company has elected to continue to apply the intrinsic value-based method of accounting as allowed by APB No. 25. See “Stock Based Compensation” below.

In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities (“FIN 46”). FIN 46 clarifies the application of Accounting Research Bulletin No. 51 for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies immediately to variable interest entities created after January 31, 2003. Initially, FIN 46 was to apply in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. At its October 2003 meeting, the FASB agreed to defer the effective date of FIN 46 for variable interests held by public companies in all entities that were acquired prior to February 1, 2003. The deferral will require that public companies adopt the provisions of FIN 46 at the end of periods ending after December 15, 2003. The interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The adoption of FIN 46 in the third fiscal quarter ended December 31, 2003 had no impact on the Company.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”). SFAS No. 150 establishes standards for how an issuer classifies and measurers in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with SFAS No. 150, financial instruments that

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embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except, mandatorily redeemable non-controlling (minority) interests which, on October 29, 2003, the FASB decided to defer indefinitely. As of March 31, 2004, the adoption of SFAS No. 150 has had no impact on the Company.

In January 2004, the FASB issued a Financial Staff Position (“FSP”) pertaining to SFAS No. 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“FSP SFAS No. 106-1”). FSP SFAS No. 106-1 permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer recognizing the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) until authoritative guidance on accounting for the federal subsidy is issued or until certain other events occur. Accordingly, the consolidated financial statements of the Company do not reflect the effect of the Act, if any. Currently, the Company does not sponsor a postretirement health care plan that provides a prescription drug benefit.

Results of Operations

Revenues

	For the Years Ended March 31:
	2004			2003			2002
Revenues	$	213,789,279		$	291,751,771		$	271,287,988
Gross profit		5,628,643			8,104,707			7,512,606
(Loss)/income before tax (expense) benefit and equity earnings of unconsolidated subsidiary		(5,623,416	)		(13,476,340	)		903,574
Income tax (expense)/benefit		(1,417,630	)		313,882			1,103,548
Net (loss)/income		(7,039,421	)		(13,162,458	)		2,007,122
Basic (loss)/income per share		(0.98	)		(1.85	)		0.29

The Company generated revenues of $213.8 million, $291.8 million, and $271.3 million for the fiscal years ended March 31, 2004, 2003, and 2002, respectively. Revenues reported for fiscal 2004 decreased approximately $78.0 million, or 26.7% as compared to revenues for fiscal 2003. Revenues for fiscal 2003 increased approximately $20.5 million, or 7.5% as compared to revenues for fiscal 2002. The following schedule summarizes the Company’s sales in its four product lines over the last three years:

	For the Fiscal Year Ended March 31, 2004		As a % of total revenues		For the Fiscal Year Ended March 31, 2003		As a % of total revenues		For the Fiscal Year Ended March 31, 2002		As a % of total revenues
Revenue from:
Branded pharmaceuticals	$	195,307,940	91.36	%	$	268,443,471	92.01	%	$	252,526,812	93.08	%
Generic pharmaceuticals		12,832,542	6.00	%		14,722,530	5.05	%		12,525,736	4.62	%
Over-the-counter and other		4,925,887	2.30	%		8,585,770	2.94	%		6,235,440	2.30	%
Respiratory products		722,910	0.34	%		-	0.00	%		-	0.00	%
Total revenues	$	213,789,279	100.00	%	$	291,751,771	100.00	%	$	271,287,988	100.00	%

The net decrease in revenues were the result of several factors:

1. As stated previously under the heading “Business,” the Company’s products function within the structure of the healthcare financing and reimbursement system of the United States. As a result of a wide variety of political, economic and regulatory influences, this system is currently under intense scrutiny and subject to fundamental changes. In recent years, the system has changed significantly in an effort to reduce costs. These changes include

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increased use of managed care, cuts in Medicare, consolidation of pharmaceutical and medical-surgical supply distributors, and the development of large, sophisticated purchasing groups. As a result, the Company’s profit margins have been negatively impacted, particularly with regard to branded pharmaceuticals. The Company expects that these forces will continue to negatively impact profit margins, including as a result of:

• changes in vendor programs affecting alternate source customers (licensed distributors without authorized distributor status with manufacturers);

• the highly-competitive nature of the pharmaceutical wholesale business;

• drug manufacturers’ reduction of wholesale buying opportunities; and

• continuing efforts by drug manufacturers and others to eliminate forward buying by wholesalers.

Buying opportunities occur when manufacturers announce that wholesalers with whom they conduct business may purchase inventory at favorable prices if they are willing to purchase more than their usual inventory of product. Forward buying is a speculative purchasing strategy employed in the industry to purchase inventory in advance of expected price increases.

As a result of these forces, the Company has implemented a business strategy aimed at increasing its margins while reducing costs by focusing on higher-margin products. In general, the Company’s branded products experience smaller margins than its generic, over-the-counter and other products. The Company implemented this strategy by focusing on its core business of servicing independent pharmacies, hospitals and small chain stores, and de-emphasizing sales to warehouse customers, which generate high-volume revenue, but nominal gross profit. The Company’s focus on higher margin-products, and corresponding de-emphasis on lower-margin products, resulted in a decrease of sales of branded pharmaceuticals. Branded drug sales declined by approximately $73 million in fiscal 2004 as compared to fiscal 2003; and declined approximately $57 million in fiscal 2004 as compared to fiscal 2002.

The decline in the sale of branded pharmaceuticals was also caused, in part, by:

• Changes in vendor programs affecting alternate source customers. Brand name drug manufacturers recently have started to require drug wholesalers to reduce or eliminate forward buying, a strategy pursuant to which wholesalers purchase products in anticipation of expected price increases. Further, brand manufacturers are reducing the number of buy-in programs that they are offering. Buy-in programs are special opportunities provided by manufacturers to purchase greater-than-normal quantities at reduced prices. Both of these trends have resulted in further downward pressure on the Company’s gross margins. Therefore, emphasis on generic sales continues to be part of the Company’s focus to improve gross profit;

• Loss of business amounting to approximately $36 million due to the complaint filed by QK Healthcare; and

• Expensive branded drugs going off patent which were replaced by generic equivalent drugs at substantially lower cost.

In 2003, one of the Company’s largest customers, QK Healthcare, ceased doing business with the Company and sued the Company in connection with the sale by the Company of 20 bottles of allegedly counterfeit Lipitor. This law suit has now been settled and the Company expects to resume its business relationship with QK Healthcare. See “Legal Proceedings.”

2. In fiscal 2004, the Company increased sales of generic products to 6% of total sales as compared to 5.05% in the prior year. Sales decreased $1.9 million in fiscal 2004 as compared to fiscal 2003 principally due to the loss of customers due to bankruptcy filings and continued downward sales, and price pressure on generic drugs after their entry into the market of multiple generic drug manufacturers.

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3. During fiscal 2004, over-the-counter and other sales amounted to approximately $5.6 million, as compared to approximately $8.6 million for fiscal 2003, and approximately $6.2 million in fiscal 2002. The decline of the revenues recognized from the over-the-counter and other products was caused by the Company’s lesser degree of participation in special buy-in programs offered by manufacturers. Manufacturers have, because of current competitive market conditions, reduced the number of special buy-in opportunities offered to wholesalers. As stated above, buy-in opportunities are opportunities provided from time-to-time by manufacturers to purchase greater than normal volumes of product prior to planned price increases by the manufacturers. Further, when these buy-in opportunities are offered by manufacturers, often times they require a volume of purchasing that exceeds the Company’s needs or abilities to acquire. Management believes this trend in reduced buying opportunities will continue in the near future.

4. In fiscal 2004, the Company generated approximately $723,000 in revenues from the respiratory vial business as a result of the acquisition of Avery Pharmaceuticals in May 2003. The Company subcontracts its productions to a specialty manufacturer. Gross margins expected on the sales of the respiratory vial business are estimated between 10-25%.

Gross Profit

The Company achieved gross profits of $5.6 million, $8.1 million and $7.5 million for the years ended March 31, 2004, 2003, and 2002, respectively, representing a decrease of approximately $2.5 million in fiscal 2004 over fiscal 2003, and an increase of approximately $.6 million in fiscal 2003 over fiscal 2002. The Company’s margin, as a percentage of revenue, decreased in fiscal 2004 to 2.6% as compared to 2.8% for both fiscal 2003 and 2002. The decrease in gross margin percentage in fiscal 2004 over 2003 and 2002, was primarily as a result of a) the overall decline in total revenue; b) the decline in volume of higher profit generic and OTC sales; c) the loss of “buy-in” opportunities and incentives from manufacturers, thus increasing the cost of purchased goods, as a result of the reduced purchasing levels caused by the loss of the QK Healthcare business; and d) the loss of primary customer base, which carries a higher gross profit due to credit issues, including bankruptcy filings. Pursuant to the Company’s focus on higher-margin products, sales of generic products as a percentage or total sales have increased, representing approximately 6.0%, 5.0% and 4.6% of the total sales for the fiscal years 2004, 2003 and 2002, respectively. The gross profit earned on sales to the Company’s core business customers ranges from 1% to 3%, and represented more than 96% of the total gross profit earned by the Company for fiscal 2004, 2003 and 2002.

Brand name drug manufacturers recently have started to require drug wholesalers to reduce or eliminate forward buying, a strategy pursuant to which wholesalers purchase products in anticipation of expected price increases. Further, brand manufacturers are reducing the number of buy-in programs that they are offering. Buy-in programs are special opportunities provided by manufacturers to purchase greater-than-normal quantities at reduced prices. Both of these trends have resulted in further downward pressure on the Company’s gross margins. Therefore, emphasis on generic sales continues to be part of the Company’s focus to improve gross profit.

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Operating Expense

The Company incurred operating expenses of approximately $10.2 million, $20.6 million and $5.6 million for the fiscal years 2004, 2003 and 2002, respectively. The following schedule details the major components of operating expenses:

	For the Fiscal Year Ended March 31, 2004		As a % of Sales		For the Fiscal Year Ended March 31, 2003		As a % of Sales		For the Fiscal Year Ended March 31, 2002		As a % of Sales
Operating expenses:
Administrative, sales, marketing and other direct operating expenses	$	7,821,875	3.7	%	$	6,647,549	2.3	%	$	5,352,876	2.0	%
Amortization and depreciation expense		210,605	0.1	%		324,577	0.1	%		260,333	0.1	%
Bad debt expense		2,186,220	1.0	%		1,114,539	0.4	%		35,757	0.0	%
Goodwill impairment loss and intangible asset charge		-	0.0	%		12,468,212	4.3	%		-	0.0	%
Total operating expenses	$	10,218,700	4.8	%	$	20,554,877	7.0	%	$	5,648,966	2.1	%

Administrative, sales, marketing and other direct operating expenses, amortization and depreciation and bad debt were approximately 4.8%, 2.8% and 2.1% of gross revenues for the fiscal years 2004, 2003 and 2002, respectively. The increases of approximately 2.0% in fiscal 2004 over 2003 and .7% in fiscal 2003 over 2002 in the administrative, sales, marketing and other direct operating expenses, were due primarily to the decline in gross revenues in 2004 and increased operating costs associated with the acquisition of Avery in May 2003, and an increase in bad debt expense of approximately $1.0 million as compared to fiscal 2003. No impairment of the goodwill asset was warranted in fiscal 2004 as compared to a goodwill impairment loss and intangible asset charge of approximately $12.5 million in fiscal 2003.

At March 31, 2004, the Company increased to approximately $3.5 million its reserve to the allowance for doubtful accounts receivable and notes receivable, primarily as a result of its continuing evaluation of the collectibility of its accounts receivable. Recently, as a result of market conditions, the Company has witnessed an increase in the filing of bankruptcy by its customers. In deciding how to account for these filings, the Company, which is an unsecured creditor in the bankruptcy proceedings, monitors the proceedings and evaluates the collectibility of the accounts in light of the bankruptcy through information and advice it receives from counsel and the bankruptcy trustee. As a result of its continuing experience in this area, in the fourth quarter, the Company increased its allowance to approximately 100% of the total amount of the accounts in bankruptcy. Of the approximately $2.2 million reserve to the allowance for doubtful accounts recorded in the fourth quarter, the accounts which were in bankruptcy accounted for over $1.5 million and an additional reserve for other accounts that the Company established accounted for approximately $400,000. The additional reserve was established as a result of the Company’s continuing experience with the management of its accounts receivable, including its experience with accounts in bankruptcy and the Company’s annualized history of losses, which approximates 3% of total accounts receivable. See, “Management’s Discussion and Analysis—Critical Accounting Policies—Allowance for Doubtful Accounts.” In addition, the Company charged to operating expense the amount of $218,000 representing the settlement with QK Healthcare, Inc. (See Note 10 to the Consolidated Financial Statements—Commitments and Contingencies.)

The Company acquired the business of Avery in May 2003. Based upon initial projections management received from Avery personnel, it was anticipated that the Avery operations would impact the Company positively, primarily as a result of the Company’s acquisition of a patent on the manufacture of respiratory products. In fiscal 2004, the Avery operations incurred administrative, sales, marketing and other direct operating expenses of approximately $.4 million, and a net loss for the same period of approximately $.3 million, resulting from merger and reorganization costs, personnel changes, and other costs of operations. Due to the delay in testing the patent pending process, the revenue cycle was comprised of the sale of purchased vials from the open market during fiscal 2004. The projections had anticipated production of the vials by the third quarter of fiscal 2004.

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Other Income and Expense

The Company realized approximately $.5 million, $.05 million and $.09 million in other income for fiscal 2004, 2003 and 2002, respectively. In April 2003, the Company recorded approximately $73,000 in costs associated with the termination of the Standard credit facility, which were charged as other expense. In April 2003, W. A. Butler and Company (“Butler”), a 30% shareholder of VetMall, executed an agreement with the Company and VetMall. The terms of the agreement provided for the transfer of Butler’s 30% ownership of VetMall stock and the forgiveness of $.5 million of long-term liabilities, which is included in other income in fiscal 2004. The agreement released Butler from operational expenses of VetMall incurred by the Company in exchange for the elimination of the long-term liability of VetMall to Butler. In fiscal 2003 and 2002, the major component of other income was finance charges to customers’ accounts.

In fiscal 2004, the Company recorded $1,625 in income from minority interests. The joint venture with MorepenMax began initial operations in the third quarter of fiscal 2004, and currently has nominal sales. The income recorded represents 49% of the joint venture’s net income.

Interest Expense

The following schedule reflects the components of interest expense for the past three fiscal years:

	For the Fiscal Year Ended March 31, 2004		For the Fiscal Year Ended March 31, 2003		For the Fiscal Year Ended March 31, 2002
Interest expense for financing activities	$	1,340,299	$	969,053	$	1,002,274
Amortization of financing costs		237,549		199,888		119,957
Total interest expense	$	1,577,848	$	1,168,941	$	1,122,231

Interest expense was approximately $1.6 million, $1.2 million and $1.1 million, for fiscal 2004, 2003 and 2002, respectively. Included in interest expense is the amortization of loan financing costs, which were approximately $.2 million, $.2 million and $.1 million for fiscal 2004, 2003 and 2002, respectively.

In April 2003, the Company recorded unamortized deferred financing costs of $78,913, and a charge to interest expense of an early termination fee of $351,000, and a fee for the waiver of the 90-day notice of termination of $30,000, related to the Standard line of credit. Included in the deferred financing costs in fiscal 2003, is $78,913 of additional unamortized financing costs because of the early termination of the Standard line of credit in April 2003 with the Congress credit facility. Amortization of loan costs in fiscal 2002 relate to the loan costs associated with the Standard credit facility. The Company does not anticipate charges to interest expense to increase materially in fiscal 2005 as compared to fiscal 2004.

Income Taxes

The Company had an estimated gross deferred income tax asset and valuation allowance of approximately $1.5 million as of the fiscal year ended March 31, 2001, which primarily represented the potential future tax benefit associated with its operating losses through the fiscal year ended March 31, 2001. Management evaluated the scheduled reversal of deferred income tax liability, the Company’s profitability for the year ended March 31, 2002, reviewed the Company’s business model, and future earnings projections, and based on such evaluation believed the evidence indicated that the Company would be able to generate sufficient taxable income to utilize the deferred income tax asset; therefore, the Company recognized the full $1.5 million deferred income tax asset, offset by deferred income tax expense of $.4 million, for a net deferred income tax benefit of $1.1 million for the year ended March 31, 2002. During the fiscal year ended March 31, 2003, the Company recorded income tax benefit of $313,882. At March 31, 2003, management believed that it was more likely than not that the Company would be able to generate sufficient taxable income to utilize the deferred income tax asset. At March 31, 2003, management recorded a valuation allowance of $580,100 for a portion of the deferred tax assets that it concluded that their realization is not more likely than not. Based upon current results and management’s analysis and discussion at

39

March 31, 2004, the Company reserved the entire deferred income tax asset at March 31, 2004, as it appears to be more likely than not that the Company will not be able to utilize the deferred income tax asset of approximately $1.4 million. Therefore, the Company recorded the $1.4 million as a charge to income tax expense in the fourth quarter of fiscal 2004. The Company’s total valuation allowance at March 31, 2004 is approximately $4.5 million.

Net Income (Loss) Per Share

Earnings (loss) per share (“EPS”) is calculated by dividing the net income (loss) by the weighted average number of shares of common stock outstanding for the period. Diluted EPS is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period, adjusted for the dilutive effect of options and warrants, using the treasury stock method. The net loss per share for fiscal 2004 was $0.98 for the basic and diluted share, compared to a net loss per basic and diluted share for fiscal 2003 of $1.85, and a net income of $.29 per basic share and $.28 per diluted share for fiscal 2002. The Company recorded the reserve for the deferred income tax asset of approximately $1.4 million at March 31, 2004 as a charge to income tax expense, which increased the loss per share by $.20. The Company recorded a goodwill and intangible asset impairment loss in its second quarter of the fiscal year ended March 31, 2003 of approximately $12.5 million, which increased the net loss per basic and diluted share by $1.75. The Company recorded for the fiscal year ended March 31, 2003 an income tax benefit of approximately $.3 million, which decreased the loss per basic and diluted share by $.04. During the year ended March 31, 2002, the Company reduced its entire valuation allowance, and booked approximately $1.1 million of deferred income tax benefit, net of the current year deferred income tax expense of approximately $.4 million, which provided the Company with additional net income of $.16 per basic and $.15 per diluted share. Over the past decade, participants in the wholesale pharmaceutical distribution industry have experienced declining gross and operating margin percentages. In addition, brand name drug manufacturers recently have started to require drug wholesalers to reduce or eliminate forward buying, a strategy pursuant to which wholesalers purchase products in anticipation of expected price increases. Further, brand manufacturers are reducing the number of buy-in programs that they are offering. Buy-in programs are special opportunities provided by manufacturers to purchase greater-than-normal quantities at reduced prices. Both of these trends may result in further downward pressure on the Company’s gross margins.

As a result of these pressures, although the Company continues to distribute brand products as requested by its customers, beginning in fiscal 2003 it began to focus its efforts on higher-margin products, including generic and over-the-counter products. As part of this strategy, from time-to-time, the Company seeks to acquire additional complementary higher-margin product lines, as it did through its acquisition of Avery.

In addition, the Company anticipated profitable results from its subsidiaries Valley South since its acquisition in October 2002, and Avery since its acquisition in May 2003; however neither operating unit has been profitable since their respective acquisitions. In the first quarter 2005, the Company began utilizing the patent pending vial machine developed for the use in the respiratory area by Avery. Management has combined the operations of Valley South and Avery for fiscal 2005 which will consolidate and eliminate overhead expenses, and believes the business model currently being developed for the combined operations will improve the profitability of the combined business unit in future fiscal periods for the Company. In fiscal 2004, the Company generated approximately $723,000 in revenues from the respiratory vial business as a result of the acquisition of Avery Pharmaceuticals in May 2003. The Company subcontracts its productions to a specialty manufacturer. Gross margins expected on the sales of the respiratory vial business are estimated between 10-25%.

The Company had issued and outstanding 2,220,479 options to purchase shares of the Company’s common stock, in addition to warrants to purchase 150,000 shares of the Company’s common stock, which were anti-dilutive and not included in the computation of diluted EPS for the fiscal year ended March 31, 2004. These anti-dilutive shares could potentially dilute the basic EPS in the future.

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A reconciliation of the number of shares of common stock used in the calculation of basic and diluted net income (loss) per share is presented below:

	For the Year Ended March 31, 2004	For the Year Ended March 31, 2003	For the Year Ended March 31, 2002
Weighted average shares - basic	7,207,659	7,119,172	7,034,969
Additional shares assuming effect of dilutive stock options	-	-	199,055
Weighted average shares - diluted	7,207,659	7,119,172	7,234,024

Inflation and Seasonality

Management believes that there was no material effect on operations or the financial condition of the Company as a result of inflation for the years ended March 31, 2004, 2003, and 2002. Management also believes that its business is not seasonal; however, significant promotional activities can have a direct impact on sales volume in any given quarter.

Financial Position, Liquidity and Capital Resources

The Company has a working capital deficit and cash and cash equivalents of approximately ($1.2) million and $2.8 million, respectively, at March 31, 2004. In April 2003, the Company obtained a $40 million revolving line of credit and a $400,000 term note from Congress to satisfy the outstanding line of credit and term loan with Standard, and to provide working capital for possible future acquisitions. The Congress credit facility is collateralized by all assets of the Company. The revolving line of credit enables the Company to borrow a maximum of $40 million, with borrowings limited to 85% of eligible accounts receivable and 65% of eligible inventory and is available until April 2006. At March 31, 2004, availability on the Congress credit facility was approximately $1.2 million. The revolving line of credit and the term note currently bear interest at the rate of 0.50% per annum in excess of the Prime Rate. The term note and revolving line of credit are payable over a 36-month period. The Congress credit facility imposes certain restrictive covenants on tangible net worth and EBIDTA. On March 31, 2004, the Company and Congress executed a Second Amendment to the Loan and Security Agreement revising the EBITDA covenant beginning March 31, 2004 and forward. At March 31, 2004, the Company was not in compliance with the tangible net worth and EBITDA covenants; therefore, Congress issued a waiver for the tangible net worth and EBITDA covenants at March 31, 2004. The Third Amendment to the Loan and Security Agreement dated June 30, 2004 amended the financial covenants going forward. The Company believes it will be able to meet its financial covenants throughout fiscal 2005.

The Company’s principal commitments at March 31, 2004 were leases on computer and office equipment and on its office and warehouse space, and seven employment agreements. There were no material commitments for capital expenditures at that date. The following are contractual obligations of the Company at March 31, 2004:

Contractual Obligations	Total		Less Than 1 year		1 - 3 Years		3 - 5 Years		More
Operating leases	$	4,861,031	$	3,661	$	1,599,693	$	1,472,677	$	1,785,000
Credit line payable		17,251,194		17,251,194		-		-		-
Term note payable		277,778		277,778		-		-		-
Capital leases		15,229		-		15,229		-		-
Employment agreements		2,031,666		67,708		1,963,958		-		-
Purchase agreements from vendors	$	20,050,000	$	20,050,000		-		-		-
Total contractual obligations	$	44,486,898	$	37,650,341	$	3,578,880	$	1,472,677	$	1,785,000

On March 19, 2004, the Company entered into an Agreement and Plan of Merger with Familymeds Group, Inc., a Connecticut Company (“FMG”), pursuant to which FMG would be merged with and into the Company, with

41

the Company being the surviving company. See “Recent Developments.” If the merger is consummated, the Company expects that the current Company stockholders will, as a group, own approximately 40%, and FMG stockholders, employees and directors will, as a group, own approximately 60%, of the issued and outstanding shares of the Company immediately after the merger. In addition, at the closing of the merger the Company will issue warrants to the FMG stockholders, the FMG warrant holders and the FMG note holders entitling them to purchase certain additional shares of the Company common stock. While the merger agreement does not require the payment of any cash consideration at closing, the Company will incur certain expenses in connection with the closing of the merger, including legal, accounting, investment banking, filing, printing and mailing fees. Further, if any shareholders of either DrugMax or FMG dissent from the merger, the Company will be required to pay such shareholders the fair value of their shares in cash. The merger agreement limits the number of shares of the Company that may dissent to 200,000 and the number of shares of FMG that may dissent to $1,000,000 worth of FMG stock. Neither FMG nor the Company are required to consummate the merger if shareholders holding shares in excess of these limits notify the Company and FMG of their intent to dissent.

Further, as set forth under the heading, “Risk Factors,” if the merger is consummated, the combined company will inherit the debt and obligations of FMG. FMG has incurred significant losses and negative cash flow in the past. Further, unless restructured in connection with the merger, FMG’s senior collateralized revolving credit facility with General Electric Capital Corporation (“General Electric”), and its debt under that facility will mature on August 31, 2004. As of May 22, 2004, the amount outstanding under the General Electric facility was approximately $27.7 million. These facts raise doubt about FMG’s ability to continue as a going concern. FMG’s auditor has issued a going concern opinion, in part as a result of its credit facility having a maturity date of less than one year. While management believes that the merger offers the combined company a greater opportunity than either company individually would have to improve its financial position, for the reasons discussed under the heading “Risk Factors,” there can be no assurance that management will be able to integrate the two companies or that the anticipated benefits of the merger will be realized. If the Company and FMG fail to integrate the companies, achieve its business plan, realize some or all of the anticipated revenue opportunities or cost savings and other benefits of the merger, or if the costs of the merger or the integration of the companies exceeds what is anticipated, its working capital and financial condition will be materially negatively impacted. “See Risk Factors.”

To complete the merger, the merger agreement requires that the Company obtain a new credit facility for at least $60 million. The Company has received proposals for a $65 million facility. While the Company has obtained these proposals, there can be no assurance that the loan, or any other acceptable credit facility, will be available to the Company prior to the closing of the merger.

Further, while management presently believes that the new credit facility proposed by Congress will be sufficient to allow the surviving company to integrate the businesses of FMG and the Company and to fund its business plan for the next 12 months, it may be insufficient to fund the Company’s credit needs. If the Company fails to realize some or all of the anticipated revenue opportunities or cost savings and other benefits of the merger, or if the costs of the merger or the integration of the companies exceeds what is anticipated, the Company may need to seek alternate or additional financing. See, “Risk Factors.”

Net cash used in operating activities was approximately $2.2 million for fiscal 2004, compared to net cash provided by operating activities of approximately $3.8 million for fiscal 2003, and net cash used in operating activities of approximately $5.9 million for fiscal 2002. Cash used in operating activities for fiscal 2004 is primarily due to increases in accounts receivable of approximately $2.0 million due to economic conditions in the industry and the increase in bankruptcy filings during the quarter, and certain customer collectibility issues, and increases in prepaid expense and other current assets of $0.7 million, and deposits of $65,000. In addition, in fiscal 2004, the Company recognized decreases in inventory of approximately $3.2 million, resulting from managements control over purchase levels due to decreased sales volume, and approximately $1.6 in other notes receivable, accrued expenses and other current liabilities in addition to a decrease in accounts payable of approximately $1.0 million.

42

Net cash used in investing activities for fiscal 2004 was approximately $537,000, resulting from the purchases of property and equipment, and the cost of filing the patent acquired from Avery for approximately $34,000.

Net cash provided by financing activities was approximately $5.4 million for fiscal 2004, resulting from the net increase in the Company’s revolving line of credit with Congress of approximately $1.4 million, the decrease in the restricted cash account with Mellon of $2.0 million, and proceeds from the private placement of common stock of the Company in the amount of approximately $2.7 million, offset by an increase in the deferred financing costs of approximately $.4 million and payments of long-term debt and capital leases of approximately $.2 million. On April 15, 2003, the Company obtained from Congress a $40 million revolving line of credit and a $400,000 term loan. The Congress credit facility along with the Mellon restricted cash account of $2 million were used to satisfy the outstanding line of credit and term loan with Standard. The Congress revolving line of credit enables the Company to borrow a maximum of $40 million, with borrowings limited to 85% of eligible accounts receivable and 65% of eligible inventory. The revolving line of credit and the term note currently bear interest at the rate of 0.50% per annum in excess of the Prime Rate. The Congress credit facility is collateralized by all of the Company’s assets. The line of credit is for a term of 36 months, and the term note is payable over the same 36-month period. The Congress credit facility imposes certain restrictive covenants on Tangible Net Worth and EBITDA. At March 31, 2004, the Company was not in compliance with the tangible net worth and EBITDA covenants. Congress issued a waiver of the covenants at March 31, 2004. Congress and the Company executed a Second Amendment to the Loan and Security Agreement to amend the tangible net worth and EBITDA covenants at March 31, 2004. The Third Amendment to the Loan and Securities Agreement dated June 30, 2004 amends the financial covenants going forward. The Company believes it will be able to meet the financial covenants throughout fiscal 2005. All costs associated with the Congress credit facility will be amortized as interest expense over the term of the loan. On March 18, 2004, the Company sold 1,000,000 shares of its common stock in a private placement to accredited investors for $3.21 million. The expenses related to this offering approximated $500,000. Maxim Group LLC, a New York-based investment firm, acted as the placement agent for the Company in the private placement. Net proceeds will be used for working capital and general corporate purposes. The private placement was made under an exemption from the registration requirements of the Securities Act of 1933, as amended, 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. The Company has filed a registration statement on Form S-3 with the Securities and Exchange Commission, which as of July 13, 2004 had not yet been declared effective by the Securities and Exchange Commission, to register the resale of the shares sold in the private placement, as is required by the subscription agreements between the investors and the Company.

In the event the merger with FMG is not consummated, management believes the Company has sufficient capital resources from its current credit facility with Congress, which expires in April 2006, and capital injected into the Company during the fourth quarter 2004 to fund the Company’s operations for the next twelve months in spite of the negative $1.2 million working capital position reported at March 31, 2004. Management’s long-range viewpoint believes that the growth and capital needs of the Company will be met through primarily achieving positive results from its business model, utilization of available debt financing from its Congress bank facility and continually looking to the equity markets for new capital.

Item  7A.  QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.

The Company is subject to market risk from exposure to changes in interest rates based on its financing and cash management activities, which could effect its results of operations and financial condition. At March 31, 2004, the Company’s outstanding debt with Congress was approximately $16.9 million on the line of credit and $.3 million on the term loan. The interest rates charged on the line of credit and term loan currently bear interest at the rate of 0.5% per annum in excess of the Prime Rate. The Company is at risk of increased interest rates, due to fluctuations in the Prime Rate, contingent upon economic conditions. At March 31, 2004, the interest rate charged on the line of credit and term loan was 4.5%. The company manages its risk by choosing the most advantageous interest option offered by its lender. See “Managements Discussion and Analysis of Financial

43

Condition and Results of Operations—Financial Condition, Liquidity and Capital Resources”. The Company holds several notes receivable from its customers which do not carry variable interest rates. The Company does not currently utilize derivative financial instruments to address market risk.

Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

44

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

DrugMax, Inc

Clearwater, FL

We have audited the accompanying consolidated balance sheets of DrugMax, Inc as of March 31, 2004 and 2003 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended March 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of DrugMax, Inc at March 31, 2004 and 2003, and the results of its operations and its cash flows for each of the two years in the period ended March 31, 2004, in conformity with United States generally accepted accounting principles.

/s/ BDO Seidman, LLP

Miami, FL

June 18, 2004, except for Note 9,

which is as of June 30, 2004.

45

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of DrugMax, Inc.:

We have audited the accompanying consolidated statements of operations, stockholders’ equity, and cash flows of DrugMax, Inc. and subsidiaries (the “Company”) for the year ended March 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of DrugMax, Inc. and subsidiaries for the year ended March 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Certified Public Accountants

Tampa, Florida

June 27, 2002

46

DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2004 AND 2003

	2004			2003
ASSETS
Current assets:
Cash and cash equivalents	$	2,787,793		$	161,489
Restricted cash		-			2,000,000
Accounts receivable, net		11,696,387			11,339,842
Inventory		16,370,969			19,458,940
Due from affiliates		-			10,470
Net deferred income tax asset - current		-			668,294
Prepaid expenses and other current assets		1,608,531			1,079,740
Total current assets		32,463,680			34,718,775
Property and equipment, net		1,409,602			767,550
Goodwill		13,105,000			13,105,000
Stockholder notes receivable		21,277			100,000
Notes receivable, net		40,843			625,329
Net deferred income tax asset - long term		-			749,336
Intangible assets, net		658,845			78,912
Other assets		50,625			95,660
Deposits		108,215			33,561
Total assets	$	47,858,087		$	50,274,123
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	14,339,752		$	14,619,341
Accrued expenses and other current liabilities		1,853,823			415,065
Credit lines payable		17,251,194			15,943,619
Current portion of long-term debt and capital leases		192,222			470,176
Due to affiliates		-			4,377
Total current liabilities		33,636,991			31,452,578
Long-term debt and capital leases		157,950			35,847
Other long-term liabilities		-			501,561
Total liabilities		33,794,941			31,989,986
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value, 2,000,000 shares authorized; no preferred shares issued or outstanding		-			-
Common stock, $0.01 par value; 24,000,000 shares authorized; 8,189,986 and 7,119,172 shares issued and outstanding.		8,189			7,120
Additional paid-in capital		43,784,716			40,967,355
Accumulated deficit		(29,729,759	)		(22,690,338	)
Total stockholders’ equity		14,063,146			18,284,137
Total liabilities and stockholders’ equity	$	47,858,087		$	50,274,123

See accompanying notes to consolidated financial statements.

47

DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Fiscal Years Ended March 31,

	2004			2003			2002
Revenues	$	213,789,279		$	291,751,771		$	271,287,988
Cost of goods sold		208,160,636			283,647,064			263,775,382
Gross profit		5,628,643			8,104,707			7,512,606
Selling, general and administrative expenses		10,008,095			7,762,088			5,388,633
Amortization expense		-			18,000			15,053
Depreciation expense		210,605			306,577			245,280
Goodwill and asset impairment loss		-			12,209,298			-
Intangible impairment loss		-			258,914			-
Total operating expenses		10,218,700			20,554,877			5,648,966
Operating (loss) income		(4,590,057	)		(12,450,170	)		1,863,640
Other (income) expense:
Interest income		(36,489	)		(94,685	)		(63,553	)
Other income and expenses, net		(508,000	)		(48,086	)		(98,612	)
Interest expense		1,340,299			969,053			1,002,274
Interest expense - loan costs		237,549			199,888			119,957
Total other expense		(1,033,359	)		(1,026,170	)		(960,066	)
(Loss) income before tax expense (benefit) and equity earnings from unconsolidated subsidiary		5,623,416			13,476,340			(903,574	)
Equity earnings from unconsolidated subsidiary		(1,625	)		-			-
Income tax expense (benefit)		1,417,630			(313,882	)		(1,103,548	)
Net (loss) income	$	(7,039,421	)	$	(13,162,458	)	$	2,007,122
(Loss) income per common share:
Basic	$	(0.98	)	$	(1.85	)	$	0.29
Diluted	$	(0.98	)	$	(1.85	)	$	0.28
Weighted average shares outstanding:
Basic		7,207,659			7,119,172			7,034,969
Diluted		7,207,659			7,119,172			7,234,024

See accompanying notes to consolidated financial statements.

48

DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Fiscal Years ended March 31, 2004, 2003 and 2002

	Common Stock		Additional Paid-in Capital		Accumulated Deficit			Total Stockholders’ Equity
Balances at March 31, 2001	$	6,470	$	38,106,755	$	(11,535,002	)	$	26,578,223
Issuance of 500,000 shares to Dynamic Health Products, Inc.		500		1,968,250		-			1,968,750
Issuance of 125,418 shares for acquisition of Penner & Welsch, Inc.		125		749,875		-			750,000
Issuance of 25,000 shares for non-compete agreement		25		142,475		-			142,500
Net income		-		-		2,007,122			2,007,122
Balance at March 31, 2002		7,120		40,967,355		(9,527,880	)		31,446,595
Net loss		-		-		(13,162,458	)		(13,162,458	)
Balance at March 31, 2003		7,120		40,967,355		(22,690,338	)		18,284,137
Issuance of 57,143 shares for personal guarantee		57		91,372		-			91,429
Stock options exercised in accordance with the 1999 Stock Option Plan		12		15,998		-			16,010
Private Placement		1,000		2,709,991		-			2,710,991
Net loss		-		-		(7,039,421	)		(7,039,421	)
Balance at March 31, 2004	$	8,189	$	43,784,716	$	(29,729,759	)	$	14,063,146

See accompanying notes to consolidated financial statements.

49

DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Fiscal Years Ended March 31,

	2004			2003			2002
OPERATING ACTIVITIES
Net (loss) income	$	(7,039,421	)	$	(13,162,458	)	$	2,007,122
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Amortization of financing costs charged to interest expense		237,549			199,888			119,957
Depreciation and amortization		210,605			324,577			260,333
Goodwill impairment loss and intangible assets charge		-			12,468,212			-
Provision for loss on accounts receivable		2,186,220			1,114,539			35,757
Reversal of forgiven accounts payable items		(543,415	)		(83,458	)		-
Loss on disposal of property and equipment		2,227			921			5,303
Change in net deferred income tax asset		1,417,630			(313,882	)		(1,103,548	)
Changes in operating assets and liabilities, net of acquisition:
Accounts receivable, net		(1,993,132	)		1,346,118			(385,375	)
Merchandise inventory		3,271,785			1,223,499			(9,270,331	)
Due from affiliated companies		10,470			13,028			2,363
Prepaid expense and other current assets		(738,273	)		(397,392	)		(29,175	)
Other assets		168,791			55,566			105,662
Notes receivable		172,543			125,144			-
Deposits		(65,324	)		11,182			(31,072	)
Accounts payable		(887,735	)		858,033			2,396,293
Accrued expenses and other current liabilities		1,423,627			(6,253	)		(3,074	)
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES		(2,165,853	)		3,777,264			(5,889,785	)
INVESTING ACTIVITIES
Purchases of property and equipment		(537,266	)		(56,483	)		(68,250	)
Proceeds from sale of property and equipment		-			2,756			2,660
Investment in MorepenMax, Inc.		-			-			(49,000	)
Cash paid for acquisitions, net		(34,071	)		-			(488,619	)
NET CASH USED IN INVESTING ACTIVITIES		(571,337	)		(53,727	)		(603,209	)
FINANCING ACTIVITIES
Decrease in restricted cash		2,000,000			-			-
Increase in cash due to reclassification of investment account		1,933			-			-
Net change under revolving line of credit agreement		1,307,575			(2,985,956	)		6,985,078
Increase in deferred financing costs		(445,172	)		(63,321	)		(50,500	)
Payments of long-term debt and capital leases		(223,466	)		(680,144	)		(663,878	)
Payments to affiliated companies, net		(4,377	)		-			(46,720	)
Proceeds from issuance of common stock		2,727,001			-			-
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		5,363,494			(3,729,421	)		6,223,980
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		2,626,304			(5,884	)		(269,014	)
Cash and Cash equivalents at beginning of year		161,489			167,373			436,387
CASH AND CASH EQUIVALENTS AT END OF YEAR	$	2,787,793		$	161,489		$	167,373
								(continued	)

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DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Fiscal Years Ended March 31,

	2004			2003		2002
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS ACTIVITIES:
Cash paid for interest	$	1,235,284		$	987,406	$	996,276
Cash paid for income taxes	$	-		$	-	$	-
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In July 2001, the Company released from escrow 500,000 shares of common stock (fair value of $1,968,750) due to Dynamic Health Products, Inc., earned through the contingent consideration clauses in conjunction with the acquisition of Becan Distributors, Inc.						$	1,968,750
In October 2001, the Company purchased substantially all the assets of Penner & Welsch, Inc. for $488,619 cash, 125,418 shares of common stock of the Company (fair value of $750,000), and $1,604,793 in forgiveness of debt owed to the Company. The Company also issued 25,000 shares of its common stock (fair value of $142,500) in conjunction with a non-compete agreement.
In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired						$	3,090,058
Cash and stock issued for acquisition							(1,381,119	)
Forgiveness of debt owed to the Company							(1,604,793	)
Liabilities assumed						$	104,146
Conversion of accounts receivable to notes receivable						$	740,281
In August 2002, the Company entered into a capital lease agreement				$	31,602
In April 2003, pursuant to the agreement with W.A. Butler & Company, the Company recorded the reversal of a long-term debt to W.A. Butler & Co.	$	501,561
In May 2003, the Company purchased substantially all the assets of Avery Pharmaceuticals, Inc. No cash was paid for the acquisition. In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired	$	789,202
Acquisition note executed		(90,000	)
Forgiveness of debt owed to the Company		(52,571	)
Liabilities assumed	$	646,631
In June 2003, the Company issued 57,143 shares of common stock of the Company to Jugal K. Taneja for his guaranty executed in favor of Congress.	$	91,429

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DRUGMAX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MARCH 31, 2004, 2003 AND 2002

NOTE 1 - BUSINESS

The Company is a full-line, wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products, nutritional supplements and other related products. The Company is headquartered in Clearwater, Florida and maintains distribution centers in Pennsylvania and Louisiana. The Company distributes its products primarily to independent pharmacies in the continental United States, and secondarily to small and medium-sized pharmacy chains, alternative care facilities and other wholesalers. The Company maintains an inventory from leading manufacturers and holds licenses to ship to all 50 states and Puerto Rico.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of DrugMax, Inc. (formerly known as DrugMax.com, Inc.) and its wholly-owned subsidiaries, Discount Rx, Inc., a Louisiana corporation (“Discount”), Valley Drug Company (“Valley”) and its wholly-owned subsidiary Valley Drug Company South (“Valley South”), Desktop Media Group, Inc. (“Desktop”) and its wholly-owned subsidiary VetMall, Inc. (“VetMall”), and Discount Rx, Inc., a Nevada corporation (“Discount Nevada”), doing business as Avery Pharmaceuticals (“Avery”), (collectively referred to as the “Company” or “DrugMax”). All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of consolidated 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 disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fiscal Year

The Company’s fiscal year end is March 31. References to years relate to fiscal years rather than calendar years, unless otherwise stated.

Cash and Cash Equivalents

The Company considers cash on hand and amounts on deposit with financial institutions which have original maturities of three months or less to be cash and cash equivalents.

Restricted Cash

Restricted cash includes amounts restricted as collateral for the credit facility with Standard Federal Bank National Association (“Standard”), formerly Michigan National Bank as successor in interest to Mellon Bank N.A. (“Mellon”). The credit facility with Standard was paid in full in April 2003 with the new credit facility with Congress Financial Corporation (“Congress”). The restricted cash was used with the Congress credit facility to satisfy the debt to Standard.

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Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are customer obligations due under normal trade terms. The Company sells its products primarily to independent pharmacies from traditional distribution channels and to companies and pharmacies through e-commerce business. The Company performs continuing credit evaluations of its customers’ financial condition and although it generally does not require collateral, letters of credit or personal guarantees may be required from its customers under certain circumstances. Receivables are stated net of allowances for doubtful accounts of approximately $2.6 million and $1.3 million at March 31, 2004 and 2003, respectively. On a regular basis, the Company evaluates its receivables and establishes the allowance for doubtful accounts based on a combination of specific customer circumstances and historical write-off experience. Credit is extended to customers based upon an evaluation of their financial position. Generally, advance payment is not required. Based on the information available to management, it believes the Company’s allowance for doubtful accounts as of March 31, 2004 is adequate. However, actual write-offs might exceed the recorded allowance.

Investments

On August 31, 2001, the Company reached an initial agreement with India-based Morepen Laboratories Ltd. (“Morepen”), to form a joint venture company, and on September 10, 2001, MorepenMax, Inc, (“MorepenMax”), a Florida corporation, was formed. Morepen is the 51% majority shareholder of MorepenMax. On March 22, 2002, the Company funded its investment of $49,000 in MorepenMax, representing its 49% interest. MorepenMax plans to utilize the Morepen facilities to develop low-cost generic pharmaceuticals in the United States. The Company is the exclusive distributor throughout the United States of the products developed by MorepenMax. In June 2003, MorepenMax introduced its first generic product for distribution through the Company. This investment is accounted for under the equity method and is included in other assets. To date the activity of the joint venture has not been material.

Inventory

Inventory is stated at the lower of cost or market. Cost is determined using the first-in, first-out basis of accounting. Inventories at March 31, 2004, and 2003 consist of brand and generic drugs, nutritional supplements, health and beauty aids and over the counter products, which when purchased by the Company as finished goods, are pre-packaged and ready for resale to the Company’s customers. The inventories of the Company’s three distribution centers are constantly monitored for out of date or damaged products, which if exist, are reclassed and physically relocated out of saleable inventory to a holding area, referred to as the “morgue” inventory, for return to and credit from the manufacturer. However, if market acceptance of the Company’s existing products or the successful introduction of new products should significantly decrease, inventory write-downs could be required. As of March 31, 2004, 2003, and 2002, no inventory valuation allowances were necessary.

Property and Equipment

Property and equipment is stated at depreciated cost. A provision for depreciation is computed using the straight-line method over the estimated useful lives, which are as follows:

Fixed Asset Category	Use Life for Depreciation
Furniture and fixtures	7 - 15 years
Computer equipment	5 years
Computer software	3 - 10 years
Leasehold improvements	3 - 15 years
Office equipment	5 years
Warehouse machinery and equipment	7 years
Vehicles	5 years

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Maintenance and repairs are charged to operations. Additions and betterments which extend the useful lives of property and equipment are capitalized. Upon retirement or disposal of the operating property and equipment, the cost and accumulated depreciation are eliminated from the accounts and the resulting gain or loss is reflected in operations.

Goodwill

On April 1, 2001, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), which addresses the financial accounting and reporting standards for the acquisition of intangible assets outside of a business combination and for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill be separately disclosed from other intangible assets in the statement of financial position and no longer be amortized, but tested for impairment on a periodic basis. Upon adoption of SFAS No. 142, the Company ceased amortization of goodwill effective April 1, 2001, and reviews goodwill annually in its second fiscal quarter, unless indicators of impairment are present and suggest earlier testing is warranted.

Deferred Financing Costs

In March 2000, the Company recorded deferred financing costs of $1,625,000 for a warrant issued to a director and non-employee consultant as a result of the director’s acting as a guarantor of the Merrill Lynch line of credit. The Merrill Lynch line of credit was paid in full on October 24, 2000, with proceeds from the Mellon credit facility; therefore, the unamortized balance of deferred financing costs of $572,244 was written off in October 2000. In conjunction with the closing of the Mellon credit facility in October 2000, and the loan modification agreement executed October 2001 with Standard (see Note 9), and subsequent amendments to the loan agreement, the Company capitalized approximately $454,000 in financing costs incurred in obtaining the loans. Amortization of deferred financing costs was $237,549, $199,888, and $119,957 for the years ended March 31, 2004, 2003 and 2002, respectively. The increase in 2004 over 2003 and 2002 was due to the acceleration of the amortization expense in March 31, 2003 and April 2003 due to the April 2003 refinancing of the Standard credit facility, and the amortization of the new deferred financing costs as a result of the Congress credit facility. Deferred financing costs are being amortized over the life of the term loan, under the effective interest rate method. Accumulated amortization of deferred financing costs was $158,639, and $374,836 at March 31, 2004 and 2003, respectively.

Impairment of Long-Lived Assets

Periodically, the Company evaluates the recoverability of the net carrying value of its property and equipment and its amortizable intangible assets, by comparing the carrying values to the estimated future undiscounted cash flows. A deficiency in these cash flows relative to the carrying amounts is an indication of the need for a write-down due to impairment. The impairment write-down would be the difference between the carrying amounts and the fair value of these assets. Losses on impairments are recognized by a charge to earnings.

Income Taxes

The Company has adopted SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”). Under the asset and liability method of SFAS No. 109, deferred income tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recorded or settled. Valuation allowances are established when necessary to reduce deferred income tax assets to amounts expected to be realized.

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Earnings (loss) Per Share

Basic earnings (loss) per share (“EPS”) is calculated by dividing the net income (loss) by the weighted average number of shares of common stock outstanding for the period. Diluted EPS is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period, adjusted for the dilutive effect of options and warrants, using the treasury stock method. The net loss per share for fiscal 2004 was $0.98 for the basic and diluted share, compared to a net loss per basic and diluted share for fiscal 2003 of $1.85, and a net income of $.29 per basic share and $.28 per diluted share for fiscal 2002. The Company recorded the reserve for the deferred income tax asset of approximately $1.4 million at March 31, 2004 as a charge to income tax expense, which increased the loss per share by $.20. The Company recorded a goodwill and intangible asset impairment loss in its second quarter of the fiscal year ended March 31, 2003 of approximately $12.5 million, which increased the net loss per basic and diluted share by $1.75. The Company recorded for the fiscal year ended March 31, 2003 an income tax benefit of approximately $.3 million, which decreased the loss per basic and diluted share by $.04. During the year ended March 31, 2002, the Company reduced its entire valuation allowance, and booked approximately $1.1 million of deferred income tax benefit, net of the current year deferred income tax expense of approximately $.4 million, which provided the Company with additional net income of $.16 per basic and $.15 per diluted share.

The Company had issued and outstanding 2,220,479 options to purchase shares of the Company’s common stock, in addition to warrants to purchase 150,000 shares of the Company’s common stock, which were anti-dilutive and not included in the computation of diluted EPS for the fiscal year ended March 31, 2004. At March 31, 2003, and 2002, the Company had 1,656,634, and 705,500 options, respectively, to purchase shares of the Company’s common stock, in addition to warrants to purchase 150,000 shares of the Company’s common stock, which were anti-dilutive and not included in the computation of diluted EPS for the years ended March 31, 2003, and 2002. These anti-dilutive shares could potentially dilute the basic EPS in the future.

Stock Based Compensation

In October 1995, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), which was effective for fiscal years beginning after December 15, 1995. Under SFAS No. 123, the Company may elect to recognize stock-based compensation expense based on the fair value of the awards or to account for stock-based compensation under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB Opinion No. 25”), and disclose in the consolidated financial statements the effects of SFAS No. 123 as if the recognition provisions were adopted. The Company has adopted the recognition provisions of APB Opinion No. 25. The following table illustrates the effect on net (loss) income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:

	For the Fiscal Year Ended March 31,
	2004			2003			2002
Net (loss) income as reported	$	(7,039,421	)	$	(13,162,458	)	$	2,007,122
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		1,426,621			661,958			2,580,619
Pro forma net (loss)		(8,466,042	)		(13,824,416	)		(573,497	)
(Loss) income per common share as reported:
Basic	$	(0.98	)	$	(1.85	)	$	0.29
Diluted		(0.98	)		(1.85	)		0.28
(Loss) income per common share - pro forma:
Basic		(1.17	)		(1.94	)		(0.08	)
Diluted		(1.17	)		(1.94	)		(0.08	)

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For purposes of the above disclosure, the determination of the fair value of stock options granted in fiscal years 2004, 2003 and 2002 was based on the following: (i) a risk free interest rate of 4.01%, 6.00%, and 3.94% to 5.31% respectively; (ii) expected option lives of 5 - 10 years in 2004, 2003 and 2002; and (iii) expected volatility in the market price of the Company’s common stock of 156%, 117%, and 67%, respectively.

The weighted average fair value of options granted to employees were $1.59, $1.29 and $2.77 per share for the fiscal years ended March 31, 2004, 2003, and 2002, respectively.

The Company did not issue any stock under the 2003 Restricted Stock Plan in fiscal 2004.

The Company has no other equity based compensation plans for its employees.

Fair Value of Financial Instruments

The estimated fair value of amounts reported in the consolidated financial statements has been determined by using available market information and appropriate valuation methodologies. The carrying value of all current assets and current liabilities approximates fair value because of their short-term nature. The fair value of long-term obligations approximates the carrying value, based on current market prices.

Advertising and Promotion Costs

Advertising costs are charged to expense as incurred. Advertising expense totaled approximately $64,000, $35,000, and $59,000 for fiscal years ended March 31, 2004, 2003, and 2002, respectively.

Revenue Recognition

The Company recognizes revenue when goods are shipped and title or risk of loss resides with unaffiliated customers or when services are provided. 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.

The Company accepts return of product from its customers for product which is saleable, in unopened containers and carries a current date. Revenue is recorded net of sales returns and allowances. Generally, product returns are received via the Company’s own delivery vehicles, thereby eliminating a direct shipping cost from being incurred by the customer or the Company. Depending on the length of time the customer has held the product, the Company may charge a handling and restocking fee. The percentage of product returns to the Company is less than 1% of gross revenues for each of the fiscal years ended March 31, 2004, 2003 and 2002. The Company has no sales incentive or rebate programs with its customers. The Company does not bill companies for shipping costs. Such costs are included in cost of goods sold.

Reclassifications

Certain amounts in the 2003 and 2002 consolidated financial statements have been reclassified to conform to 2004 presentation.

Recent Accounting Pronouncements

In April 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections (“SFAS No. 145”). SFAS No. 145 will rescind SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary

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item, net of related income tax benefit. As a result of SFAS No. 145, the criteria in APB No. 30 will be used to classify those gains and losses. The provisions of SFAS No. 145 related to of the rescission of FASB No. 13 shall be applied in fiscal years beginning after May 15, 2002. Early application of the provisions of SFAS No. 145 related to the rescission of FSAB No. 13 is encouraged. The components of SFAS No. 145 adopted in fiscal 2003, resulted in the Company recording forgiveness of debt to other income in the fiscal year ended March 31, 2004.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”), which replaces Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. SFAS No. 146 requires that liabilities associated with exit or disposal activities be recognized when they are incurred. Under EITF Issue No. 94-3, a liability for exit costs is recognized at the date of a commitment to an exit plan. SFAS No. 146 also requires that the liability be measured and recorded at fair value. Accordingly, the adoption of this standard may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The Company adopted the provisions of SFAS No. 146 for any restructuring activities initiated after December 31, 2002. As of March 31, 2004, the Company had not undertaken any such restructuring activities.

In November 2002, the FASB issued FASB Interpretation Number (“FIN”) 45, Guarantors’ Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also requires that at all times a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company will apply the provisions of FIN 45 to any guarantees issued after December 31, 2002. As of March 31, 2004, the Company did not have any guarantees outstanding.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (“SFAS No. 148”) which addresses financial accounting and reporting for recording expenses for the fair value of stock options. SFAS No. 148 provides alternative methods of transition for a voluntary change to fair value-based method of accounting for stock-based employee compensation. Additionally, SFAS No. 148 requires more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002, with early application permitted in certain circumstances. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company has elected to continue to apply the intrinsic value-based method of accounting as allowed by APB No. 25.

In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities (“FIN 46”). FIN 46 clarifies the application of Accounting Research Bulletin No. 51 for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies immediately to variable interest entities created after January 31, 2003. Initially, FIN 46 was to apply in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. At its October 2003 meeting, the FASB agreed to defer the effective date of FIN 46 for variable interests held by public companies in all entities that were acquired prior to February 1, 2003. The deferral will require that public companies adopt the provisions of FIN 46 at the end of periods ending after December 15, 2003. The interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The adoption of FIN 46 in the third fiscal quarter ended December 31, 2003 had no impact on the Company.

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In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”). SFAS No. 150 establishes standards for how an issuer classifies and measurers in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with SFAS No. 150, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except, mandatorily redeemable non-controlling (minority) interests which, on October 29, 2003, the FASB decided to defer indefinitely. As of March 3, 2004, the adoption of SFAS No. 150 has had no impact on the Company.

In January 2004, the FASB issued a Financial Staff Position (“FSP”) pertaining to SFAS No. 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“FSP SFAS No. 106-1”). FSP SFAS No. 106-1 permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer recognizing the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) until authoritative guidance on accounting for the federal subsidy is issued or until certain other events occur. Accordingly, the consolidated financial statements of the Company do not reflect the effect of the Act, if any. Currently, the Company does not sponsor a postretirement health care plan that provides a prescription drug benefit.

NOTE 3 - ACQUISITIONS

Valley Drug Company

On April 18, 2000, Valley loaned the Sellers $170,000, of which $21,277 was outstanding at March 31, 2004 and $100,000 was outstanding at March 31, 2003, to pay for a portion of the flow through effects of their S Corporation taxable income resulting from the sale of Valley to the Company. These interest-free notes receivable are to be repaid upon the Sellers’ sale of Company common stock, which is restricted stock subject to a holding period that ended on April 19, 2001.

Penner and Welsch, Inc.

On October 25, 2001, Discount purchased substantially all of the net assets of Penner & Welsch, Inc. (“Penner”), a wholesale distributor of pharmaceuticals based in Louisiana, pursuant to an Agreement for the Purchase and Sale of Assets dated October 12, 2001 (“the Agreement”). Penner was a Chapter 11 debtor which had voluntarily filed for Chapter 11 protection in the US Bankruptcy Court Eastern Division of Louisiana. Prior to this acquisition, commencing in September 2000, the Company managed the day-to-day operations of Penner, in exchange for a management fee equal to a percentage of the gross revenues of Penner each month. The Company recorded management fees of approximately $364,000 and $550,000 from Penner for the years ended March 31, 2002 and 2001, respectively. During the management period, the Company provided Penner with a collateralized revolving line of credit for the sole purpose of purchasing inventory from the Company. Pursuant to the Agreement, Penner received an aggregate of 125,418 shares of restricted common stock of the Company, valued at $5.98 per share, cash in the amount of $488,619, and forgiveness of $1,604,793 in trade accounts payable and management fees owed to Discount. The Agreement, including the nature and amount of the consideration paid to Penner, was negotiated between the parties and, on October 15, 2001, was approved by the US Bankruptcy Court, Eastern Division of Louisiana.

On October 19, 2001, the Company entered into an Employment Agreement with Gregory M. Johns (“Johns”), former owner of Penner, for an annual salary of $125,000, payable bi-weekly for an initial term of three years, through October 18, 2004, renewable for subsequent terms of one year thereafter. In accordance with the Employment Agreement, the Company agreed to issue a total of 100,000 employee non-qualified stock options (the “Options”) to Johns at a price of $8.00 per share contingent upon the attainment of gross profit goals by

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Discount over the three year term of the Employment Agreement. The Options, provided the goals are attained, would be issued one third of the total 100,000 each year for three years, and would be issued within sixty days of each anniversary date of the Employment Agreement. In conjunction with the Employment Agreement, on October 19, 2001, Johns executed a Restrictive Covenants Agreement and Agreement Not to Compete (“Non Compete Agreement”) with the Company. The Non Compete Agreement constrains Johns during the minimum three year term of the Employment Agreement in addition to a period of one year following his termination. In consideration for Johns’ execution of the Non Compete Agreement, the Company issued to Johns 25,000 shares of common stock of the Company, with a fair market value of $142,500. The Non Compete Agreement was recorded as an intangible asset with associated amortization of $15,000 in fiscal 2002. In fiscal 2003, an intangible impairment loss was recorded for the unamortized balance (see Note 4).

The acquisition of Penner was accounted for by the purchase method of accounting. The results of the operations of Penner are included in the consolidated financial statements from its purchase date. The Company acquired the following assets and liabilities in the business combination:

	For the Year Ended March 31, 2002
Accounts receivable	$	1,180,756
Inventory		717,954
Property and equipment		670,000
Other assets		94,391
Intangible assets		291,914
Goodwill		135,043
Assumption of liabilities		(104,146	)
Net value of purchased assets		2,985,912
Forgiveness of trade payables and management fees		(1,604,793	)
Value of common stock issued		(892,500	)
Cash paid for acquisition	$	488,619

The unaudited pro forma effect of the acquisition of Penner on the Company’s revenues, net loss and net loss per basic and diluted share, had the acquisition occurred on April 1, 2001 is as follows:

	For the Year Ended March 31, 2002
Revenues	$	273,944,559
Net loss	$	(22,483	)
Basic and diluted net loss per share	$	(0.00	)

The proforma information for the fiscal year ended March 31, 2002 has been presented after the elimination of revenues and net income derived from the sales to Penner by Discount prior to the acquisition. In addition, the proforma information for the fiscal year ended March 31, 2002 has been presented after the elimination of non-recurring charges from the Penner operations as follows:

	For the Year Ended March 31, 2002
Management fees	$	547,220
Trustee fees		25,000
Legal fees		160,577

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Avery Pharmaceuticals, Inc.

On May 14, 2003, Discount Rx, Inc., a Nevada corporation and a wholly owned subsidiary of the Company, purchased substantially all of the assets, subject to certain liabilities, of Avery Pharmaceuticals, Inc., Avery Wholesale Pharmaceuticals, Inc., also known as Texas Vet Supply (jointly “Avery”), and Infinity Custom Plastics, Inc. (“Infinity”), wholesale distributors of pharmaceuticals and respiratory products based in Texas, pursuant to an Asset Purchase Agreement dated May 14, 2003 (the “Avery Agreement”).

Pursuant to the Avery Agreement, the Company acquired accounts receivable, inventory, equipment, furniture, the trade name and a patent pending for the process of the manufacture of vials for the respiratory therapy industry, totaling approximately $789,000. The liabilities assumed, which were comprised principally of trade payables, amounted to approximately $647,000, in addition to the forgiveness of debt owed to the Company of approximately $53,000. In addition, the Company executed a promissory note in the amount of $318,000 to the predecessor company’s 50% shareholder (“Sankary”) (the “Sankary Note”), as additional consideration. The Sankary Note includes a right of off set for accounts payable in excess of an agreed upon amount assumed at closing. The original Sankary Note may not be reduced below $90,000 after set off. Management believes the adjusted Sankary note amount will be $90,000 after the set off for accounts payables honored by the Company since the acquisition; therefore, the Company recorded the Sankary Note in the amount of $90,000. The Company and Avery specifically contemplated that the Company 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 Agreement permit the Company to “set off” payments due under the Sankary Note against payments made in excess of the assumed liabilities. The Company believes that it has paid Avery’s obligations well in excess of the assumed liabilities. Therefore, all other payments under the Sankary Note are offset such that nothing more is due and payable there under.

On March 26, 2004, Sankary filed a lawsuit against the Company, in the 342^nd Judicial District Court of Tarrant County, Texas (“Sankary Suit”). The complaint in the Sankary Suit alleges that the Company defaulted under the Sankary Note as a result of the Company’s failure to make payments when due to Sankary.

The Company has paid to Sankary the minimum amount due under the Sankary Note (approximately $90,000) and has paid liabilities of Avery in excess of its obligations under the agreement, such that it is entitled to offset any further liability under the Sankary Note. The Company 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. Additionally, the Avery Agreement contains a provision whereby based on Avery’s earnings, the Sankary Note may be increased to the original amount of $318,000 which would be treated as an addition to the purchase price; however, the Company has reported a net loss for the Avery operations since its acquisition; therefore, no adjustment was made to the Sankary note based on performance.

Also, the Company executed a Consulting and Non-Competition Agreement (“Consulting Agreement”) with John VerVynck (“VerVynck”) an officer and shareholder of Avery Pharmaceuticals and Infinity. The Consulting Agreement provided for the payment to VerVynck of $39,360, payable bi-monthly, over the six-month term of the Consulting Agreement. Upon completion of the Consulting Agreement in December 2003 VerVynck’s employment with the Company was terminated. The Consulting Agreement prohibits VerVynck from competing for one year following his termination and the six-month term of the consulting agreement. In October 2003, the Company relocated the Avery operations to St. Rose, Louisiana and currently operates the acquired business through its wholly owned subsidiary Valley South.

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The acquisition of Avery was accounted for by the purchase method of accounting. The result of the operations of the acquired business is included in the condensed consolidated financial statements from the purchase date. The Company acquired the following assets and liabilities in the Avery acquisition:

Accounts receivable – trade	$	47,025
Accounts receivable – other		39,920
Inventory		224,643
Property and equipment		340,000
Other assets		10,930
Patent		126,684
Assumption of liabilities		(646,631	)
Net value of purchased assets		142,571
Forgiveness of trade payables due to the Company		(52,571	)
Acquisition note payable		(90,000	)
Cash paid for acquisition	$	—

The unaudited pro forma effect of the acquisition of Avery on the Company’s revenue, net income (loss) and net income (loss) per share for the fiscal years ended March 31, 2004, and 2003 had the acquisition occurred on April 1, 2002, are as follows:

	For the Fiscal Year ended March 31, 2004			For the Fiscal Year ended March 31, 2003
Revenues	$	214,893,942		$	298,015,536
Net (Ioss) income before tax benefit		(5,641,389	)		(13,807,551	)
Tax (expense) benefit		(1,417,630	)		313,882
Net (loss) income		(7,059,019	)		(13,493,669	)
(Loss) income per common share – basic		(0.98	)		(1.94	)
(Loss) income per common share – diluted		(0.98	)		(1.94	)

VetMall

In April 2003, W.A. Butler & Company (“Butler”) and the Company executed an agreement (the “April 2003 Agreement”) whereby Butler transferred its remaining 30% ownership in VetMall to the Company and the forgiveness of $.5 million of long term liabilities of the Company to Bulter which was recorded in other income; accordingly, the Company now owns 100% of VetMall stock. The April 2003 Agreement was negotiated due to the fact that VetMall had no current or anticipated operations; therefore, Butler desired to be relieved of any possible future business activities and financial liability of VetMall. Neither VetMall nor Desktop currently have any operations, and management anticipates the dissolution of these entities.

NOTE 4 - IMPAIRMENT OF ASSETS

The Company has completed several acquisitions which have generated significant amounts of goodwill and intangible assets and related amortization. The values assigned to goodwill and intangibles, as well as their related useful lives, are subject to judgment and estimation by the Company. In addition, upon adoption of SFAS No. 142, the Company ceased amortization of goodwill effective April 2001, and reviews goodwill annually for impairment. Goodwill and intangibles related to acquisitions are determined based on purchase price allocations. Valuation of intangible assets is generally based on the estimated cash flows related to those assets, while the initial value assigned to goodwill is the residual of the purchase price over the fair value of all identifiable assets acquired and liabilities assumed. Thereafter, the value of goodwill cannot be greater than the excess of the fair value of the Company’s reportable unit over the fair value of identifiable assets and liabilities, based on the annual impairment test. Useful lives 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. During the second quarter of fiscal 2003, the Company completed its annual two-step process of the goodwill impairment test prescribed in SFAS No. 142, based upon September 30, 2002 values. The first step of the impairment test was the measurement of the Company’s fair market value versus book value, as defined under SFAS No. 142. Because the Company’s fair

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market value, as determined by independent valuation using a discounted cash flow approach, was below book value at September 30, 2002, the Company was required to perform the second step of the impairment test. The second step involved comparing the implied fair value of the Company’s goodwill to its fair market value to measure the amount of impairment. The goodwill impairment test resulted in the Company recognizing a non-cash goodwill impairment loss of approximately $12.2 million relating to the goodwill recorded with the acquisitions of Becan Distributors, Inc. (“Becan”) in November 1999, Valley in April 2000 and Penner in October 2001. During the second quarter of fiscal 2003, the Company also reviewed for impairment the Non-Compete Agreement and the domain name that were recorded as a result of the acquisition of Penner in October 2001. These other intangible assets were determined by an independent appraisal to have no value. Accordingly, the Company recognized an impairment loss of $258,914 related to these other intangible assets. The Company completed its impairment testing at September 30, 2003 and determined that no impairment existed for the fiscal year ended March 31, 2004.

NOTE 5 - PROPERTY AND EQUIPMENT

At March 31, 2004 and 2003 property and equipment consist of the following:

	2004			2003
Furniture, equipment and vehicles	$	1,553,410		$	787,790
Computer software		250,971			483,049
Leasehold improvements		110,314			75,417
Total		1,914,695			1,346,256
Accumulated depreciation		(505,093	)		(578,706	)
Property and equipment, net	$	1,409,602		$	767,550

Depreciation expense for the years ended March 31, 2004, 2003, and 2002 was $210,605, $306,577, and $245,280, respectively.

NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS

Changes in the carrying amount of goodwill for the fiscal years ended March 31, 2004, and 2003, are as follows:

Balance as of March 31, 2002	$	25,314,298
Goodwill impairment charge		(12,209,298	)
Balance as of March 31, 2003		13,105,000
Changes in goodwill		-
Balance as of March 31, 2004	$	13,105,000

The Company has determined that it has one reporting unit in the distribution business. Management further has determined that the distribution reporting unit should be reported in the aggregate based upon similar economic characteristics within each company within that segment.

The following table reflects the components of other intangible assets:

	March 31, 2004				March 31, 2003
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Amortizable intangible assets:
Patent pending	$	280,883	$	-	$	-	$	-
Deferred financing costs		536,601		158,639		453,748		374,836
Total	$	817,484	$	158,639	$	453,748	$	374,836

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Amortization expense for the fiscal years ended March 31, 2004, 2003 and 2002 was $0, $18,000 and $15,044, respectively. Amortization of deferred financing costs charged to interest expense was $237,549, $199,888 and $119,957 for the fiscal years ended March 31, 2004, 2003 and 2002, respectively. The following schedule outlines anticipated amortization expense over the next five fiscal years:

	Fiscal Year Ending March 31:
	2005		2006		2007		2008		2009
Patent pending	$	16,523	$	16,523	$	16,523	$	16,523	$	16,523
Deferred financing costs		188,981		188,981		-		-		-
Total amortization expense		205,504		205,504		16,523		16,523		16,523

NOTE 7 - NOTES RECEIVABLE

On April 15, 2002, the Company arranged a note maturing on December 1, 2005 with one of its customers for an account receivable. The note bears interest at 7%, is unsecured, and requires the customer to purchase at least $7,000 generic and $20,000 branded pharmaceuticals each month on COD terms, in addition to the repayment of the note balance. The outstanding balance on the note at March 31, 2004 and 2003, was $95,877 and $147,197, respectively, of which $55,032 and $51,322, respectively, representing the portion due within one year, is included in other current assets.

On November 8, 2002, the Company renegotiated a note receivable maturing in November 2007, which originated on March 28, 2002, with one of its customers for an account receivable. The renegotiated note bears interest at 2.5%, is collateralized by the customer’s accounts receivable and inventory, and requires any subsequent charges after the date of the note to be paid currently in addition to the repayment of the note balance. The outstanding balance on the note at March 31, 2004 and 2003 was $245,344 and $268,763, respectively. In October 2003, the customer filed for bankruptcy protection under Chapter 7. At March 31, 2004, the Company recorded a reserve allowance representing 100% of the outstanding balance for the receivable.

On November 8, 2002, the Company renegotiated a note receivable maturing in November 2007, which originated on March 28, 2002, with one of its customers for an account receivable. The note bears interest at 2.5%, is unsecured, and requires any subsequent charges after the date of the note to be paid currently in addition to the repayment of the note balance. The outstanding balance on the note at March 31, 2004 and 2003 was $309,385 and $344,261, respectively. In October 2003, the customer filed for bankruptcy protection under Chapter 7. At March 31, 2004, the Company recorded a reserve allowance representing 100% of the outstanding balance for the receivable.

NOTE 8 - INCOME TAXES

The income tax expense ( benefit) consists of the following for the fiscal years ended March 31, 2004, 2003 and 2002:

	Federal			State			Total
Fiscal year ended March 31, 2004
Current	$	-		$	-		$	-
Deferred		1,280,877			136,753			1,417,630
Total	$	1,280,877		$	136,753		$	1,417,630
Fiscal year ended March 31, 2003
Current	$	-		$	-		$	-
Deferred		(282,927	)		(30,955	)		(313,882	)
Total	$	(282,927	)	$	(30,955	)	$	(313,882	)
Fiscal year ended March 31, 2002
Current	$	-		$	-		$	-
Deferred		(950,084	)		(153,464	)		(1,103,548	)
Total	$	(950,084	)	$	(153,464	)	$	(1,103,548	)

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The expense (benefit) for income taxes differs from the amount computed by applying the U.S. federal income tax rate of 34% to income (loss) before income taxes for 2004, 2003, and 2002 is shown below:

	2004					2003					2002
	Amount			Effective Rate		Amount			Effective Rate		Amount			Effective Rate
Statutory federal rate	$	(1,911,961	)	(34.00	%)	$	(4,581,956	)	(34.00	%)	$	307,215		34.00	%
State income taxes		(204,130	)	(3.63	%)		(47,133	)	(0.35	%)		33,656		3.72	%
Goodwill impairment		-		-			4,151,161		30.80	%		-		0.00	%
Other		-		-			(5,634	)	0.00	%		14,081		1.56	%
Understatement of prior years net operating losses		(394,334	)	(7.00	%)		(410,420	)	(3.40	%)		-		0.00	%
Change in valuation allowance		3,928,055		69.83	%		580,100		4.00	%		(1,458,500	)	(161.41	%)
	$	1,417,630		25.20	%	$	(313,882	)	(2.95	%)	$	(1,103,548	)	(122.13	%)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of deferred income tax assets and liabilities, net of valuation allowance, as of March 31, 2004 and 2003 are as follows:

	2004			2003
Net operating losses	$	3,270,335		$	1,091,562
New operating losses - acquired		189,930			190,384
Use of cash basis method of accounting for income tax purposes		-			(128,500	)
Uniform capitalization of inventory cost		192,983			229,935
Basis difference in property and equipment		(207,916	)		(47,078	)
Basis difference on deductible goodwill and other intangibles		-			55,010
Other		7,174			7,555
Bad debt		1,055,649			598,862
Net deferred income tax assets		4,508,155			1,997,730
Valuation allowance		4,508,155			580,100
Net deferred income tax asset after valuation allowance	$	-		$	1,417,630

At March 31, 2004, the net operating loss and acquired tax loss carry forward benefits of approximately $9.0 million and $.5 million expire through 2024. Due to the Company’s acquisition of Desktop, the Company’s ability to utilize the acquired net operating loss carry forward of $500,000 will be limited by IRS Section 382 to $113,000 per year.

SFAS No. 109 requires a valuation allowance to reduce the deferred income tax assets reported, if based on the weight of the evidence, it is more likely than not that a portion or all of the deferred income tax assets will not be realized. As such, a valuation allowance of $4,508,155 was established at March 31, 2004.

In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management evaluated the scheduled reversal of deferred income tax asset, the Company’s profitability for the year ended March 31, 2005 and later years, reviewed the Company’s business model, and future earnings projections, and believes the evidence indicates that it is not more likely than not that the Company will be able to generate sufficient taxable income to utilize the deferred income tax asset; therefore, the Company reserved the full $4,508,155 deferred income tax asset in the fourth quarter of the year ended March 31, 2004.

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NOTE 9 - DEBT

On October 24, 2000, the Company obtained from Mellon Bank N.A. (“Mellon”) a $15 million line of credit and a $2 million term loan to refinance its prior bank indebtedness, to provide additional working capital and for other general corporate purposes. The line of credit enabled the Company to borrow a maximum of $15 million, with borrowings limited to 85% of eligible accounts receivable and 65% of eligible inventory. The line of credit bore interest at the floating rate of 0.25% per annum over the base rate. The term loan was payable over a 36-month period with interest at 0.75% per annum over the base rate, which was the higher of Mellon’s prime rate or the effective federal funds rate plus 0.50% per annum. In conjunction with the closing of the Mellon credit facility, the Company deposited $2 million in a restricted cash account with Mellon. In October 2001, the Company executed a loan modification agreement modifying the original Mellon line of credit with Standard Federal Bank National Association (“Standard”), formerly Michigan National Bank as successor in interest to Mellon, increasing the line to $23 million. The line of credit and term loan were paid in full with the April 15, 2003 Congress Financial Corporation (“Congress”) credit facility and the restricted cash account with Mellon. In March 2003, the Company recorded 50% of the unamortized financing costs to interest expense related to the early termination of the Standard credit facility, and recorded the remaining balance of the unamortized financing costs to interest expense in April 2003 in addition to an early termination fee of $351,000 and a fee for the waiver of the 90-day notice of termination of $30,000.

On April 15, 2003, the Company obtained from Congress a $40 million revolving line of credit and a $400,000 term loan. The Congress credit facility along with the Mellon restricted cash account of $2 million were used to satisfy the outstanding line of credit and term loan with Standard. The Congress revolving line of credit enables the Company to borrow a maximum of $40 million, with borrowings limited to 85% of eligible accounts receivable and 65% of eligible inventory. The revolving line of credit and the term note currently bear interest at the rate of 0.50% per annum in excess of the Prime Rate. The Congress credit facility is collateralized by all of the Company’s assets and is to mature in April 2006. The line of credit is for a term of 36 months, and the term note is payable over the same 36-month period. The Congress credit facility imposes certain restrictive covenants on tangible net worth and EBITDA. At March 31, 2004, the Company was not in compliance with the tangible net worth and EBITDA covenants. On March 31, 2004, the Company and Congress executed a Second Amendment to the Loan and Security Agreement which revised the EBITDA covenant for the year ended March 31, 2004 and forward. Congress issued a waiver of the tangible net worth and EBITDA covenants at March 31, 2004. The Third Amendment to the Loan and Security Agreement dated June 30, 2004 revises the financial covenants going forward. All costs associated with the Congress credit facility will be amortized as interest expense over the term of the loan. At March 31, 2004, availability on the Congress credit facility was approximately $1.2 million. The outstanding balance on the revolving line of credit and term loan were approximately $17,251,000 and $278,000, respectively, at March 31, 2004. At March 31, 2004, the interest rate on the revolving line of credit and term loan was 4.5%.

On April 15, 2003, Jugal K. Taneja, the Chairman of the Board, CEO and a Director of the Company executed a Guarantee (the “Guarantee”) in favor of Congress. The Guarantee provides Congress with Mr. Taneja’s unconditional guaranty of all obligations, liabilities, and indebtedness of any kind of the Company to Congress, provided that the Guarantee shall not exceed $2 million in year one; is reduced to $1.5 million in year two; and is further reduced to $1 million in year three, subject to the Company achieving collateral availability objectives. In June 2003, the Company issued 57,143 shares of common stock of the Company to Mr. Taneja as compensation for his guarantee in favor of Congress, valued at $91,429, based on the fair market value of the stock on the date of the grant. The cost of the common stock has been recorded as a financing cost related the Congress credit facility and is being amortized as interest expense over the term of the loan.

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NOTE 10 - COMMITMENTS AND CONTINGENCIES

Leases

The Company has operating leases for facilities that expire at various dates through 2019. Certain leases provide an option to extend the lease term. Certain leases provide for payment by the Company of any increases in property taxes, insurance, and common area maintenance over a base amount and others provide for payment of all property taxes and insurance by the Company.

The Company leases computer and office equipment with original lease terms ranging from three to five years. These leases expire at various dates through fiscal 2009.

The Company leases vehicles for delivery and sales purposes with original lease terms ranging from one to five years. These leases expire at various dates through fiscal 2010.

The Company has capital leases on office and warehouse equipment each with original lease terms of five years. These capital leases expire at various dates during fiscal 2006.

Future minimum lease payments, by year and in aggregate under non-cancelable leases that have initial or remaining terms in excess of one year, are as follows:

Year Ending March 31,	Operating Leases		Capital Leases
2005	$	583,638	$	14,163
2006		574,839		3,529
2007		441,216		-
2008		313,450		-
2009 and thereafter		2,944,227		-
Total payments	$	4,857,370	$	17,692

Total rent expense for the years ended March 31, 2004, 2003, and 2002 was approximately $436,000, $344,000, and $226,000, respectively.

Purchase Commitments

The Company currently has purchase commitments with three vendors which require the Company to annually purchase a minimum of approximately $20,050,000. These commitments expire in November 2004, except for a $50,000 commitment which is ongoing until the agreement is terminated by either party.

Litigation

In March 2000, the Company 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. (the “Reorganization Agreement”). On February 7, 2002, Messrs. Miller and Fagala filed a complaint against the Company in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, Florida, alleging, among other things, that the Company had breached the Reorganization Agreement by failing to pay 38,809 shares of the Company’s common stock to plaintiffs. The complaint also includes a count of conversion and further alleges that the Company breached its employment agreements with Messrs. Miller and Fagala, for which the plaintiffs seek monetary damages. On March 11, 2002, the Company filed its answer, affirmative defenses and counterclaim against plaintiffs and HCT Capital Corp. (“HCT”), in which it alleged, among other things, that plaintiffs had

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breached the Reorganization Agreement by misrepresenting the state of the acquired business, that the Company was entitled to set off its 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 the Company and cross-claim against the plaintiffs. In December 2003, a Settlement Agreement and Release (the “Release”) was executed by HCT and the Company whereby HCT and 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. There has been little activity by Messrs. Miller and Fagala with regard to this matter, and the Company is currently considering how to proceed in light of this inactivity. The Company intends to vigorously defend the actions filed against it and to pursue its counterclaim. The Company cannot reasonably estimate any possible future loss or recovery as a result of this matter; therefore, the Company has made no provision in the accompanying consolidated financial statements for resolution of this matter.

On May 1, 2002, the Company filed suit against an established customer of the Company’s Pittsburgh distribution center for collection of past due accounts receivable. The customer accounted for approximately $4.1 million, or 1.5%, of the gross revenue of the Company in the fiscal year ended March 31, 2002. The Company has an unconditional personal guaranty signed by the customer’s owner. On May 23, 2002, the customer filed a voluntary petition in bankruptcy in the U.S. Bankruptcy Court, under Chapter Eleven of the United States Bankruptcy Act, subsequent to which the customer failed to file the proper financial data with the court, causing the voluntary bankruptcy filing to be withdrawn. Management is continuing to pursue its claim for payment through the courts and working with the major creditors to process return of inventory. The Company currently has reserved an allowance account representing 100% of the account balance.

On October 2, 2003, QK Healthcare, Inc. (“QK”) filed a complaint against Valley in the United States District Court of the Eastern District of New York, which included several counts with regard to the sale of twenty bottles of Lipitor by Valley to QK, including breach of contract, violations of the implied warranty of merchantability and fraud. The complaint demands actual damages, punitive damages and legal fees and expenses. On January 9, 2004, the Company filed an answer and counterclaim against QK, in which the Company seeks to recover from QK losses caused when QK refused to pay for pharmaceuticals ordered from the Company. The parties reached a settlement on May 14, 2004, pursuant to which the case will be dismissed. The settlement agreement requires the Company to pay QK $218,000, calls for the parties to resume their business relationship, with the Company giving QK certain price reductions in the products QK purchases from the Company for one year, and provides for the mutual release of both parties. In the fourth quarter of fiscal 2004, the Company expensed $218,000 in operating expense, and $32,000 in legal expense related to the QK settlement.

On November 12, 2003, Phil & Kathy’s, Inc. d/b/a Alliance Wholesale Distributors (“Alliance”) served a complaint against the Company seeking to recover the non-payment of open invoices approximating $2,000,535, 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 purchase of twenty bottles of Lipitor from Alliance, which the Company later sold to QK. The Company intends to vigorously defend Alliance’s breach of contract action and prosecute the counterclaim. 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 the lawsuit against Valley by QK in New York. At March 31, 2004, the amount that the Company recorded as a trade payable balance due Alliance on the above was approximately $1.5 million. While the Company has recorded the foregoing trade payable, it continues to assess the extent of its full damages and cannot at this time reasonable estimate the total future possible loss that it will sustain as a result of the Alliance complaint or the possible recovery through the Company’s counterclaim or Valley’s consolidated action.

On May 14, 2003, Discount, a wholly owned subsidiary of the Company, 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”

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payments due under the Sankary Note against payments made in excess of the Assumed Liabilities. Discount believes that it has paid Avery’s obligations well in excess of the Assumed Liabilities. Therefore, all other payments under the Sankary Note are offset such that nothing more is due and payable there under.

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) and has paid liabilities of Avery in excess of its obligations under the agreement, such that it is entitled to offset any further liability under the Sankary Note. 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.

Additionally, since the closing of the Avery transaction, various creditors and other third parties owed money by Avery have threatened to file lawsuits against Discount. To date, Discount has not been sued by any of these creditors or other third parties and their claims remain unliquidated. The Company intends to vigorously defend any actions filed against Discount. In the unlikely event that Discount is not permitted to offset liabilities paid against the obligation under the Sankary Note, the total amount that remains payable under the Sankary Note as of June 25, 2004, is $228,000. However, because the Company believes that it is entitled to offset any further liability under the Sankary Note, the Company has made no provision in the accompanying consolidated financial statements for resolution of the Sankary Suit. Similarly, because no other lawsuits have been filed nor any threatened to be filed, the Company has made no provision in the accompanying consolidated financial statements for resolution of any other claims against Discount.

The Company is, from time to time, involved in litigation relating to claims arising out of its operations in the ordinary course of business. The Company believes that none of the claims that were outstanding as of March 31, 2004 should have a material adverse impact on its financial position, results of operations, or cash flows.

NOTE 11 - EMPLOYEE BENEFIT PLAN

In January 2002, the Company adopted the DrugMax, Inc. 401(k) Plan (the “401(k) Plan”). Full time employees are eligible to participate in the 401(k) Plan beginning the next quarterly enrollment date after completion of one year of employment with the Company. Eligible employees may contribute to the 401(k) Plan an amount up to $13,000 and $12,000 of their annual compensation on a pre-tax basis for the calendar years ended December 31, 2004 and 2003, respectively. Participant contributions are immediately vested. In addition, under the terms of the 401(k) Plan, for each plan year, the Company may contribute an amount of matching contributions determined by the Company at its discretion. Participants become vested in the Company matching contributions over a six-year period. The Company made no contributions to the 401(k) Plan in the fiscal years ended March 31, 2004, 2003 and 2002.

NOTE 12 - STOCK AND BENEFIT PLANS

Private Placement

On March 18, 2004, the Company sold 1,000,000 shares of its common stock in a private placement to accredited investors for $3.21 million. The expenses related to this offering approximated $500,000. Maxim Group LLC, a New York-based investment firm, acted as the placement agent for the Company in the private placement. Net proceeds will be used for working capital and general corporate purposes. The private placement was made under an exemption from the registration requirements of the Securities Act of 1933, as amended, and the investors purchasing shares in the private placement may not offer or sell the securities sold in the offering in the absence

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of an effective registration statement or exemption from registration requirements. The Company has filed a registration statement on Form S-3 with the Securities and Exchange Commission, which as of June 28, 2004 had not yet been declared effective by the Securities and Exchange Commission, to register the resale of the shares sold in the private placement, as is required by the subscription agreements between the investors and the Company.

Stock Options

In August 1999, the Company’s Board of Directors adopted the DrugMax, Inc. 1999 Stock Option Plan (the “Plan”), which was approved by the Company’s shareholders at its annual meeting in August 2000. The Plan provides for the grant of incentive and nonqualified stock options to key employees, including officers, directors and consultants of the Company. Under the provisions of the Plan, all options, except for incentive options granted to “greater-than-10%-stockholders,” have an exercise price equal to the fair market value on the date of the grant and expire no more than ten years after the grant date. The exercise price of incentive options issued to “greater-than-10%-stockholders” shall not be less than 110% of the fair market value of the common stock on the date of the grant, and such options shall expire five years after the date of the grant. During the years ended March 31, 2004, 2003, and 2002, no stock options were issued to consultants. Through March 31, 2004, options to acquire up to 2,000,000 shares of common stock were granted pursuant to the Plan.

Stock option activity is summarized as follows:

Incentive and Non-Qualified Stock Options	Number of Shares		Weighted Average Exercise Price
Outstanding March 31, 2001	290,300		$	12.65
Granted	950,700			4.13
Forfeited	(21,900	)		6.05
Outstanding March 31, 2002	1,219,100			6.13
Granted	702,934			1.94
Forfeited	(265,400	)		6.49
Outstanding March 31, 2003	1,656,634			4.25
Granted	726,155			1.74
Forfeited	(151,300	)		6.06
Exercised	(11,010	)		1.45
Outstanding March 31, 2004	2,220,479			2.69

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Outstanding options under the Plan vest over a one- to three-year period. As of March 31, 2004 and 2003, 1,739,386 and 1,094,439 options, respectively, with a weighted average exercise price of $3.92 and $5.85, respectively, were exercisable. The following is a summary of stock options outstanding and exercisable as of March 31, 2004.

Exercise Price	Options Outstanding	Contractual Life (years)	Options Exercisable
$10.00	5,000	5.65	5,000
13.00	136,800	5.78	136,800
11.38	7,500	6.13	7,500
7.00	7,500	6.49	7,500
3.50	478,300	7.01	318,867
5.70	900	7.28	600
5.00	142,500	7.43	142,500
5.75	40,000	7.55	26,666
6.05	25,900	7.66	17,267
4.00	25,000	7.97	25,000
3.85	5,000	8.17	1,667
3.25	25,000	8.19	25,000
1.70	6,000	8.46	2,000
1.55	212,500	8.47	212,500
1.00	156,090	8.58	52,030
8.00	33,334	8.61	33,334
2.00	220,000	8.61	145,000
1.05	30,000	9.14	-
1.44	30,000	9.30	-
2.99	42,500	9.53	42,500
2.72	15,000	9.53	15,000
2.72	195,000	9.53	195,000
2.72	50,000	9.53	-
2.52	33,333	9.55	33,333
2.00	3,000	9.83	-
3.28	294,322	9.96	294,322
	2,220,479		1,739,386

Remaining non-exercisable options as of March 31, 2004 become exercisable as follows:

2005	300,063
2006	118,363
2007	62,667
	481,093

NOTE 13 - RELATED PARTY TRANSACTIONS

Innovative Companies, Inc., a publicly traded company, formerly GO2 Pharmacy, Inc. and Innovative Health Products, Inc., (“Innovative”), is a supplier of manufactured dietary supplements and health and beauty care products. Jugal K. Taneja (“Taneja”) is a Director and Chairman of the Board of Innovative and of the Company. Belcher Pharmaceuticals, Inc., is a wholly-owned subsidiary of Innovative. In the fiscal years ended March 31, 2004, 2003, and 2002, the Company purchased approximately $6,000, $3,200, and $5,200, respectively, of

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products for resale from Innovative. Management believes the terms and conditions extended to the Company by Innovative are as favorable to the Company as terms and conditions would have been from unrelated third parties.

On September 13, 2000, the Company entered into a management agreement with Penner, pursuant to which it agreed to manage the day-to-day operations of Penner during the bankruptcy proceeding in exchange for a management fee equal to a percentage of the gross revenues of Penner each month. In turn, the Company entered into a management agreement with Dynamic Health Products, Inc. (“Dynamic”) pursuant to which Dynamic provided accounting support services to the Company in connection with the Company’s management responsibilities relating to Penner. Pursuant to this agreement, Dynamic was entitled to receive one-third of all fees collected by the Company from Penner. In the fiscal year ended March 31, 2002, the Company paid Dynamic $225,226. Taneja is a Director and Chairman of the Board of Dynamic and of the Company. Both agreements were terminated in October 2001, in connection with the closing of the acquisition of certain assets from Penner by the Company.

In April 2000, in connection with the acquisition of Valley, the Company loaned the sellers of Valley a total of $170,000 to pay for a portion of the flow through effects of their S Corporation taxable income resulting from the sale of Valley. The notes are interest-free and are to be repaid by Ronald J. Patrick (“Patrick”), Chief Financial Officer of the Company, and Ralph Blundo (“Blundo”), the President of Valley, upon the sale of Company stock received by Patrick and Blundo in connection with the acquisition of Valley, which is restricted stock subject to a holding period which ended on April 19, 2001. In December 2003, the Company received $78,723 in payment on the outstanding balance. At March 31, 2004 and 2003, the outstanding balance on the notes was $21,277 and $100,000, respectively. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

Blundo, the President of Valley, and Patrick, the Chief Financial Officer of the Company, together are 2/3 owners of Professional Pharmacy Solutions, LLC (“PPS”), a pharmacy management company. Valley sells products to PPS under Valley’s normal terms and conditions. The Company generated revenues of approximately $1.9 million, $1.5 million and $1.1 million for each of the fiscal years ended March 31, 2004, 2003 and 2002, respectively, from PPS. The receivable balance due from PPS at March 31, 2004 and 2003 was approximately $300,000 and $400,000, respectively. Also, in the fiscal year ended March 31, 2004, the Company purchased approximately $123,000 in merchandise from PPS for resale. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

In October 2001, the Company executed a Commercial Lease Agreement (the “Lease”) with River Road Real Estate, LLC (“River Road”), a Florida limited liability company, to house the operations of Valley South in St. Rose, Louisiana. The officers of River Road are Jugal K. Taneja, a Director, Chief Executive Officer, Chairman of the Board and a majority shareholder of the Company; William L. LaGamba (“LaGamba”), a Director, Chief Operating Officer, and the President of the Company; Stephen M. Watters, a former Director of the Company; and Gregory M. Johns, an employee of the Company and the former owner of Penner. 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 made to River Road by the Company. In each of the fiscal years ended March 31, 2004 and 2003, the Company paid $180,000, and in the fiscal year ended March 31, 2002, the Company paid $90,000 to River Road, which was a charge to rent expense. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

T&L, Inc., doing business as Advanced Pharmacy, Inc. (“T&L”), is a retail pharmacy for prescription drugs owned by Mandeep Taneja, a stockholder of the Company and the adult son of Taneja, and Michelle LaGamba, the spouse of LaGamba The Company sells products to Advanced under normal terms and conditions. In the fiscal years ended March 31, 2004, 2003, and 2002, the Company generated revenues of approximately

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$5.3 million, $4.9 million, $.02 million, respectively, from T&L. At March 31, 2004 and 2003, the receivable balance due from T&L was approximately $530,000 and $255,000, respectively. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

In the fiscal year ended March 31, 2003, the Company advanced to its employee and former owner of Penner, Gregory M. Johns (“Johns”), funds in the amount of approximately $80,000, which is secured by a note executed by Johns. The note bears no interest and is being paid by Johns through deductions from his compensation from the Company. At March 31, 2004 and 2003, the outstanding balance due from Johns was approximately $32,000 and $73,600, respectively.

On August 31, 2001, the Company and India-based Morepen Laboratories Ltd. (“Morepen Laboratories”) formed a joint venture company, and on September 10, 2001, MorepenMax, Inc, (“MorepenMax”), a Florida corporation, was formed. Morepen Laboratories is the 51% majority shareholder of MorepenMax and the Company owns the remaining 49% interest. MorepenMax plans to utilize the Morepen facilities to develop low-cost generic pharmaceuticals for distribution in the United States. The Company will be the exclusive distributor throughout the United States of the products developed by MorepenMax. Mr. Suri, one of the Company’s directors, is the Chairman of the Board and Chief Executive Officer of Morepen Laboratories and MorepenMax. In June 2003, MorepenMax introduced its first generic product for distribution through the Company, as a result, in the fiscal year ended March 31, 2004, the Company purchased approximately $46,000 in generic pharmaceuticals from MorepenMax, and the outstanding liability to MorepenMax at March 31, 2004 was approximately $46,000. The Board of Directors of the Company has considered allowing Taneja, and the management team, to purchase the Company’s 49% interest in MorepenMax upon a change of control of the Company.

In January 2004, the Company executed a Commercial Lease Agreement (the “Lease”) with Becan Development, LLC (“Becan Development”), a Pennsylvania limited liability company, to house the operations of Valley in New Castle, Pennsylvania. The officers of Becan Development are Taneja, a Director, Chief Executive Officer, Chairman of the Board and a majority shareholder of the Company; LaGamba, a Director, Chief Operating Officer, and the President of the Company; Phillip J. Laird, Secretary of Discount and an employee of the Company; Patrick, Chief Financial Officer and a Director of the Company; John Cairns, an employee of Valley; and Blundo, President of Valley. The Lease is for an initial period of fifteen years with a base monthly lease payment of $17,000. In the fiscal year ended March 31, 2004, the Company paid $34,000, to Becan Development, which was a charge to rent expense. Management believes the terms of this agreement are comparable to those that the Company would have received from an unrelated, third party.

NOTE 14 - SEGMENT INFORMATION

The Company has adopted SFAS No. 131, “Disclosures About Segments of Enterprise and Related Information,” which established standards for reporting information about a Company’s operating segments. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance of the segment.

The Company has determined that is has one reportable segment because all distribution subsidiaries have similar economic characteristics, such as margins, products, customers, distribution networks and regulatory oversight. The distribution line of business represents 100% of consolidated revenues in fiscal years 2004, 2003 and 2002. The accounting policies of the operating segment are those discussed in Note 2, Summary of Significant Accounting Policies.

The Company distributes product both within and outside the United States. Revenues from distribution within the United States represented approximately 99.4%, 99.5%, and 99.8% of gross revenues for the years ended

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March 31, 2004, 2003, and 2002, respectively. Foreign revenues were generated primarily from distribution to customers in Puerto Rico.

The following table presents distribution revenues from the Company’s only segment for each of the Company’s four primary product lines for the fiscal years ended March 31:

	2004		2003		2002
Revenue from:
Branded pharmaceuticals	$	195,307,940	$	268,443,471	$	252,526,812
Generic pharmaceuticals		12,832,542		14,722,530		12,525,736
Over-the-counter and other		4,925,887		8,585,770		6,235,440
Respiratory products		722,910		-		-
Total revenues	$	213,789,279	$	291,751,771	$	271,287,988

NOTE 15 - MAJOR CUSTOMER CONCENTRATION

During the fiscal years ended March 31, 2004, 2003, and 2002, the Company’s 10 largest customers accounted for approximately 40%, 44%, and 37%, respectively, of the Company’s net sales. The Company’s two largest customers during fiscal 2004 and 2003, Supreme Distributors and QK Healthcare, Inc. accounted for approximately 10% each of net sales in fiscal 2004, and 17% and 11% of net sales in fiscal 2003, respectively. In fiscal 2002, the Company’s largest customer, QK Healthcare, Inc. accounted for approximately 13% of net sales.

NOTE 16 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The following tables set forth certain unaudited quarterly financial data for each of the four quarters in the fiscal years ended March 31, 2004 and 2003:

	FISCAL QUARTER
	First			Second			Third			Fourth			Total
	(restated)
2004
Revenues	$	60,659,545		$	60,188,732		$	50,245,129		$	42,695,873		$	213,789,279
Gross profit		1,987,213			2,135,547			1,438,492			67,391			5,628,643
Net (loss) income		(35,728	)		36,791			(621,479	)(2)		(6,419,005	)(1)		(7,039,421	)
(Loss) income per common share
Basic		(0.01	)		0.01			(0.09	)		(0.89	)		(0.98	)
Diluted		(0.01	)		0.01			(0.09	)		(0.89	)		(0.98	)
2003
Revenues	$	63,103,819		$	73,736,121		$	85,233,822		$	69,678,009		$	291,751,771
Gross profit		1,980,826			2,279,786			1,883,182			1,960,913			8,104,707
Net (loss) income		(571,690	)		(12,298,531	)(4)		10,333	(3)		(84,137	)		(13,162,458	)
(Loss) income per common share
Basic		(0.08	)		(1.73	)		0.00			(0.04	)		(1.85	)
Diluted		(0.08	)		(1.73	)		0.00			(0.04	)		(1.85	)

(1) During the fourth quarter of 2004 the Company incurred the following operational issues resulting in a negative financial performance.

a) Increase of $2.2 million reserve to the allowance for doubtful accounts receivable and notes receivable, primarily as a result of its continuing evaluation of the collectibility of its accounts receivable, noting an increase in the filing of bankruptcy of its customer base.

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b) Determination that the deferred tax assets, amounting to $1.4 million, require a full reserve to be recorded. Management believes it is more likely than not that the deferred income tax assets would not be able to be utilized;

c) Settlement of a customer lawsuit, QK Healthcare, Inc., amounting to approximately $250,000 including legal costs;

d) Gross profit earned was minimized as a result of:

1. the overall decline in total revenue;

2. the decline in volume of higher profit generic and OTC sales;

3. the loss of “buy-in” opportunities and incentives from manufacturers, thus increasing the cost of purchased goods, as a result of the reduced purchasing levels caused by the loss of the QK Healthcare business; and

4. the loss of primary customer base, which carries a higher gross profit, due to credit issues, including bankruptcy filings as noted above;

e) Merger costs incurred for professional services associated therewith in the amount of approximately $150,000.

(2) The third quarter of fiscal 2004 has been restated due to the premature recognition of a contingent gain in relation to the lawsuit with Alliance. The adjustment to the third quarter resulted in an increase in accounts payable of approximately $629,000 and a decrease in gross profit of approximately $629,000. (See Note 10—Commitments and Contingencies—Litigation). The Company recorded the impact of the settlement with QK Healthcare in the fourth quarter of fiscal 2004. The related 10Q is in the process of being amended.

(3) In the first quarter 2003, the Company recorded an allowance for an account receivable in the amount of $897,000 and accrued expenses related thereto in the amount of $19,132. The Company also recorded a deferred income tax benefit of $342,629 for the first quarter 2003, relating to these charges.

(4) During the second quarter 2003, the Company completed its annual two-step process of the goodwill impairment as prescribed in SFAS No. 142, and recorded a goodwill impairment loss of $12,209,298, and an intangible asset impairment loss of $258,914.

NOTE 17 - SUBSEQUENT EVENTS

On March 19, 2004, the Company entered into an Agreement and Plan of Merger with Familymeds Group, Inc., a Connecticut Company (“FMG”), pursuant to which FMG would be merged with and into the Company, with the Company being the surviving company. If the merger is consummated, the Company expects that the current Company stockholders will, as a group, own approximately 40%, and FMG stockholders, employees and directors will, as a group, own approximately 60%, of the issued and outstanding shares of the Company immediately after the merger. In addition, at the closing of the merger the Company will issue warrants to the FMG stockholders, the FMG warrant holders and the FMG note holders entitling them to purchase certain additional shares of the Company common stock. While the merger agreement does not require the payment of any cash consideration at closing, the Company will incur certain expenses in connection with the closing of the merger, including legal, accounting, investment banking, filing, printing and mailing fees. Further, if any shareholders of either DrugMax or FMG dissent from the merger, the Company will be required to pay such shareholders the fair value of their shares in cash. The merger agreement limits the number of share of the

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Company that may dissent to 200,000 and the number of shares of FMG that may dissent to $1,000,000 worth of FMG stock. Neither FMG nor the Company are required to consummate the merger if shareholders holding shares in excess of these limits notify the Company and FMG of their intent to dissent.

Further, if the merger is consummated, the combined company will inherit the debt and obligations of FMG. FMG has incurred significant losses and negative cash flow in the past. Further, unless restructured in connection with the merger, FMG’s senior collateralized revolving credit facility with General Electric Capital Corporation (“General Electric”), and its debt under that facility will mature on August 31, 2004. As of May 22, 2004, the amount outstanding under the General Electric facility was approximately $27.7 million. These facts raise doubt about FMG’s ability to continue as a going concern. FMG’s auditor has issued a going concern opinion, in part as a result of its credit facility having a maturity date of less than one year. While management believes that the merger offers the combined company a greater opportunity than either company individually would have to improve its financial position, for the reasons discussed under the heading “Risk Factors,” there can be no assurance that management will be able to integrate the two companies or that the anticipated benefits of the merger will be realized. If the Company and FMG fail to integrate the companies, achieve its business plan, realize some or all of the anticipated revenue opportunities or cost savings and other benefits of the merger, or if the costs of the merger or the integration of the companies exceeds what is anticipated, its working capital and financial condition will be materially negatively impacted.

At the closing of the merger, as required by the merger agreement with FMG, the Company must obtain a new credit facility. The Company has received proposals from lenders for a secured revolving credit facility of up to $65 million to be used to repay certain existing indebtedness of FMG and the Company, to pay certain merger transaction expenses and for future working capital of the combined company. The exact amount of the revolving loan will be based upon lending formulas and subject to sub-limits. While the Company has received these proposals, there can be no assurance that the loan, or any other acceptable credit facility, will be available prior to the merger.

Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

On February 5, 2003, the Company appointed BDO Seidman, LLP (“BDO”) as its new independent accountants for the fiscal year ended March 31, 2003, replacing the firm of Deloitte & Touche, LLP (“Deloitte”), which served as the Company’s independent accountants for the fiscal years ended March 31, 2002, 2001 and 2000. During the two most recent fiscal years and any subsequent interim period prior to engaging BDO, the Company did not consult with BDO 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 the Company’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 appointment of BDO was approved by the Audit Committee and the Company’s Board of Directors.

The reports of Deloitte on the Company’s financial statements for the fiscal year ended March 31, 2002 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 the fiscal year ended March 31, 2002 and through the subsequent period ending on February 5, 2003, there were no disagreements with Deloitte on matters of accounting principle or practice, financial statement disclosure, or audit scope or procedure which, if not resolved to Deloitte’s satisfaction, would have caused Deloitte to refer to the subject matter of the disagreements in their report. In addition, during the fiscal year ended March 31, 2002, there have been no reportable events (as defined in Item 304(a)(1)(v) of Regulation S-K), except as follows:

As previously reported, the Company’s Board of Directors, in consultation with Deloitte, determined that a restatement of the Company’s consolidated financial statements for the

75

years ended March 31, 2002 and 2001 and the quarter ended June 30, 2002 was required to appropriately account for a warrant issued to a director and non-employee on January 23, 2000. The Company has filed the amended Form 10-KSB for its fiscal year ended March 31, 2002, and the amended Form 10-Q for its quarter ended June 30, 2002.

On February 27, 2003, the Company authorized Deloitte to respond fully to the inquiries of BDO concerning this matter.

A letter from Deloitte was addressed to the Securities and Exchange Commission and was attached as an exhibit to the Company’s Form 8-K/A, dated February 27, 2003.

Item 9A.  CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in its 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 its Chief Executive Officer and its Chief Financial Officer/Principal Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

In connection with the completion of its audit of, and the issuance of an unqualified report on, the Company’s consolidated financial statements for the fiscal year ended March 31, 2004, the Company’s independent auditors, BDO Seidman, LLP (“BDO”), communicated to the Company’s Audit Committee that the following matters involving the Company’s 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 analyses and reconciliations including lack of timely management review, which contributed to fourth quarter adjustments relating to inventories, accounts receivable and accounts payable; and

• the Company’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 the Company’s ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. In addition, BDO has advised the Company that they consider these matters, which are listed above, to be “material weaknesses” that, by themselves or in combination, result in a more than remote likelihood that a material misstatement in our financial statements will not be prevented or detected by our employees in the normal course of performing their assigned functions.

As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of March 31, 2004. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer determined that deficiencies identified by BDO caused the Company’s disclosure controls and procedures not to be effective at a reasonable assurance level. However, the CEO and CFO noted that the Company is actively seeking to remedy the deficiencies identified herein and did not note any other material weaknesses or significant

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deficiencies in the Company’s disclosure controls and procedures during their evaluation. The Company continues to improve and refine its internal controls. This process is ongoing, and includes the following:

1. The Company decided to convert its operating divisions to new accounting software and an integrated networked computerized system linking all divisions, which will roll up financial information on a real-time basis. The implementation of that process began during the fourth quarter of 2004 and is expected to be completed during the second quarter of 2005. The Company believes this conversion will provide more timely operating information, a more efficient system of checks and balances to assure accurate reporting of detailed transactions, and more efficient month-end closing procedures to provide a comprehensive internal review before financial information is considered final. The Company’s accounts payable detailed ledger at Valley is not fully integrated to the general ledger system, which has caused large amounts of reconciling items. Management believes this issue will be significantly improved with the conversion to the new integrated accounting system. As a result of the efficiencies of the new system, the Company’s controllers will have appropriate time to better analyze cutoff and other detailed transactions in order to assure the proper processing of its accounts payable and other accounting functions.

2. The Company has reorganized its credit and collection functions and previously hired a Vice President of Asset Management to assist in the granting of credit to customers or potential customers. In addition, in the first week of July 2004, the Company hired a credit manager, who will report directly to the Vice President of Asset Management and who will be responsible for daily management of the credit function. Recently, more independent pharmacies, which are a significant part of the Company’s core business, have incurred financial difficulties, as indicated by the number of recent bankruptcies by such pharmacies. As a result, the Company’s credit policy is being reviewed and restructured.

3. The Company improved its control over morgue inventory (inventory to be returned to vendors) during the fourth quarter of 2004 in connection with the relocation of Valley to its new warehouse facility. In the future the Company will be taking frequent physical inventory counts to properly record quantities in the morgue inventory at Valley. In addition, the Company intends to hire a full-time warehouse clerk assigned to manage the movement of the morgue inventory.

4. Management continues to evaluate the number of personnel involved in the accounting and finance function of the Company. Due to the acquisitions made by the Company over the past three years and pressures on operations resulting from competition, shrinking margins and regulatory matters, management is reassessing its existing personnel and resources to address its internal control and operational requirements. This is an ongoing process.

Other than for the matters discussed above, the Company’s Chief Executive Officer and Chief Financial Officer/Principal Accounting Officer have determined that the Company’s internal controls and procedures were effective as of the end of the period covered by this report. Other than the improvements discussed above, in the fourth quarter of fiscal 2004, there were no significant changes in the Company’s internal control over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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PART III

Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information required by this Item is incorporated herein by reference to the information under the headings “Management—Directors and Executive Officers” in the Company’s definitive Proxy Statement to be used in connection with the Company’s Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2004.

Item 11.  EXECUTIVE COMPENSATION.

The information required by this Item is incorporated herein by reference to the information under the headings “Management—Compensation of Executive Officers and Directors” in the Company’s definitive Proxy Statement to be used in connection with the Company’s Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2004.

Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information required by this Item is incorporated herein by reference to the information under the headings “Management—Security Ownership of Management and Others” in the Company’s definitive Proxy Statement to be used in connection with the Company’s Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2004.

Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information required by this Item is incorporated herein by reference to the information under the headings “Certain Relationships and Related Transactions” in the Company’s definitive Proxy Statement to be used in connection with the Company’s Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2004.

Item 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES.

The information required by this Item is incorporated herein by reference to the information under the heading “Principal Account Fees and Services” in the Company’s definitive Proxy Statement to be used in connection with the Company’s Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2004.

PART IV

Item 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K

(a) Documents filed as part of this report:

1. Financial Statements and Reports of BDO Seidman, LLP and Deloitte & Touche, LLP

The financial statements included in Part II, Item I of this Annual Report on Form 10-K are filed as part of this Report.

2. Financial Statement Schedule.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

DrugMax, Inc

Clearwater, FL

The audits referred to in our report dated June 18, 2004, except for Note 9, which is as of June 30, 2004, relating to the 2004 and 2003 consolidated financial statements of DrugMax, Inc, which is contained in Item 8 of this Form 10-K included the audits of the financial statement schedule listed in Item 15. This financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this financial statement schedule based upon our audits.

In our opinion such 2004 and 2003 financial statement schedule presents fairly, in all material respects, the information set forth therein.

/s/ BDO Seidman, LLP

Miami, FL

June 18, 2004, except for Note 9,

which is as of June 30, 2004

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of DrugMax, Inc.:

We have audited the consolidated financial statements of DrugMax, Inc. (the “Company”) for the year ended March 31, 2002, and have issued our report thereon dated June 27, 2002. Our audit also included the consolidated financial statement schedule of DrugMax, Inc. listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audit. In our opinion, such 2002 consolidated 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.

/s/  DELOITTE & TOUCHE LLP

Certified Public Accountants

Tampa, Florida

June 27, 2002

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SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

THREE YEARS ENDED MARCH 31, 2004

DESCRIPTION	Balance at Beginning of Year		Additions Charged to Cost and Expenses			Other			Deductions		Balance at End of Year
Allowance for doubtful accounts receivable:
Year ended March 31,
2004	$	1,253,829	$	1,388,627		$	15,840	(A)	$	41,160	$	2,617,136
2003		340,575		1,114,539			(50,000	)(B)		151,285		1,253,829
2002		381,944		35,757			62,750	(C)		139,876		340,575
Allowances for doubtful notes and other receivables:
Year ended March 31,
2004	$	102,000	$	797,594		$	-		$	-	$	899,594
2003		102,000		-			-					102,000
2002		-		165,000			-			63,000		102,000
Valuation allowance on deferred tax assets:
Year ended March 31,
2004	$	580,100	$	3,928,055	(D)	$	-		$	-	$	4,508,155
2003		-		580,100	(D)		-			-		580,100
2002		1,458,500		-			-			1,458,500		-

(A) Related to allowance previously included in the accounts receivable of Avery at acquisition.

(B) Provision for other receivable included in bad debt expense.

(C) Recovery of debt previously written off.

(D) Increase in amount of deferred income tax asset for which realization is not considered more likely than not.

3. Exhibits

2.1	Agreement and Plan of Merger by and between NuMed Surgical, Inc. and Nutriceuticals.com Corporation, dated as of January 15, 1999. (1)
2.2	Agreement and Plan of Reorganization dated September 8, 1999 by and between Nutriceuticals.com Corporation and Dynamic Health Products, Inc. (2)
2.3	Agreement and Plan of Reorganization between DrugMax, Inc., Jimmy L. Fagala, K. Sterling Miller, and HCT Capital Corp. dated as of March 20, 2000. (3)
2.4	Stock Purchase Agreement between DrugMax, Inc. and W.A. Butler Company dated as of March 20, 2000. (3)
2.5	Merger Agreement between DrugMax, Inc., DrugMax Acquisition Corporation, and Valley Drug Company, Ronald J. Patrick and Ralph A. Blundo dated as of April 19, 2000. (4)
2.6	Agreement for Purchase and Sale of Assets by and between Discount Rx, Inc., and Penner & Welsch, Inc., dated October 12, 2001. (11)

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2.7	Agreement and Plan of Merger between DrugMax, Inc. and Familymeds Group, Inc. dated March 19, 2004, as amended. *
2.8	First Amendment to Agreement and plan of Merger between DrugMax, Inc. and Family Meds Group, Inc., dated July 1, 2004.*
3.1	Restated Articles of Incorporation of DrugMax, Inc. filed September 5, 2001. (18)
3.7	Amended and Restated Bylaws, dated November 11, 1999. (5)
4.2	Specimen of Stock Certificate. (8)
10.1	Employment Agreement by and between DrugMax, Inc. and William L. LaGamba dated April 1, 2003. (16)
10.2	Employment Agreement by and between DrugMax, Inc. and Ronald J. Patrick dated April 1, 2003 (16)
10.3	Employment Agreement by and between DrugMax, Inc. and Jugal K. Taneja, dated April 1, 2003. (16)
10.4	DrugMax.com, Inc. 1999 Incentive and Non-Statutory Stock Option Plan. (8)
10.5	Amendment No. 1 to DrugMax, Inc. 1999 Incentive and Non-Statutory Stock Option Plan, dated June 5, 2002. (14)
10.6	Loan and Security Agreement by an between Congress Financial Corporation and DrugMax, Inc., Valley Drug Company, Valley Drug Company South and Discount Rx, Inc., dated April 15, 2003. (15)
10.7	DrugMax, Inc. 2003 Restricted Stock Plan dated August 27, 2003. (17)
10.8	First Amendment to the Loan and Security Agreement by and between Congress Financial Corporation and DrugMax, Inc., together with its subsidiaries, Valley Drug Company, Valley Drug Company South, and Discount Rx, Inc., dated August 19, 2003. *
10.9	Second Amendment to the Loan and Security Agreement by and between Congress Financial Corporation and DrugMax, Inc., together with its subsidiaries, Valley Drug Company, Valley Drug Company South, and Discount Rx, Inc., dated March 31, 2004. *
21.0	Subsidiaries of DrugMax, Inc. (18)
23.1	Consent of BDO Seidman, LLP*
23.2	Consent of Deloitte & Touche, LLP*
31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
31.2	Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
32.1	Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
32.2	Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

* Filed herewith.

(1) Incorporated by reference to the Company’s Registration Statement on Form SB-2, filed June 29, 1999, File Number 0-24362, as amended.

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(2) Incorporated by reference to Amendment No. 1 to the Company’s Registration Statement on Form SB-2, filed on September 13, 1999, File No. 0-24362.

(3) Incorporated by reference to the Company’s Report on Form 8-K, filed April 6, 2000, File Number 0-24362.

(4) Incorporated by reference to the Company’s Report on Form 8-K, filed May 3, 2000, File Number 0-24362.

(5) Incorporated by reference to Amendment No. 2 to the Company’s Registration Statement on Form SB-2, filed on November 12, 1999, File No. 0-24362.

(6) Incorporated by reference to the Company’s Report on Form 8-K, filed February 8, 2000, File No. 0-24362.

(7) Incorporated by reference to the Company’s Form 10-KSB, filed June 29, 2000, File No. 0-24362.

(8) Incorporated by reference to the Company’s Form 10-KSB/A, filed July 14, 2000, File No. 0-24362.

(9) Incorporated by reference to the Company’s Registration Statement on Form SB-2, filed on November 1, 2000.

(10) Incorporated by reference to the Company’s Form 10-QSB, filed November 14, 2000, File No. 1-15445.

(11) Incorporated by reference to the Company’s Report on Form 8-K, filed November 9, 2001.

(12) Incorporated by reference to the Company’s Form 10-QSB, filed November 14, 2001.

(13) Incorporated by reference to the Company’s Form 10-QSB, filed February 14, 2002.

(14) Incorporated by reference to the Company’s Form 10-KSB, filed July 1, 2002.

(15) Incorporated by reference to the Company’s Form 10-K, filed July 15, 2003.

(16) Incorporated by reference to the Company’s Form 10-K/A, filed July 29, 2003.

(17) Incorporated by reference to the Company’s Definitive Proxy Statement filed September 8, 2003.

(18) Incorporated by reference to the Company’s Form 10-Q, filed November 14, 2003.

(b) Reports on Form 8-K.

During the three months ended March 31, 2004, the Company filed the following reports on Form 8-K:

Form 8-K dated March 18, 2004, with respect to the Company’s press release to announce the Company’s private placement of Company stock.

Form 8-K dated March 22, 2004, with respect to the Company’s press release to announce the Merger Agreement with Familymeds Group, Inc.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	DRUGMAX, INC.
Dated:  July 13, 2004	By	/s/ Jugal K. Taneja                 Jugal K. Taneja, Chief Executive Officer and Chairman of the Board
Dated:  July 13, 2004	By	/s/ William L. LaGamba                 William L. LaGamba, President and Chief Operating Officer
Dated:  July 13, 2004	By	/s/ Ronald J. Patrick                 Ronald J. Patrick, Chief Financial Officer and Principal Accounting         Officer

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

Signatures	Title	Date
By: /s/ Jugal K. Taneja         Jugal K. Taneja	Chairman of the Board, Chief Executive Officer and Director	July 13, 2004
By: /s/ William L. LaGamba         William L. LaGamba	President, Chief Operating Officer and Director	July 13, 2004
By: /s/ Ronald J. Patrick         Ronald J. Patrick	Chief Financial Officer, Principal Accounting Officer and Director	July 13, 2004
By: /s/ Dr. Howard L. Howell, DDS         Dr. Howard L. Howell, DDS	Director	July 13, 2004
By: /s/ Robert G. Loughrey         Robert G. Loughrey	Director	July 13, 2004
By: /s/ Martin Sperber         Martin Sperber	Director	July 13, 2004

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EX-2.7

AGREEMENT AND PLAN OF MERGER

BY AND BETWEEN

FAMILYMEDS GROUP, INC.

AND

DRUGMAX, INC.

Dated as of March 19, 2004

AGREEMENT AND PLAN OF MERGER

This AGREEMENT AND PLAN OF MERGER is made and entered into as of March 19, 2004 (this “Agreement”), by and among DrugMax, Inc., a Nevada corporation (the “Company”), Familymeds Group, Inc., a Connecticut Company (the “Acquired Corporation”), and, to the extent specifically provided herein, Jugal K. Taneja (“Mr. Taneja”), an individual with an address of 25400 US Highway 19 North, Suite 137, Clearwater, Florida 33763 and Edgardo A. Mercadante (“Mr. Mercadante”), an individual with an address of 312 Farmington Avenue, Farmington, Connecticut 06032.

WHEREAS, Acquired Corporation wishes to merge with and into the Company (the “Merger”) in accordance with the applicable provisions of the Connecticut Business Corporation Act (“CBCA”) and the Nevada Revised Statutes, Chapter 92A (“NRS”);

WHEREAS, for United States federal income tax purposes, it is intended that the Merger shall qualify as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended (the “Code”), and that this Agreement shall be, and is hereby, adopted as a plan of reorganization for purposes of Section 368(a) of the Code.

NOW, THEREFORE, in consideration of the foregoing and the respective representations, warranties, covenants and agreements set forth below, the parties hereto agree as follows:

ARTICLE I

THE MERGER

Section 1.1 THE MERGER. Subject to the terms and conditions of this Agreement, on the Effective Date (as defined in Section 1.2), Acquired Corporation shall merge with and into the Company in accordance with the CBCA and NRS, the separate corporate existence of Acquired Corporation shall cease, and the Company shall continue as the surviving corporation in the Merger. The Company, in its capacity as the corporation surviving the Merger, is hereinafter sometimes referred to as the “Surviving Corporation.” The name of the Surviving Corporation shall continue to be DrugMax, Inc.

Section 1.2 EFFECTIVE DATE. On the Effective Date (as defined below), the Acquired Corporation and the Company shall cause the Merger to be consummated by filing a duly executed and delivered certificate of merger as required by the CBCA and NRS (the “Certificate of Merger”) with the Secretaries of State of the states of Connecticut and Nevada, in such form as required by, and executed in accordance with the relevant provisions of, the CBCA and NRS. The later of the date and time that the Certificate of Merger is accepted by the Secretaries of State of the states of Connecticut and Nevada, or such other date and time as the Acquired Corporation and the Company shall specify in the Certificate of Merger, shall be hereinafter referred to as the “Effective Date.”

Section 1.3 EFFECT OF THE MERGER. On the Effective Date, the effect of the Merger shall be as provided in this Agreement and the Certificate of Merger and Section 92.250 of the NRS. In addition, on the Effective Date, all rights, franchises and interests of Acquired Corporation and the Company, respectively, in and to every type of property (real, personal and mixed) and choses in action shall be transferred to and vested in the Surviving Corporation by virtue of the Merger without any deed or other transfer.

Section 1.4 CERTIFICATE OF INCORPORATION. On and after the Effective Date, the Certificate of Incorporation of the Company (the “Company Charter”), in the form attached as Exhibit 1.4 hereto, shall be the Certificate of Incorporation of the Surviving Corporation, until amended in accordance with the NRS.

Section 1.5 BY-LAWS OF THE SURVIVING CORPORATION. On and after the Effective Date, the By-Laws of the Company (the “Company By-Laws”), in the form attached as Exhibit 1.5 hereto, shall be the By-Laws of the Surviving Corporation, until amended in accordance with the Certificate of Incorporation of the Surviving Corporation and the NRS.

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Section 1.6 DIRECTORS AND OFFICERS OF THE SURVIVING CORPORATION.

(a) Mr. Taneja, Mr. William LaGamba (“Mr. LaGamba”), Mr. Mercadante, Dr. Philip Gerbino, Martin Sperber, Peter Grua and Laura Witt shall be elected in connection with the Merger as the initial directors of the Surviving Corporation and shall hold office from the Effective Date until their respective successors are duly elected or appointed and qualified in the manner provided in the Certificate of Incorporation or By-Laws of the Surviving Corporation or as otherwise provided by law. Mr. Taneja and Mr. Mercadante shall be elected Co-Chairs of the Board of Directors.

(b) The initial officers (the “Officers”) of the Surviving Corporation elected in connection with the Merger shall be:

Mr. Mercadante	–	Chief Executive Officer
Mr. LaGamba	–	Chief Operating Officer and President
Dale Ribaudo	–	Chief Financial Officer and Senior Vice President, and Treasurer
Allison Kiene	–	Secretary

and the foregoing shall hold office while employed by the Surviving Corporation from the Effective Date until their respective successors are duly elected or appointed and qualified in the manner provided in the Certificate of Incorporation or By-Laws of the Surviving Corporation or as otherwise provided by law.

Section 1.7 CLOSING. Subject to the provisions of this Agreement, the closing of the Merger (the “Closing”) shall take place at 10:00 a.m. Eastern Time, at the offices of Shumaker, Loop & Kendrick, LLP, on a date to be specified by Acquired Corporation and the Company which shall be no later than the fifth business day after satisfaction or waiver of each of the conditions set forth in Article VII (other than the delivery of items to be delivered at Closing and other than those conditions that by their nature are to be satisfied at the Closing, it being understood that the occurrence of the Closing shall remain subject to the delivery of such items and the satisfaction or waiver of such conditions at the Closing) or on such other date and such other time and place as Acquired Corporation and the Company shall agree.

Section 1.8 TAKING OF NECESSARY ACTION; FURTHER ACTION. Each of Acquired Corporation and the Company shall take all such reasonable and lawful action as may be necessary or appropriate in order to effectuate the Merger in accordance with this Agreement as promptly as possible. If, at any time after the Effective Date, any such further action is necessary or desirable to carry out the purposes of this Agreement and to vest the Surviving Corporation with full right, title and possession to all assets, property, rights, privileges, powers and franchises of the Company or Acquired Corporation, the officers and directors of the Company and Acquired Corporation immediately prior to the Effective Date are fully authorized in the name of their respective corporations or otherwise to take, and shall take, all such lawful and necessary action.

Section 1.9 MATERIAL ADVERSE EFFECT.

(a) The term “Company Material Adverse Effect” means any change, effect or circumstance that, individually or when taken together with all other such similar or related changes, effects or circumstances that have occurred prior to the date of determination of the occurrence of the Company Material Adverse Effect, (i) is materially adverse to the business, assets (including intangible assets), liabilities, capitalization, financial condition or results of operations of the Company and its Subsidiaries, taken as a whole, or (ii) materially adversely affects the ability of the Company to consummate the transactions contemplated hereby; PROVIDED, HOWEVER, that no change, effect or circumstance to the extent resulting from any of the following shall be deemed to constitute, in and of itself, a Company Material Adverse Effect, nor shall it be taken into consideration when determining whether there has occurred a Company Material Adverse Effect: (A) general market, economic or political conditions affecting the industries in which the Company participates, provided that such change, effect or circumstance does not have a substantially disproportionate adverse impact on the Company and its Subsidiaries, taken as a whole; (B) compliance

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with the terms and conditions of this Agreement, the transactions contemplated by this Agreement or the pendency or announcement of this Agreement or the transactions contemplated by this Agreement; (C) any litigation brought or threatened by stockholders of the Company (whether on behalf of the Company or otherwise) arising out of or in connection with the announcement of this Agreement or the consummation of the Merger; (D) any decrease in the market price or trading volume of the Company’s publicly traded common stock; (E) the Company’s failure to meet published industry analyst expectations; or (F) any change in applicable accounting requirements or principles, or applicable laws, rules or regulations which occurs or becomes effective after the date of this Agreement.

(b) The term “Acquired Corporation Material Adverse Effect” means any change, effect or circumstance that, individually or when taken together with all other such similar or related changes, effects or circumstances that have occurred prior to the date of determination of the occurrence of the Acquired Corporation Material Adverse Effect, (i) is materially adverse to the business, assets (including intangible assets), liabilities, capitalization, financial condition or results of operations of the Acquired Corporation and its Subsidiaries, taken as a whole, or (ii) materially adversely affects the ability of the Acquired Corporation to consummate the transactions contemplated hereby; PROVIDED, HOWEVER, that no change, effect or circumstance to the extent resulting from any of the following shall be deemed to constitute, in and of itself, an Acquired Corporation Material Adverse Effect, nor shall it be taken into consideration when determining whether there has occurred an Acquired Corporation Material Adverse Effect: (A) general market, economic or political conditions affecting the industries in which the Acquired Corporation participates, provided that such change, effect or circumstance does not have a substantially disproportionate adverse impact on the Acquired Corporation and its Subsidiaries, taken as a whole; (B) compliance with the terms and conditions of this Agreement, the transactions contemplated by this Agreement or the pendency or announcement of this Agreement or the transactions contemplated by this Agreement; (C) any litigation brought or threatened by stockholders of the Acquired Corporation (whether on behalf of the Acquired Corporation or otherwise) arising out of or in connection with the announcement of this Agreement or the consummation of the Merger; (D) the Company’s failure to meet published industry analyst expectations; or (E) any change in applicable accounting requirements or principles, or applicable laws, rules or regulations which occurs or becomes effective after the date of this Agreement.

ARTICLE II

CONVERSION AND EXCHANGE OF SECURITIES

Assuming that immediately prior to the Effective Date 8,185,642 shares of the common stock, par value $.001 per share, of the Company (“Company Common Stock”) are issued and outstanding, then, upon the consummation of the Merger, the stockholders of the Company immediately prior to the Merger (assuming that none of those stockholders dissent from the Merger) shall own approximately 38%, and the stockholders of the Acquired Corporation (assuming that none of those stockholders dissent from the Merger) (the “Acquired Corporation Stockholders”) and the Employees (as defined below) shall jointly own approximately 62%, of the 21,530,405 shares of Company Common Stock to be issued and outstanding immediately after the Merger, assuming the vesting and exercise of all Management Stock and Options (as defined below), which ownership structure shall be effected as follows:

Section 2.1 CONVERSION OF CAPITAL STOCK.

(a) Company Common Stock. The shares of Company Common Stock issued and outstanding immediately before the Effective Date shall continue to be issued and outstanding shares of the Surviving Corporation after the Effective Date.

(b) Acquired Corporation Stock. On the Effective Date, each share of Acquired Corporation Stock (as defined below) and each Series E Warrant outstanding and held of record by the Acquired Corporation

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Stockholders shall be converted by operation of law and without any action by any holder thereof into the right to receive (i) shares of Company Common Stock in the amounts and pursuant to the ratios set forth in Exhibit 2.1(b), which exhibit is to be delivered and updated by the Acquired Corporation on or prior to the Closing Date and attached hereto and made a part hereof (the “Stock Consideration”), and (ii) a Warrant (as defined below) to purchase Company Common Stock in the amounts set forth in Exhibit 2.1(c) and as further contemplated by Section 2.1(c) below. As set forth in Exhibit 2.1(b), the aggregate number of shares to be issued to the Acquired Corporation Stockholders pursuant to the foregoing sentence is 11,480,507. The various ratios set forth in Exhibit 2.1(b) that are used to calculate the Stock Consideration for each separate class of Acquired Corporation Stock are hereinafter referred to as the “Exchange Ratios.” The Warrants combined with the Stock Consideration are referred to as the “Merger Consideration.” All shares of Acquired Corporation Stock, when so converted, shall no longer be outstanding and shall automatically be cancelled and retired and shall cease to exist, and each holder of a certificate representing any such shares shall cease to have any rights with respect thereto, except the right to receive holder’s respective portion of the Merger Consideration pursuant to this Section 2.1. As set forth in Exhibit 2.1(b), on the Effective Date, all notes issued by Acquired Corporation to its stockholders, including the holders of its 12% Convertible Subordinated Promissory Notes dated January 21, 2003, shall be canceled by allocating a portion of the Merger Consideration to such stockholders in full satisfaction of such notes.

(c) Warrants. At the Closing, the number of shares of Company Common Stock subject to outstanding options and warrants with an exercise price below the ten-day weighted average (as calculated below) of the Company Common Stock (collectively, whether options or warrants, the “in the Money Options”), and the average exercise price (the “Average Exercise Price”) and average remaining duration (the “Average Remaining Duration”) of the in the Money Options, shall be ascertained. On the Effective Date, the Company shall issue to the Acquired Corporation Stockholders, as part of the Merger consideration, warrants, in the form attached hereto as Exhibit 2.1(d) (the “Warrants”), to purchase, at the Average Exercise Price and with the Average Remaining Duration, a total of twice the number of shares as the holders of the in the Money Options are entitled to purchase pursuant to the in the Money Options. The total number of Warrants shall be allocated amongst the Acquired Corporation Stockholders as set forth in Exhibit 2.1(c). For the purposes of this Section 2.1(c), the ten-day weighted average shall be determined by (i) multiplying the closing bid price for the Company Common Stock, as reported by the Nasdaq, for each of the ten trading days immediately prior to the Effective Date by the volume of shares traded during the corresponding day, (ii) adding the result of each such daily calculation, (iii) dividing such sum by ten (10) and (iv) dividing such quotient by the average daily number of shares traded during such ten-day period. It is understood that the Warrants are being issued as a form of one-time anti-dilution protection for the recipients of the Stock Consideration and that no further or additional pre-emptive or anti-dilution rights attach to the Stock Consideration or the Warrants.

(d) Acquired Corporation Options. Any and all options, warrants or other rights to purchase any shares of Acquired Corporation Stock shall immediately terminate on the Effective Date and shall not be converted into the right to purchase Company Common Stock. On or before the Closing, the Acquired Corporation shall use its best efforts to deliver to the Company, in a form reasonably acceptable to the Company, written evidence executed by the holders of any such options, warrants or other rights to purchase Acquired Corporation Stock terminating such options, warrants and rights and agreeing to hold the Company harmless with respect thereto; provided, however, that the Acquired Corporation shall not be required to terminate prior to the Effective Date options to purchase an aggregate of no more than 50,000 shares of Acquired Corporation Common Stock held by employees other than the executive officers or directors of Acquired Corporation if the Acquired Corporation is unable to obtain such remaining terminations prior to the Effective Date. Edgardo A. Mercadante, Dale Ribaudo and James Beaumariage, on a pro rata basis on behalf of the Acquired Corporation, agree to deliver to the Company 50,000 shares of the Company’s Common Stock held by them to satisfy any claims that might arise from former holders of options, warrants or other rights to purchase Acquired Corporation Stock which were not terminated prior to the Effective Date.

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Section 2.2 EMPLOYEE SHARES. On the Effective Date, the Company shall enter into employment agreements and/or stock option agreements with the employees listed on Exhibit 2.2 (the “Employees”) upon terms acceptable to such employees and the independent directors of the Company, and, in connection therewith and pursuant to the terms of their respective employment agreements and/or stock option agreements, the Company shall issue a combination of restricted stock and employee stock options to such Employees in the amounts and as set forth in Exhibit 2.2 (collectively, the “Management Shares and Options”). Such options and restricted stock shall entitle the Employees to a total of 1,864,256 shares of Company Common Stock assuming the vesting and exercise of all of the Management Shares and Options. All of the options to be granted pursuant hereto shall be subject to the terms of stock option agreements acceptable to the Company’s independent directors; provided, however, that the exercise price of the vested options to be issued in accordance with Exhibit 2.2 shall be the lower of fair market value on the date of issuance or Three Dollars and Fifty Cents ($3.50) per share; provided, further, that in the event that the issuance of the Management Shares and Options shall result as of the Effective Date in an expense to the Company in excess of Three Million Five Hundred Thousand and No/100 Dollars ($3,500,000.00), the exercise price of the vested options to be issued to the Employees shall be adjusted to fair market value pro rata to the extent necessary to eliminate such excess. Promptly after the Effective Date, Surviving Corporation shall amend its existing Form S-8 registration statement, as previously filed with the United States Securities and Exchange Commission (the “SEC”), as necessary to register the issuance of the shares of Company Common Stock to be issued pursuant to such options and shall use its reasonable best efforts to maintain the effectiveness of such registration statement for so long as such options remain outstanding.

Section 2.3 REGISTRATION. Neither the shares of Company Common Stock to be issued to the Acquired Corporation Stockholders nor the Management Shares and Options shall at Closing be registered with the SEC. However, the Company shall register the shares of Company Common Stock to be issued to the Acquired Corporation Stockholders pursuant to the terms of the Registration Rights and Lockup Agreement attached hereto as Exhibit 2.3 (the “Lock Up Agreement”).

Section 2.4 EFFECT OF POSSIBLE TRANSACTION. In the event that the Company, prior to the Effective Date, issues any Company Common Stock to any third party in a transaction approved by the boards of directors of the Company and Acquired Corporation, in accordance with state and federal securities laws, the parties agree that the number of shares to be issued to the Acquired Corporation Stockholders, the Management Shares and Options and the Exchange Ratios shall not be adjusted, but that instead the Acquired Corporation Stockholders and the Employees shall continue to receive the same number of shares, restricted stock and options that they would have been entitled to receive had the sales of stock not taken place.

Section 2.5 FRACTIONAL SHARES. No fractional shares of Company Common Stock shall be issued as part of the Stock Consideration, and each holder of shares of Acquired Corporation Stock having a fractional interest arising upon the conversion of such shares into shares of Company Common Stock shall, at the time of surrender of the certificates previously representing Acquired Corporation Stock, be paid by the Company an amount in cash equal to the market value of such fractional share based upon the closing bid price of the Company Common Stock on the last trading day immediately prior to the Effective Date.

Section 2.6 ADJUSTMENTS. In the event that prior to the Effective Date Company Common Stock shall be changed into a different number of shares or a different class of shares by reason of any recapitalization or reclassification, stock dividend, combination, stock split, or reverse stock split of the Company Common Stock, an appropriate and proportionate adjustment shall be made in the number of shares of Company Common Stock and Warrants into which the Acquired Corporation Stock shall be converted.

Section 2.7. SURRENDER OF ACQUIRED CORPORATION STOCK. After the Effective Date, each holder of an outstanding certificate or certificates which prior thereto represented shares of Acquired Corporation Stock, Series E Warrants and 12% Convertible Subordinated Promissory Notes dated January 21, 2003, who is entitled to receive the Merger Consideration shall be entitled, upon surrender to the Company of their certificate

5

or certificates representing such Acquired Corporation securities (or an affidavit or affirmation by such holder of the loss, theft, or destruction of such certificate or certificates in such form as the Company may reasonably require and, if the Company reasonably requires, a bond of indemnity in form and amount, and issued by such sureties, as the Company may reasonably require), to receive in exchange therefore the Merger Consideration, with the Stock Consideration being in the form of a certificate or certificates representing the number of whole shares of Company Common Stock into and for which the shares of Acquired Corporation Stock or other Acquired Corporation securities so surrendered shall have been converted, and the Warrant being in the form attached hereto as Exhibit 2.1(d), such certificates to be of such denominations and registered in such names as such holder may reasonably request. Until so surrendered and exchanged, each such outstanding certificate which, prior to the Effective Date, represented shares of Acquired Corporation Stock or other Acquired Corporation securities and which is to be converted into the Merger Consideration shall for all purposes evidence the right to receive the Merger Consideration into and for which such shares shall have been so converted, except that no dividends or other distributions with respect to such Company Common Stock shall be made until the certificates previously representing shares of Acquired Corporation Stock or other Acquired Corporation securities shall have been properly tendered. Once so surrendered and exchanged, the Company shall cause its transfer agent to promptly issue the certificates to which the shareholders are entitled.

Section 2.8 DISSENTING SHARES.

(a) Anything in this Agreement to the contrary notwithstanding, the holders of shares of Company Common Stock which are issued and outstanding immediately prior to the Effective Date and which are held by shareholders of the Company who have the right to dissent with respect to the Merger pursuant to Section 92A.380 et. seq. of the NRS (“Dissenting Shares”) shall be entitled to receive payment of the fair value of such Dissenting Shares in accordance with the provisions of the NCA, unless and until such holders shall have failed to perfect or shall have effectively withdrawn or lost such right under the NCA. If any such holder of Dissenting Shares shall have failed to perfect or shall effectively withdrawn or lost such right, such holder’s shares of Company Common Stock shall thereupon be retained by such holder without interest thereon.

(b) Anything in this Agreement to the contrary notwithstanding, any shareholder of Acquired Corporation who shall not have voted in favor of this Agreement and who has complied with the applicable procedures set forth in the CBCA, relating to rights of dissenting shareholders, shall be entitled to receive payment for the fair value of his Acquired Corporation Stock. If after the Effective Date a dissenting shareholder of Acquired Corporation fails to perfect, or effectively withdraws or loses his right to appraisal and payment for his shares of Acquired Corporation Stock, the Company shall issue and deliver the Merger Consideration to which such holder of shares of Acquired Corporation Stock is entitled under Section 2.1 (without interest) upon surrender by such holder of the certificate or certificates representing shares of Acquired Corporation Stock held by him or her.

ARTICLE III

REPRESENTATIONS AND WARRANTIES

The Company represents and warrants to Acquired Corporation that, except as set forth in the written disclosure schedule prepared by the Company which is dated as of the date of this Agreement and arranged in sections corresponding to the numbered and lettered sections contained in this Article III and was previously delivered to Acquired Corporation in connection herewith (the “Disclosure Schedule”) (disclosure in any section of the Disclosure Schedule qualifying the corresponding section in this Article III and other sections of this Article III to the extent such disclosure reasonably appears to be applicable to such sections):

Section 3.1 ORGANIZATION AND QUALIFICATION; SUBSIDIARIES. Each of the Company and each of its Subsidiaries is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has the requisite corporate power and authority necessary to own, lease and operate the properties it purports to own, lease or operate and to carry on its business as it is now being conducted or presently proposed to be conducted. Each of the Company and each of its Subsidiaries is duly

6

qualified or licensed as a foreign corporation to do business, and is in good standing, in each jurisdiction where the character of the properties owned, leased or operated by it or the nature of its activities makes such qualification or licensing necessary, except for such failures to be so duly qualified or licensed and in good standing that could not reasonably be expected to have a Company Material Adverse Effect. A true, complete and correct list of all of the Company’s Subsidiaries, together with the jurisdiction of incorporation of each Subsidiary, the authorized capitalization of each Subsidiary, and the percentage of each Subsidiary’s outstanding capital stock owned by the Company or another Subsidiary or affiliate of the Company (excluding nominal qualifying directors’ share ownership information relating to the Company’s Subsidiaries), is set forth in Section 3.1 of the Disclosure Schedule. Except as set forth in such Section 3.1 of the Disclosure Schedule, the Company directly or indirectly owns one hundred percent (100%) of the capital stock of each Subsidiary. The Company does not directly or indirectly own any equity or similar interest in, or any interest convertible into or exchangeable or exercisable for any equity or similar interest in, any corporation, partnership, limited liability company, joint venture or other business association or entity, other than a Subsidiary disclosed in such Section 3.1, excluding securities in any publicly traded company held for investment by the Company and comprising less than one percent of the outstanding stock of such company.

Section 3.2 CERTIFICATE OF INCORPORATION AND BY-LAWS. The Company has heretofore made available to Acquired Corporation a true, complete and correct copy of its Amended and Restated Certificate of Incorporation, as amended to date (the “Company Charter”), and Amended and Restated By-Laws, as amended to date (the “Company By-Laws”), and has furnished to Acquired Corporation true, complete and correct copies of the charter and By-Laws (or equivalent organizational documents), each as amended to date, of each of its Subsidiaries (the “Subsidiary Documents”). The Company Charter, Company By-Laws and the Subsidiary Documents are in full force and effect. The Company is not in violation of any of the provisions of the Company Charter or Company By-Laws and the Company’s Subsidiaries are not in violation of any of the provisions of their respective Subsidiary Documents.

Section 3.3 CAPITALIZATION.

(a) The authorized capital stock of the Company consists of 24,000,000 shares of Company Common Stock and 2,000,000 shares of preferred stock. As of March 17, 2004, (i) 8,185,642 shares of Company Common Stock are issued and outstanding; (ii) 2,083,901 shares of Company Common Stock are reserved for issuance upon exercise of options and warrants; (iii) no shares of Company Common Stock are issued and held in the treasury of the Company; and (iv) no shares of preferred stock are or have been issued or outstanding nor have the rights of such preferred stock been defined nor has the issuance of such preferred stock ever been authorized. The aggregate number of shares of Company Common Stock subject to Company Stock Options as defined in subsection (b) below is 1,933,901. The aggregate number of shares of Company Common Stock subject to warrants or other rights as described in subsection (c) below is 150,000.

(b) Section 3.3(b) of the Disclosure Schedule sets forth a true, complete and correct list of all persons who, as of the date hereof held outstanding options to purchase shares of Company Common Stock (the “Company Stock Options”), indicating, with respect to each Company Stock Option then outstanding, the number of shares of Company Common Stock subject to such Company Stock Option, the relationship of the holder of such Company Stock Option to the Company, and the exercise price, date of grant, vesting schedule and expiration date thereof, including the extent to which any vesting had occurred as of the date of this Agreement and whether (and to what extent) the vesting of such Company Stock Option will be accelerated in any way by the consummation of the transactions contemplated by this Agreement or by the termination of employment or engagement or change in position of any holder thereof following or in connection with the consummation of the Merger. The Company has made available to Acquired Corporation true, complete and correct copies of all Company Stock Option plans (the “Company Stock Plans”) and the forms of all stock option agreements evidencing outstanding Company Stock Options. No consent of any holder of Company Stock Options is required in connection with this Agreement or the Merger.

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(c) Except as described in Section 3.3(a) of this Agreement or as set forth in Section 3.3(b) of the Disclosure Schedule, no capital stock of the Company or any of its Subsidiaries or any security convertible or exchangeable into or exercisable for such capital stock, is issued, reserved for issuance or outstanding as of the date of this Agreement. Except as described in Section 3.3(a) of this Agreement or as set forth in Section 3.3(b) of the Disclosure Schedule, there are no options, preemptive rights, warrants, calls, rights, commitments, agreements, arrangements or understandings of any kind to which the Company or any of its Subsidiaries is a party, or by which the Company or any of its Subsidiaries is bound, obligating the Company or any of its Subsidiaries to issue, deliver or sell, or cause to be issued, delivered or sold, additional shares of capital stock of the Company or any of its Subsidiaries or obligating the Company or any of its Subsidiaries to grant, extend or accelerate the vesting of or enter into any such option, warrant, call, right, commitment, agreement, arrangement or understanding. Except as set forth in Section 3.3(c) of the Disclosure Schedule, there are no stockholder agreements, voting trusts, proxies or other similar agreements, arrangements or understandings to which the Company or any of its Subsidiaries is a party, or by which it or they are bound, obligating the Company or any of its Subsidiaries with respect to any shares of capital stock of the Company or any of its Subsidiaries. There are no rights or obligations, contingent or otherwise (including rights of first refusal in favor of the Company), of the Company or any of its Subsidiaries, to repurchase, redeem or otherwise acquire any shares of capital stock of the Company or any of its Subsidiaries or to provide funds to or make any investment (in the form of a loan, capital contribution or otherwise) in any such Subsidiary or any other entity. There are no registration rights or other agreements, arrangements or understandings to which the Company or any of its Subsidiaries is a party, or by which it or they are bound, obligating the Company or any of its Subsidiaries with respect to any shares of Company Common Stock or shares of capital stock of any such Subsidiary.

(d) All outstanding shares of the Company’s capital stock are, and all shares of Company Common Stock reserved for issuance as specified above shall be, upon issuance on the terms and conditions specified in the instruments pursuant to which they are issuable, duly authorized, validly issued, fully paid and nonassessable and not subject to or issued in violation of any purchase option, call option, right of first refusal, pre-emptive right, subscription right or any similar right under any provision of the NRS, the Company Charter or the Company By-Laws or any agreement to which the Company is a party or otherwise bound. None of the outstanding shares of the Company’s capital stock have been issued in violation of any federal or state securities laws. No material change in the Company’s capitalization has occurred since December 31, 2002. All of the outstanding shares of capital stock of each of the Company’s Subsidiaries are duly authorized, validly issued, fully paid and nonassessable, and all such shares (other than directors’ qualifying shares in the case of foreign Subsidiaries) are owned by the Company or a Subsidiary of the Company free and clear of all security interests, liens, claims, pledges, agreements, limitations in voting rights, charges or other encumbrances of any nature whatsoever (collectively, “Liens”). There are no accrued and unpaid dividends with respect to any outstanding shares of capital stock of the Company or any of its Subsidiaries.

(e) The Company Common Stock constitutes the only class of securities of the Company or its Subsidiaries registered or required to be registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Section 3.4 AUTHORITY RELATIVE TO THIS AGREEMENT. The Company has all necessary corporate power and authority to execute and deliver this Agreement and each instrument required hereby to be executed and delivered by it at the Closing and to perform its obligations hereunder and to consummate the transactions contemplated hereby. The execution and delivery by the Company of this Agreement and each instrument required hereby to be executed and delivered at the Closing by the Company and the consummation by the Company of the transactions contemplated hereby have been duly and validly authorized by all necessary corporate action on the part of the Company. This Agreement has been duly and validly executed and delivered by the Company and, assuming the due authorization, execution and delivery of this Agreement by Acquired Corporation, constitutes the legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms.

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Section 3.5 ANTI-TAKEOVER STATUTE NOT APPLICABLE. No “business combination,” “fair price,” “moratorium,” “control share acquisition” or other similar anti-takeover statute or regulation (each a “Takeover Statute”) under the laws of the State of Nevada or the State of Florida is applicable to the Company, the shares of Company Common Stock, the Merger or any of the other transactions contemplated by this Agreement.

Section 3.6 AGREEMENTS, CONTRACTS AND COMMITMENTS. Except as disclosed in Section 3.6 of the Disclosure Schedule:

(a) Other than leases listed in Section 3.15 of the Disclosure Schedule, neither the Company nor any of its Subsidiaries has any agreements, contracts or commitments which (i) require payment by the Company or any of its Subsidiaries in excess of $100,000 or (ii) require the making of any charitable contribution in excess of $50,000;

(b) No purchase contracts or purchase commitments of the Company or any of its Subsidiaries have a duration in excess of the normal, ordinary and usual requirements of the business of the Company or its Subsidiary, as applicable;

(c) There are no outstanding sales contracts or sales commitments of the Company or any of its Subsidiaries which have a duration in excess of the normal, ordinary and usual practices of the business of the Company, and there are no outstanding contracts, bids or sales or service proposals quoting prices or terms which would not reasonably be expected to result in a normal profit;

(d) Except for (i) nondisclosure agreements entered into in the ordinary course; (ii) agreements for the trial, evaluation, purchase, sale, license, distribution, maintenance or support of Company products entered into in the ordinary course; (iii) agreements which require payment by or to the Company or any of its Subsidiaries not in excess of $100,000; (iv) agreements which do not provide for any term extension or expansion of the rights granted with respect to the Intellectual Property owned by the Company as a result of the Merger; or (v) real property leases, licenses or other occupancy agreements (collectively, “Real Property Leases”) for individual properties listed in Section 3.15 of the Disclosure Schedule comprising less than 5,000 square feet, there are no contracts or agreements of the Company or any of its Subsidiaries which do not expire or which the Company may not terminate within one year after the date of this Agreement or which may be renewed at the option of any person other than the Company so as to expire more than one year after the date of this Agreement;

(e) Except for (i) nondisclosure agreements entered into in the ordinary course or (ii) agreements for the trial, evaluation, purchase, sale, license, distribution, maintenance or support of Company products entered into in the ordinary course, neither the Company nor any of its Subsidiaries has (A) any contracts or agreements with officers, employees, agents, consultants, advisors, salesmen, sales representatives, distributors or dealers which require payment by or to the Company or any of its Subsidiaries in excess of $100,000 and which are not cancelable by it on notice of not longer than thirty days and without liability, penalty or premium or (B) any contracts, agreements or arrangements providing for the payment of any bonus or commission based on sales or earnings, in each case where the cost to the Company will exceed $100,000;

(f) Neither the Company nor any of its Subsidiaries is in default, nor is there any known basis for any valid claim of default, under any contract made or obligation owed by it, except for such defaults that would not reasonably be likely to have, in the aggregate, a Company Material Adverse Effect;

(g) Neither the Company nor any of its Subsidiaries has any employee to whom it is paying compensation at the annual rate of more than $100,000;

(h) Neither the Company nor any of its Subsidiaries is restricted by agreement from carrying on its business in any material respect anywhere in the world by any agreement under which the Company (i) is restricted from selling, licensing or otherwise distributing any of its technology or products or providing services to customers or potential customers or any class of customers, including resellers or other distributors, in any geographic area, during any period of time, or in segment of any market or line of

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business; (ii) is required to give favored pricing to any customers or potential customers or any class of customers (that is, required to give pricing to such customers or potential customers or classes of customers that is at least as good or better to that offered to others) or to provide exclusive or favored access to any product features, excluding exclusive customizations, to any customers or potential customers or any class of customers (it being understood that agreements to provide updates, enhancements or new versions as they become available shall not be considered “favorable access,” nor shall agreements to provide alpha, beta or other similar restricted release versions of products); (iii) has agreed to purchase a material minimum amount of goods or services; or (iv) has agreed to purchase goods or services exclusively from a certain party;

(i) Neither the Company nor any of its Subsidiaries is under any liability or obligation with respect to the return of inventory or merchandise in the possession of wholesalers, distributors, resellers, retailers or other customers, except for such obligations or liabilities that would not reasonably be likely to have, in the aggregate, a Company Material Adverse Effect;

(j) Neither the Company nor any of its Subsidiaries has any debt obligation for borrowed money (other than capital leases), including guarantees of or agreements to acquire any such debt obligation of others (other than guarantees by the Company of obligations of its Subsidiaries);

(k) The Company and its Subsidiaries do not have contracts for capital expenditures exceeding $1,000,000 in the aggregate;

(l) Neither the Company nor any of its Subsidiaries has any contract, agreement or commitment currently in force relating to the disposition or acquisition of assets not in the ordinary course of business;

(m) Neither the Company nor any of its Subsidiaries has any contract, agreement or commitment for the purchase of any ownership interest in any corporation, partnership, joint venture or other business enterprise;

(n) Neither the Company nor any of its Subsidiaries has any outstanding loan (other than any loan for employee relocation or any loan not in excess of $50,000) to any person other than to the Company or a wholly owned Subsidiary of the Company in an amount that exceeds $50,000;

(o) Neither the Company nor any of its Subsidiaries has any power of attorney outstanding or any material obligations or liabilities (whether absolute, accrued, contingent or otherwise), as guarantor (other than guarantees by the Company of obligations of its Subsidiaries), surety, co-signer, endorser or co-maker in respect of any obligation of any person, corporation, partnership, joint venture, association, organization or other entity, or any capital maintenance, keep-well or similar agreements or arrangements;

(p) Neither the Company nor any of its Subsidiaries has any agreements, contracts or arrangements containing any provision requiring the Company to indemnify another party (excluding indemnities contained in agreements for the trial, evaluation, purchase, sale, distribution, maintenance, support or license of products entered into in the ordinary course of business consistent with past practice and in any Real Property Leases) or, other than in the case of settlement agreements entered into prior to the date of this Agreement with current or former officers or employees of the Company in their individual capacity, containing any covenant not to bring legal action against any third party;

(q) The Company has made available to Acquired Corporation true, complete and correct copies of each contract listed in Section 3.6 of the Disclosure Schedule (collectively, the “Material Contracts”); and

(r) (i) Neither the Company nor any of its Subsidiaries has breached, is in default under, or has received written notice of any breach of or default under, any Material Contract, which breach or default remains uncured, (ii) to the Company’s knowledge, no other party to any Material Contract has breached or is in default of any of its obligations thereunder, which breach or default remains uncured, (iii) each Material Contract is in full force and effect and (iv) each Material Contract is a legal, valid and binding obligation of the Company or its Subsidiary and each of the other parties thereto, enforceable in accordance with its terms.

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(s) Without limitation of any other provision of this Agreement, in connection with its acquisitions of or mergers with other companies in the five (5) years preceding the date hereof: the Company or a Subsidiary took title, by acquisition or merger, to the assets, and only to those defined liabilities, described in the acquisition or merger documentation and its title to the assets has not been challenged; no other party to any acquisition agreement or merger has claimed breach or indemnification; and each acquisition or merger agreement remains fully enforceable in accordance with its terms except for provisions not surviving such agreement by its terms or the effect of the statute of limitations.

(t) The Company’s agreements with River Road Real Estate LLC, Becan Development LLC, Advanced Pharmacy, Inc., Professional Pharmacy Solutions, LLC and all other agreements between the Company and any affiliate are on fair market value terms reflective of an arm’s-length transaction.

(u) There is no written agreement of the Company with Professional Pharmacy Solutions, LLC and its orders and those of Advanced Pharmacy, Inc. have been and will be handled in the ordinary course and will not be below market. There is no current agreement between the Company and Dynamic Health Products, Inc. or Innovative Companies, Inc.

Section 3.7 NO CONFLICT; REQUIRED FILINGS AND CONSENTS.

(a) The execution and delivery by the Company of this Agreement do not, the execution and delivery by the Company of any instrument required hereby to be executed and delivered by the Company at the Closing will not, and the performance of its agreements and obligations under this Agreement by the Company will not, (i) conflict with or violate the Company Charter or Company By-Laws or any Subsidiary Documents, (ii) conflict with or violate any law, rule, regulation, order, judgment or decree applicable to the Company or any of its Subsidiaries or by which its or any of their respective properties is bound or affected, (iii) conflict with, result in any breach of or constitute a default (or an event that with notice or lapse of time or both would become a default), or impair the Company’s or any of its Subsidiaries’ rights or alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, payment, acceleration or cancellation of, or result in the creation of a Lien on any of the properties or assets (including intangible assets) of the Company or any of its Subsidiaries pursuant to, any note, bond, mortgage, indenture, contract, agreement, lease, license, permit, franchise or other instrument or obligation to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries or its or any of their respective properties is bound or affected, or (iv) give rise to or result in any person having, or having the right to exercise, any pre-emptive rights, rights of first refusal, rights to acquire or similar rights with respect to any capital stock of the Company or any of its Subsidiaries or any of their respective assets or properties, other than, in the case of (iii) above, such breaches, defaults, impairments, rights of termination, amendment, acceleration or cancellation, or Liens that would not be reasonably expected to have, in the aggregate, a Company Material Adverse Effect.

(b) The execution and delivery by the Company of this Agreement do not, the execution and delivery by the Company of any instrument required hereby to be executed and delivered by the Company at the Closing will not, and the performance of its agreements and obligations under this Agreement by the Company will not, require any consent, approval, order, license, authorization, registration, declaration or permit of, or filing with or notification to, any court, arbitrational tribunal, administrative or regulatory agency or commission or other governmental authority or instrumentality (whether domestic or foreign, a “Governmental Entity”), except (i) as may be required by the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”), (ii) such consents, approvals, orders, licenses, authorizations, registrations, declarations, permits, filings, and notifications as may be required under applicable U.S. federal and state securities laws, (iii) the filing of the Certificate of Merger or other documents as required by the NRS and the CBCA, and (iv) such other consents, approvals, orders, registrations, declarations, permits, filings and notifications which, if not obtained or made, could not reasonably be expected to have a material adverse effect.

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Section 3.8 COMPLIANCE; PERMITS.

(a) (i) To the best of the Company’s knowledge, the Company and its Subsidiaries are and have been in material compliance with and are not in material default or violation of (and have not received any notice of material non-compliance, default or violation with respect to) any law, rule, regulation, order, judgment or decree applicable to the Company or any of its Subsidiaries or by which any of their respective properties is bound or affected (and the Company is not aware of any such material non-compliance, default or violation thereunder), including but not limited to: employment, labor, health and safety, including, but not limited to all United States Food and Drug Administration guidelines and OSHA regulations in connection with any oxygen filling stations, storage, distribution or sale by the Company or any Subsidiary, Medicare/Medicaid fraud and abuse and environmental laws.

(ii) To the best of the Company’s knowledge, the Company and its Subsidiaries are and have been in material compliance with all other laws, statutes, ordinances, orders, rules, regulations, policies and guidelines promulgated, and all judgments, decisions and orders entered, by any Federal, state, local or foreign court or governmental authority or instrumentality which are applicable or relate to the business or properties of the Company or any Subsidiary, including, without limitation, health and healthcare industry regulations, third-party reimbursement laws (including Medicare and Medicaid), Title VII of the Civil Rights Act of 1964, as amended, the Fair Labor Standards Act, as amended, the Occupational Safety and Health Act of 1970, as amended, the Americans with Disabilities Act of 1990, the Controlled Substances Act, the Federal Food, Drug and Cosmetic Act (as amended by the Prescription Drug Marketing Act of 1987) and the Health Insurance Portability & Accountability Act of 1996 as amended.

(iii) To the best of the Company’s knowledge, neither the Company nor any Subsidiary thereof nor the officers, directors, employees or agents of any of them, have engaged in any activities which are in violation of Medicare, Medicaid or any other “State Health Care Program” (as defined in Section 1128(h) of the Social Security Act (“SSA”)) or “Federal Health Care Program” (as defined in SSA Section 1128B(f)) under § 1320a–7, 1320a-7a, 1320a-7b, or 1395nn of Title 42 of the Code, the federal Civilian Health and Medical Plan of the Uniformed Services (“CHAMPUS”) statute, or the regulations promulgated pursuant to such statutes or regulations or related state or local statutes or which are prohibited by any private accrediting organization from which the Company or any Subsidiary seeks accreditation or by generally recognized professional standards of care or conduct, including but not limited to the following activities: (i) knowingly and willfully making or causing to be made a false statement or representation of a material fact in any application for any benefit or payment; (ii) knowingly and willfully making or causing to be made any false statement or representation of a material fact for use in determining rights to any benefit or payment; or (iii) presenting or causing to be presented a claim for reimbursement under CHAMPUS, Medicare, Medicaid or any other State Health Care Program of Federal Health Care Program that is (A) for an item or service that the person presenting or causing to be presented knows or should know was not provided as claimed, (B) for an item or service and the person presenting knows or should know that the claim is false or fraudulent, (C) knowingly and willfully offering, paying, soliciting or receiving any remuneration (including any kickback, bribe, or rebate), directly or indirectly, overtly or covertly, in cash or in kind in return for referring, or to induce the referral of, an individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made in whole or in part by CHAMPUS, Medicare, Medicaid, or any other State Health Care Program or Federal Health Care Program, or in return for, or to induce, the purchase, lease, or order, or the arranging for or recommending of the purchase, lease, or order, or any good, facility, service, or item for which payment may be made in whole or in part by CHAMPUS, Medicare, Medicaid or any other State Health Care Program or Federal Health Care Program certification, or (D) knowingly and willfully making or causing to be made or inducing or seeking to induce the making of any false statement or representation (or omitting to state a material fact required to be stated therein or necessary to make the statements contained therein not misleading) or a material fact with respect to the conditions or operations of a facility in

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order that the facility may qualify for CHAMPUS, Medicare, Medicaid or any other State Health Care Program or Federal Health Care Program certification, or information required to be provided under SSA § 1124A.

(b) The Company and its Subsidiaries hold all permits, licenses, easements, variances, exemptions, consents, certificates, authorizations, registrations, orders and other approvals from Governmental Entities that are material to the operation of the business of the Company and its Subsidiaries taken as a whole as currently conducted (collectively, the “Company Permits”). The Company Permits are in full force and effect, have not been violated in any material respect and, to the best knowledge of the Company, no suspension, revocation or cancellation thereof has been threatened, and there is no action, proceeding or investigation pending or, to the Company’s knowledge, threatened, seeking the suspension, revocation or cancellation of any Company Permits. No Company Permit shall cease to be effective as a result of the consummation of the transactions contemplated by this Agreement.

(c) Except as set forth in Section 3.8(c) to the Disclosure Schedule or as would not, individually or in the aggregate, reasonably be expected to have a Company Material Adverse Effect, to the best knowledge of the Company:

(i) all necessary clearances or approvals from Governmental Entities for all drug and device products which are manufactured and/or sold by the Company and its Subsidiaries have been obtained and the Company and its Subsidiaries are in substantial compliance with the most current form of each applicable clearance or approval with respect to the manufacture, storage, distribution, promotion and sale by the Company and its Subsidiaries of such products;

(ii) none of the Company, its Subsidiaries, or any of their officers, employees or agents (during the term of such person’s employment by the Company or any of its Subsidiaries or while acting as an agent of the Company or any of its Subsidiaries, or, to the knowledge of the Company, prior to such employment) has made any untrue statement of a material fact or fraudulent statement to the Food and Drug Administration (“FDA”), the U.S. Nuclear Regulatory Commission (the “NRC”) or any similar Governmental Entities, failed to disclose a material fact required to be disclosed to the FDA, NRC or similar Governmental Entities, or committed an act, made a statement or failed to make a statement that would reasonably be expected to provide a basis for the FDA, NRC or similar Governmental Entities to invoke its policy respecting “Fraud, Untrue Statements of Material Facts, Bribery, and Illegal Gratuities” or similar governmental policy, rule, regulation or law;

(iii) as to each article of drug, device, cosmetic or vitamin manufactured (directly or indirectly) and/or distributed by the Company and its Subsidiaries, such article is not adulterated or misbranded within the meaning of the Food, Drug and Cosmetic Act or any similar governmental act or law of any jurisdiction; and

(iv) none of the Company, its Subsidiaries or any of their officers, or to the knowledge of the Company, employees or agents (during the term of such person’s employment by the Company or any of its Subsidiaries or while acting as an agent of the Company or any of its Subsidiaries, or, to the knowledge of the Company, prior to such employment), has been convicted of any crime or engaged in any conduct for which debarment or similar punishment is mandated or permitted by any applicable law.

(d) The offer, sale and all other actions by the Company, its Subsidiaries and their officers, employees and agents in connection with its private placement of 1,000,000 shares of Company Common Stock closed on March 17, 2004, and any sale or sales under Section 2.4, have been, are and shall be (i) in full compliance with all federal and state securities laws, rules and regulations, including without limitation, those governing registration of securities and the offer and sale of securities; and (ii) done with full disclosure to the buyers of all material facts concerning the Merger, and without any untrue statements or omission to state a material fact necessary to make the statements made to the buyers, in light of the circumstances in which they were made, not misleading.

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Section 3.9 SEC FILINGS; FINANCIAL STATEMENTS.

(a) The Company has timely filed and made available to Acquired Corporation all forms, reports, schedules, statements and other documents, including any exhibits thereto (collectively, the “Company SEC Reports”), required to be filed by the Company with the SEC. The Company SEC Reports, including all forms, reports and documents filed by the Company with the SEC after the date hereof and prior to the Effective Date, (i) were and, in the case of Company SEC Reports filed after the date hereof, will be prepared in all material respects in accordance with the applicable requirements of the Securities Act of 1933, as amended (the “Securities Act”) and the Exchange Act, as the case may be, and the rules and regulations thereunder, and (ii) did not at the time they were filed (or if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing), and in the case of such forms, reports and documents filed by the Company with the SEC after the date of this Agreement, will not as of the time they are filed, contain any untrue statement of a material fact or omit to state a material fact required to be stated in such Company SEC Reports or necessary in order to make the statements in such Company SEC Reports, in light of the circumstances under which they were and will be made, not misleading. None of the Company’s Subsidiaries is required to file any forms, reports, schedules, statements or other documents with the SEC. The Company’s restatement of its financial statements for 2001 and 2002 and the fiscal quarter ended June 30, 2002 was acceptable to the SEC.

(b) Each of the consolidated financial statements (including, in each case, any related notes and schedules), contained in the Company SEC Reports, including any Company SEC Reports filed after the date of this Agreement, complied or will comply, as of its respective date, in all material respects with all applicable accounting requirements and the published rules and regulations of the SEC with respect thereto, was or will be prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) (except as may be indicated in the notes thereto) applied on a consistent basis throughout the periods involved and fairly presented in all material respects or will fairly present in all material respects the consolidated financial position of the Company and its Subsidiaries as of the respective dates thereof and the consolidated results of its operations and cash flows for the periods indicated, except that any unaudited interim financial statements are subject to normal and recurring year-end adjustments which have not been and are not expected to be material in amount, individually or in the aggregate. The unaudited balance sheet of the Company contained in the Company SEC Report on Form 10-Q for the fiscal quarter ended December 31, 2003 is referred to herein as the “Company Balance Sheet.”

(c) The chief executive officer and chief financial officer of the Company have made all certifications required by, and would be able to make such certifications as of the date hereof and as of the Effective Date as if required to be made as of such dates pursuant to, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and any related rules and regulations promulgated by the SEC, and the statements contained in any such certifications are complete and correct; and the Company is otherwise in compliance with all applicable effective provisions of the Sarbanes-Oxley Act and the applicable listing and corporate governance rules of The Nasdaq Small-Cap Market.

Section 3.10 ABSENCE OF CERTAIN CHANGES OR EVENTS. Since the date of the Company Balance Sheet, the Company has conducted its business in the ordinary course consistent with past practice and, since such date, there has not occurred: (i) any change, development, event or other circumstance, situation or state of affairs that has had or would reasonably be expected to have a Company Material Adverse Effect; (ii) any amendments to or changes in the Company Charter or Company By-Laws; (iii) any damage to, destruction or loss of any asset of the Company or any of its Subsidiaries (whether or not covered by insurance) that could reasonably be expected to have a Company Material Adverse Effect; (iv) any change by the Company in its accounting methods, principles or practices; (v) any revaluation by the Company of any of its assets, including writing down the value of inventory or writing off notes or accounts receivable other than in the ordinary course of business consistent with past practice, in terms of both frequency and amount, and in any event in excess of $100,000; (vi) except as set forth in Section 3.10 of the Disclosure Schedule, any sale of a material amount of assets (tangible or intangible) of the Company; or (vii) any other action or event that would have required the consent of Acquired Corporation pursuant to Section 5.1 had such action or event occurred after the date of this Agreement.

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Section 3.11 NO UNDISCLOSED LIABILITIES.

(a) Except as reflected in the Company Balance Sheet, neither the Company nor any of its Subsidiaries has any liabilities (absolute, accrued, contingent or otherwise) which are required by GAAP to be set forth on a consolidated balance sheet of the Company and its consolidated subsidiaries or in the notes thereto, other than (i) any liabilities and obligations incurred since December 31, 2003 in the ordinary course of business consistent with past practice, (ii) any liabilities or obligations incurred in connection with the transactions contemplated by this Agreement and (iii) liabilities that, individually and in the aggregate, have not had, and would not reasonably be expected to have, a Company Material Adverse Effect.

(b) Neither the Company nor any of its Subsidiaries is a party to, or has any commitment to become a party to, any joint venture, partnership agreement or any similar contract (including any contract relating to any transaction, arrangement or relationship between or among the Company or any of its Subsidiaries, on the one hand, and any unconsolidated affiliate, including any structured finance, special purpose or limited purpose entity or person, on the other hand) where the purpose or intended effect of such arrangement is to avoid disclosure of any material transaction involving the Company or any of its Subsidiaries in the Company’s consolidated financial statements.

(c) Neither the Company nor any of its Subsidiaries is a party to, or has any commitment to become a party to, any tax shelter arrangement as described in Internal Revenue Service final regulations (T.D. 9046).

Section 3.12 ABSENCE OF LITIGATION; INVESTIGATIONS. Except as set forth in Section 3.12 of the Disclosure Schedule:

There are no material claims, actions, suits, proceedings or, to the knowledge of the Company, governmental investigations, inquiries or subpoenas (a) pending against the Company or any of its Subsidiaries or any properties or assets of the Company or of any of its Subsidiaries or (b) to the knowledge of the Company, threatened against the Company or any of its Subsidiaries, or any properties or assets of the Company or of any of its Subsidiaries, or (c) whether filed or threatened, that have been settled or compromised by the Company or any Subsidiary within the three years prior to the date of this Agreement. Neither the Company nor any Subsidiary of the Company is subject to any outstanding order, writ, injunction or decree that would reasonably be expected to be material or would reasonably be expected to prevent or delay the consummation of the transactions contemplated by this Agreement. There has not been since January 1, 2000 nor are there currently any internal investigations or inquiries being conducted by the Company, its Board of Directors (or any committee thereof) or any third party at the request of any of the foregoing concerning any financial, accounting, tax, conflict of interest, self-dealing, fraudulent or deceptive conduct or other misfeasance or malfeasance issues.

Section 3.13 EMPLOYEE BENEFIT PLANS, OPTIONS AND EMPLOYMENT AGREEMENTS.

(a) Section 3.13(a) of the Disclosure Schedule sets forth a complete and accurate list of all Employee Benefit Plans maintained, or contributed to, by the Company, any of the Company’s Subsidiaries or any of their ERISA Affiliates or to which the Company, any of the Company’s Subsidiaries or any of their respective ERISA Affiliates is obligated to contribute, or under which any of them has or may have any liability for premiums or benefits (collectively, the “Company Employee Plans”). For purposes of this Agreement, the following terms shall have the following meanings: (i) “Employee Benefit Plan” means any “employee pension benefit plan” (as defined in Section 3(2) of ERISA), any “employee welfare benefit plan” (as defined in Section 3(1) of ERISA), and any other written or oral plan, agreement or arrangement involving material compensation, including insurance coverage, severance benefits, disability benefits, deferred compensation, bonuses, stock options, stock purchase, phantom stock, stock appreciation or other forms of fringe benefits, perquisites, incentive compensation or post-retirement compensation and all employment, change in control, severance or similar agreements, written or otherwise, for the benefit of, or relating to, any current or former employee, officer or director of the Company or any of its Subsidiaries or any ERISA Affiliate; (ii) “ERISA” means the Employee Retirement Income Security Act of 1974, as amended; and (iii) “ERISA Affiliate” means any entity which is, or at any applicable time was, a member of

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(A) a controlled group of corporations (as defined in Section 414(b) of the Code), (B) a group of trades or businesses under common control (as defined in Section 414(c) of the Code) or (C) an affiliated service group (as defined under Section 414(m) of the Code or the regulations under Section 414(o) of the Code), any of which includes or included the Company or a Subsidiary.

(b) With respect to each Company Employee Plan, the Company has made available to Acquired Corporation complete and accurate copies of (i) such Company Employee Plan (or a written summary of any unwritten plan) together with all amendments, (ii) in the case of any plan for which Forms 5500 are required to be filed, the most recent annual report (Form 5500) with schedules attached, (iii) in the case of any plan that is intended to be qualified under Section 401(a) of the Code, the most recent determination letter from the IRS, (iv) each trust agreement, group annuity contract, administration and similar material agreements, investment management or investment advisory agreements, (v) the most recent summary plan descriptions and employee handbook, or other similar material employee communications, (vi) all personnel, payroll and employment manuals and policies, and (vii) the most recent financial statements for each Company Employee Plan that is funded.

(c) Each Company Employee Plan has been administered in all material respects in accordance with ERISA, the Code and all other applicable laws and the regulations thereunder and materially in accordance with its terms and each of the Company, the Company’s Subsidiaries and their ERISA Affiliates have in all material respects met their obligations with respect to each Company Employee Plan and have timely made (or timely will make) all required contributions thereto. All material filings and reports as to each Company Employee Plan required to have been submitted to the Internal Revenue Service or to the United States Department of Labor have been timely submitted. With respect to the Company Employee Plans, no event has occurred, and, to the knowledge of the Company, there exists no condition or set of circumstances in connection with which Acquired Corporation, the Company or any of its Subsidiaries or any plan participant could be subject to any material liability (including penalties or taxes) under ERISA, the Code or any other applicable law, nor will the negotiation or consummation of the transactions contemplated by this Agreement give rise to any such material liability.

(d) With respect to the Company Employee Plans, there are no material benefit obligations for which contributions have not been made or properly accrued and there are no benefit obligations which have not been accounted for by reserves, or otherwise properly footnoted in accordance with the requirements of GAAP, on the financial statements of the Company. The assets of each Company Employee Plan which is funded are reported at their fair market value on the books and records of such Employee Benefit Plan.

(e) No Company Employee Plan has assets that include securities issued by the Company, any of the Company’s Subsidiaries or any of their ERISA Affiliates.

(f) All the Company Employee Plans that are intended to be qualified under Section 401(a) of the Code (each, a “Qualified Plan”) have received determination, opinion or advisory letters from the Internal Revenue Service to the effect that such Company Employee Plans are qualified and the plans and trusts related thereto are exempt from federal income taxes under Sections 401(a) and 501(a), respectively, of the Code, or the Company has remaining a period of time under applicable U.S. Department of the Treasury regulations or IRS pronouncements in which to apply for such a letter and to make any amendments necessary to obtain a favorable determination as to the qualified status of each such Qualified Plan. To the Company’s knowledge, no such determination, opinion or advisory letter has been revoked and revocation has not been threatened, and no such Employee Benefit Plan has been amended or operated since the date of its most recent determination letter or application therefor in any respect, and no act or omission has occurred, that would adversely affect its qualification or materially increase its cost. There has been no termination, partial termination or discontinuance of contributions to any Qualified Plan that will result in material liability to the Company. Each Company Employee Plan which is required to satisfy Section 401(k)(3) or Section 401(m)(2) of the Code has been tested for compliance with, and satisfies in all material respects the requirements of Section 401(k)(3) and Section 401(m)(2) of the Code, as the case may be, for each plan year ending prior to the Effective Date for which testing is required to be completed.

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(g) Neither the Company, any of the Company’s Subsidiaries nor any of their ERISA Affiliates has (i) ever maintained a Company Employee Plan which was ever subject to Section 412 of the Code or Title IV of ERISA or (ii) ever been obligated to contribute to a “multiemployer plan” (as defined in Section 4001(a)(3) of ERISA). No Company Employee Plan is funded by, associated with or related to a “voluntary employees’ beneficiary association” within the meaning of Section 501(c)(9) of the Code.

(h) To the extent permitted by applicable law, each Company Employee Plan (other than the Company Stock Plans or an employment, severance, change in control or similar agreement with an individual) is amendable and terminable unilaterally by the Company and any of the Company’s Subsidiaries party thereto or covered thereby at any time without material liability to the Company or any of its Subsidiaries as a result thereof, other than for benefits accrued as of the date of such amendment or termination and routine administrative costs.

(i) Other than as required under Section 601 et seq. of ERISA, none of the Company Employee Plans promises or provides health or other welfare benefits (excluding normal claims for benefits under the Company’s group life insurance, accidental death and dismemberment insurance and disability plans and policies) or coverage to any person following retirement or other termination of employment. Section 3.13(i) of the Disclosure Schedule lists each Company Employee Plan which provides benefits after termination of employment (other than medical benefits required to be continued under Section 4980B of the Code and part 6 of Subtitle B of Title I of ERISA) and the amount, if any, by which the present value of benefits accrued under each such Company Employee Plan exceeds the fair market value of the assets of each such Company Employee Plan.

(j) There is no action, suit, proceeding, claim, arbitration, audit or investigation pending or, to the knowledge of the Company, threatened, with respect to any Company Employee Plan, other than claims for benefits in the ordinary course. No Company Employee Plan is or within the last three calendar years has been the subject of, or has received notice that it is the subject of, examination by a government agency or a participant in a government sponsored amnesty, voluntary compliance or similar program.

(k) Except as set forth in Section 3.13(k) of the Disclosure Schedule, to the knowledge of the Company, each individual who has received compensation for the performance of services on behalf of the Company, any of the Company’s Subsidiaries or its ERISA Affiliates has been properly classified as an employee or independent contractor in accordance with applicable law.

(l) Each Company Employee Plan maintained or covering employees outside the United States, and the books and records thereof, is in material compliance with all applicable laws, rules and regulations of each applicable jurisdiction. Section 3.13(l) of the Disclosure Schedule lists each country in which the Company or any of its affiliates has operations and the number of employees in each such country.

(m) Section 3.13(m) of the Disclosure Schedule sets forth a true, complete and correct list of (i) all employment agreements with employees of the Company or any of its Subsidiaries obligating (or potentially obligating) the Company or any of its Subsidiaries to make annual cash payments in an amount equal to or exceeding $50,000; (ii) all employees of the Company or any of its Subsidiaries who have executed a non-competition agreement with the Company or any of its Subsidiaries; (iii) all severance agreements, programs and policies of the Company or any of its Subsidiaries with or relating to its employees, in each case with potential obligations equal to or exceeding $50,000, excluding programs and policies required to be maintained by law; and (iv) all plans, programs, agreements and other arrangements of the Company or any of its Subsidiaries pursuant to which payments (or acceleration of benefits or vesting of options or lapse of repurchase rights) may be required upon, or may become payable directly or indirectly as a result of or in connection with, the negotiation or consummation of the transactions contemplated by, or the execution of, this Agreement. True, complete and correct copies of each of the foregoing agreements to which any employee of the Company is a party have been made available to Acquired Corporation.

(n) All contributions required to be made with respect to any Company Employee Plan on or prior to the Effective Date have been or will be timely made or are reflected on the Company’s balance sheet. There

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are no pending, threatened or reasonably anticipated claims by or on behalf of any Plan, by any employee or beneficiary covered under any such Company Employee Plan, or otherwise involving any such Plan (other than routine claims for benefits).

(o) The negotiation or consummation of the transactions contemplated by this Agreement will not, either alone or in combination with another event, (i) except as set forth in Section 3.13 of the Disclosure Schedule, entitle any current or former employee or officer of the Company or any Subsidiary of the Company to severance pay, or any other payment from the Company or any of its Subsidiaries or (ii) accelerate the time of payment or vesting of any rights, a lapse of repurchase rights or increase the amount of compensation due any such employee or officer. There is no Company Employee Plan or other contract, agreement, plan or arrangement that, individually or collectively, could give rise to the payment of any amount that would not be deductible pursuant to Sections 280G (determined without regard to Section 280G(b)(4) of the Code) or 162(m) of the Code.

(p) No employee of the Company who has not executed a standard confidentiality agreement in use by the Company possesses confidential information of the Company.

Section 3.14 LABOR MATTERS. (a) The Company and each of its Subsidiaries are in compliance in all material respects with all applicable laws respecting employment, employment practices and occupational safety and health, terms and conditions of employment and wages and hours, and are not engaged in any unfair labor practices; (b) there are no actions, suits, claims or grievances pending or, to the knowledge of the Company or any of its Subsidiaries, threatened, between the Company or any of its Subsidiaries and any of their respective employees, consultants or independent contractors, which actions, suits, claims or grievances have or would reasonably be expected to have a Company Material Adverse Effect; (c) neither the Company nor any of its Subsidiaries is a party to any collective bargaining agreement or other labor union contract applicable to persons employed by the Company or its Subsidiaries, nor does the Company or any of its Subsidiaries know of any activities or proceedings of any labor union to organize any such employees; and (d) to the knowledge of the Company, there are no labor disputes, strikes, slowdowns, work stoppages, lockouts, or threats thereof, by or with respect to any employees of, or consultants or independent contractors to, the Company or any of its Subsidiaries. No employee of the Company or any of its Subsidiaries (i) to the Company’s knowledge is in violation of any term of any patent disclosure agreement, non-competition agreement, or any restrictive covenant to a former employer relating to the right of any such employee to be employed by the Company or any of its Subsidiaries because of the nature of the business conducted or presently proposed to be conducted by the Company or any of its Subsidiaries or to the use of trade secrets or proprietary information of others, or (ii) in the case of any key employee or group of key employees, has given notice as of the date of this Agreement to the Company or any of its Subsidiaries that such employee or any employee in a group of key employees intends to terminate his or her employment with the Company. Neither the Company nor any of its Subsidiaries has any material liability for (i) a plant closing, as defined in the Worker Adjustment and Retaining Notification Act of 1988, as amended ( the “WARN Act”), or (ii) a mass layoff, as defined in the WARN Act. Neither the Company nor any of its Subsidiaries is currently engaged in any layoffs or employment terminations sufficient in number to trigger application of any similar state, local or foreign law.

Section 3.15 PROPERTIES; ENCUMBRANCES. Each of the Company and each of its Subsidiaries has good and valid title to, or a valid leasehold interest in, all the properties and assets which it purports to own or lease (real, tangible, personal and mixed), including all the properties and assets reflected in the Company Balance Sheet (except for personal property sold since the date of the Company Balance Sheet in the ordinary course of business consistent with past practice). All properties and assets reflected in the Company Balance Sheet are free and clear of all Liens, except for Liens reflected on the Company Balance Sheet and Liens for current taxes not yet due and other Liens that do not materially detract from the value or impair the use of the property or assets subject thereto. Section 3.15 of the Disclosure Schedule sets forth a true, complete and correct list of all real property owned, leased, subleased or licensed by the Company and the location of such premises. Each of the Company and each of its Subsidiaries is and has been in material compliance with the provisions of each lease or sublease for the real property which is set forth in Section 3.15 of the Disclosure Schedule.

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Section 3.16 TAXES. Except as set forth in Section 3.16 of the Disclosure Schedule:

(a) For purposes of this Agreement, “Tax” or “Taxes” shall mean taxes, fees, assessments, liabilities, levies, duties, tariffs, imposts and governmental impositions or charges of any kind in the nature of (or similar to) taxes, payable to any federal, state, local or foreign taxing authority, or any agency or subdivision thereof, including (i) income, franchise, profits, gross receipts, ad valorem, net worth, value added, sales, use, service, real or personal property, special assessments, capital stock, license, payroll, withholding, employment, social security, workers’ compensation, unemployment compensation, utility, severance, production, excise, stamp, occupation, premiums, windfall profits, transfer and gains taxes, and (ii) interest, penalties, fines, additional taxes and additions to tax imposed with respect thereto; and “Tax Returns” shall mean returns, reports and information statements with respect to Taxes required to be filed with a taxing authority, domestic or foreign, including, consolidated, combined or unitary tax returns and any amendments to any of the foregoing.

(b) The Company and each of its Subsidiaries have filed with the appropriate taxing authorities all Tax Returns required to be filed by them, except to the extent that the failure to file would not reasonably be likely to have, in the aggregate, a Company Material Adverse Effect, and all such Tax Returns were true, complete and correct. All Taxes shown to be due on such Tax Returns have been timely paid. There are no Tax Liens on any assets of the Company or any Subsidiary thereof other than liens relating to Taxes not yet due and payable. Neither the Company nor any of its Subsidiaries has granted any outstanding waiver of any statute of limitations with respect to, or any outstanding extension of a period for the assessment of, any Tax. The accruals and reserves for Taxes (exclusive of any accruals for “deferred taxes” or similar items that reflect timing differences between tax and financial accounting principles) reflected in the Company Balance Sheet are adequate to cover all Taxes accruable through the date thereof (including interest and penalties, if any, thereon and Taxes being contested) in accordance with GAAP applied on a consistent basis with the Company Balance Sheet. All liabilities for Taxes attributable to the period commencing on the date following the date of the Company Balance Sheet were incurred in the ordinary course of business and are consistent in type and amount with Taxes attributable to similar prior periods.

(c) The Company and each of its Subsidiaries have timely withheld with respect to its employees all federal and state Taxes required to be withheld, except to the extent that the failure to withhold would not reasonably be likely to have, in the aggregate, a Company Material Adverse Effect. Neither the Company nor any of its Subsidiaries has received any written notice of any Tax deficiency outstanding, proposed or assessed against the Company or any of its Subsidiaries. Neither the Company nor any of its Subsidiaries has received any written notice of any audit examination, deficiency, refund litigation, proposed adjustment or matter in controversy with respect to any Tax Return of the Company or any of its Subsidiaries. Neither the Company nor any of its Subsidiaries has filed any consent under Section 341(f) of the Code or agreed to have Section 341(f)(2) of the Code apply to any disposition of a subsection (f) asset (as defined in Section 341(f)(4) of the Code) owned by the Company. Neither the Company nor any of its Subsidiaries is a party to or bound by any tax indemnity, tax sharing or tax allocation agreements with any entity not included in the Company’s consolidated financial statements most recently filed by the Company with the SEC. Except for the group of which the Company and its Subsidiaries are now currently members, neither the Company nor any of its Subsidiaries has ever been a member of an affiliated group of corporations within the meaning of Section 1504 of the Code. Neither the Company nor any of its Subsidiaries is liable for the Taxes of any person under Treasury Regulation 1.1502-6 (or any similar provision of state, local or foreign law) as a transferee or successor, by contract or otherwise.

(d) The Company made available to Acquired Corporation (i) complete and correct copies of all income Tax Returns, examination reports and statements of deficiencies assessed against or agreed to by the Company or any of its Subsidiaries with respect to all taxable years for which the statutes of limitation have not expired.

(e) None of the assets of the Company or any of its Subsidiaries: (i) is property that is required to be treated as being owned by any other person pursuant to the provisions of former Section 168(f)(8) of the

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Code; (ii) is “tax-exempt use of property” within the meaning of Section 168(h) of the Code; or (iii) directly or indirectly secures any debt the interest on which is tax exempt under Section 103(a) of the Code.

(f) Neither the Company nor any of its Subsidiaries has agreed nor is it required to make any material adjustment under Section 481 of the Code by reason of a change in accounting method or otherwise prior to the Effective Date.

(g) Neither the Company nor any of its Subsidiaries is, or has been, a United States real property holding corporation (as defined in Section 897(c)(2) of the Code) during the applicable period specified in Section 897(c)(1)(A)(ii) of the Code.

(h) Neither the Company nor any of its Subsidiaries has constituted either a “distributing corporation” or a “controlled corporation” (within the meaning of Section 355(a)(1)(A) of the Code) in a distribution of stock qualifying for tax-free treatment under Section 355 of the Code (A) in the two years prior to the date of this Agreement or (B) in a distribution which could otherwise constitute part of a “plan” or “series of related transactions” (within the meaning of Section 355(e) of the Code) in connection with the Merger.

(i) Neither the Company nor any of its Subsidiaries has taken any action or knows of any fact, agreement, plan or other circumstance that is reasonably likely to prevent the Merger as qualifying as a “reorganization” within the meaning of Section 368(a) of the Code.

Section 3.17 ENVIRONMENTAL MATTERS.

(a) Except as set forth in Section 3.17 of the Disclosure Schedule (i) the Company and its Subsidiaries are and have been in material compliance with all Environmental Laws (as defined below); (ii) there has been no release or threatened release of any pollutant, contaminant or toxic or hazardous material, substance or waste, or petroleum or any fraction thereof (each a “Hazardous Substance”) on, upon, into or from any site currently or heretofore owned, leased or otherwise used by the Company or its Subsidiaries, except for such releases that would not reasonably be likely to have, in the aggregate, a Company Material Adverse Effect; (iii) there have been no Hazardous Substances generated by the Company or its Subsidiaries that have been disposed of or come to rest at any site that has been included in any published U.S. federal, state or local “superfund” site list or any other similar list of hazardous or toxic waste sites published by any Governmental Entity within or outside the United States, except as would not reasonably be likely to have, in the aggregate, a Company Material Adverse Effect; and (iv) there are no underground storage tanks located on, no polychlorinated biphenyls (“PCBs”) or PCB-containing equipment used or stored on, and no hazardous waste as defined by the Resource Conservation and Recovery Act, as amended, stored on, any site owned or operated by the Company or its Subsidiaries, except for the storage of hazardous waste in compliance with Environmental Law and except for such storage that would not reasonably be likely to have, in the aggregate, a Company Material Adverse Effect. The Company and its Subsidiaries have made available to Acquired Corporation true and correct copies of all material environmental records, reports, notifications, certificates of need, permits, pending permit applications, correspondence, engineering studies, and environmental studies or assessments relating to the business of the Company and its Subsidiaries or any of their respective properties and

(b) For purposes of this Section 3.17, “Environmental Laws” means any law, regulation, or other applicable requirement (whether domestic or foreign) relating to (i) releases or threatened release of any Hazardous Substance; (ii) pollution or protection of employee health or safety, public health or the environment; or (iii) the manufacture, handling, transport, use, treatment, storage, or disposal of any Hazardous Substance.

Section 3.18 INTELLECTUAL PROPERTY.

(a) Section 3.18(a)(i) of the Disclosure Schedule sets forth as of the date hereof a true, complete and correct list of all U.S. and foreign (i) patents and pending patent applications owned by the Company or any of its Subsidiaries as of the date of this Agreement; (ii) trademark registrations (including internet domain

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registrations) and pending trademark applications owned by the Company or any of its Subsidiaries as of the date of this Agreement; and (iii) copyright registrations and pending copyright applications owned by the Company or any of its Subsidiaries as of the date of this Agreement (collectively the “Registered Intellectual Property”). All of the Registered Intellectual Property, including without limitation the pending patent application relative to the Avery Pharmaceuticals respiratory vial, is owned solely by the Company or one of its Subsidiaries and no royalty or other payment is payable with respect thereto.

(b) The Company or one or more of its Subsidiaries owns, or has a valid right to use all of the Intellectual Property (as defined below) that is used in the business of the Company and its Subsidiaries as currently conducted.

(c) The Registered Intellectual Property that is or has been used in the business of the Company or any of its Subsidiaries as currently or previously conducted, is (and at the time of any previous use, was), to the Company’s knowledge, subsisting (except with respect to applications), and has not expired or been cancelled, or abandoned.

(d) There is no pending or, to the Company’s knowledge, threatened (and at no time within the two years prior to the date of this Agreement has there been pending any) material suit, arbitration or other adversarial proceeding before any court, government agency or arbitral tribunal or in any jurisdiction alleging that any activities or conduct of the Company’s or any of its Subsidiaries’ business infringes or will infringe upon, violate or constitute the unauthorized use of the Intellectual Assets of any third party or challenging the ownership, validity, enforceability or registrability of any Intellectual Property owned by the Company or any of its Subsidiaries. The Company is not party to any settlements, covenants not to sue, consents, decrees, stipulations, judgments, or orders resulting from suits, actions or similar legal proceedings which (i) materially restrict the Company’s or any of its Subsidiaries’ rights to use any Intellectual Property owned by and material to the business of the Company or any of its Subsidiaries as currently conducted, (ii) materially restrict the conduct of the business of the Company or any of its Subsidiaries as currently conducted in order to accommodate any third party’s rights to such third party’s Intellectual Assets, or (iii) permit third parties to use any Intellectual Property owned by and material to the business of the Company or any of its Subsidiaries as currently conducted.

(e) The conduct of the business of the Company and its Subsidiaries as currently conducted does not infringe upon any rights of any third party to such third party’s Intellectual Assets. The Company and its Subsidiaries have taken reasonable measures to protect the proprietary nature of the Intellectual Property owned by the Company or such Subsidiary that is material to the business of the Company and its Subsidiaries as currently conducted (other than trade secrets with respect to which the Company knowingly made a reasonable judgment to not keep such trade secrets confidential and other than rights to Intellectual Assets where the Company knowingly made a reasonable judgment not to seek to secure registration of the applicable rights). To the Company’s knowledge, no third party is misappropriating, infringing, diluting or violating any rights to Intellectual Property owned by the Company or any of its Subsidiaries that is material to the business of the Company and its Subsidiaries as currently conducted, and no Intellectual Property misappropriation, infringement, dilution or violation suits, arbitrations or other adversarial proceedings have been brought before any court, government agency or arbitral tribunal against any third party by the Company or any of its Subsidiaries which remain unresolved.

(f) The Company and each of its operating Subsidiaries has, and uses reasonable efforts to enforce, a policy of requiring each relevant employee who participates in the development of Intellectual Property to execute a confidentiality and assignment of proprietary rights agreement substantially in the Company’s standard form as set forth in Section 3.18(f) of the Disclosure Schedule, and, except (i) as may be made under nondisclosure agreements or other agreements containing nondisclosure obligations, and (ii) for confidential information or trade secrets that the Company knowingly made a reasonable judgment not to keep such confidential information and trade secrets confidential, there has been no disclosure to any third party by the Company or any of its Subsidiaries of material confidential information or material trade secrets of the Company or any of its Subsidiaries related to any material proprietary product currently being

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marketed, sold, licensed or developed by the Company or any of its Subsidiaries (each such product owned by the Company or its Subsidiaries, a “Proprietary Product”). All consultants and independent contractors who have made material contributions to the development of any Proprietary Product (including all consultants and independent contractors who have designed, written, tested or worked on any software code contained in any Proprietary Product) have assigned to the Company or one or more of its Subsidiaries (or a third party that has assigned its rights in such Proprietary Product to the Company or one or more of its Subsidiaries) all of their right, title and interest (other than moral rights, if any) in and to the portions of such Proprietary Product developed by them in the course of their work for the Company or one or more of its Subsidiaries (or applicable third party). Assignments of the patents and patent applications listed in Section 3.18(a) of the Disclosure Schedule to the Company or one or more of its Subsidiaries have been duly executed and filed with the United States Patent and Trademark Office.

(g) Neither the Company nor any of its Subsidiaries has (i) granted or is obligated to grant access to any of its source code contained in any Proprietary Product, (ii) made its source code contained in any Proprietary Product subject to any open source license, or (iii) licensed or has the right to obtain any source code, object code or any open license of any third party contained in any Proprietary Product (including in any such case any conditional right to access or under which the Company has established any escrow arrangement for the storage and conditional release of any source code, object code or open license).

(h) None of the Proprietary Products contains any third party software code that is, in whole or in part, subject to the provisions of any open source or quasi-open source license agreement under which the Company or any of its Subsidiaries is obligated to make the source code for such Proprietary Product generally available to the public.

(i) The Company does not have and will not have any obligation to pay any third party any royalties or other fees in excess of $100,000 in any calendar year for the use of Intellectual Property and no obligation to pay such royalties or other fees will result from the consummation of the transactions contemplated by this Agreement.

(j) Neither the Company nor any of its Subsidiaries is in violation of any material license, sublicense, agreement or instrument to which the Company or any of its Subsidiaries is party or otherwise bound under which the Company or its Subsidiaries derive rights to Intellectual Property that is material to the Company’s or its Subsidiaries’ business as currently conducted, nor will the consummation by the Company of the transactions contemplated hereby result in any loss or impairment of ownership by the Company or any of its Subsidiaries of, or the right of any of them to use, any Intellectual Property that is material to the business of the Company and its Subsidiaries as currently conducted, nor, to the Company’s knowledge, require the consent of any Governmental Entity or third party with respect to any such Intellectual Property. Neither the Company nor any of its Subsidiaries is a party to any agreement under which a third party would be entitled to receive or expand a license or any other right to any Intellectual Asset of Acquired Corporation or any of Acquired Corporation’s affiliates as a result of the consummation of the transactions contemplated by this Agreement.

(k) For purposes of this Agreement, “Intellectual Property” shall mean trademarks, service marks, trade names, and internet domain names, together with all goodwill, registrations and applications related to the foregoing; patents and industrial design registrations or applications (including any continuations, divisionals, continuations-in-part, renewals, reissues, re-examinations and applications for any of the foregoing); works of authorship protected by copyright registrations; copyrights (including any registrations and applications for any of the foregoing); mask works rights and trade secrets and other confidential information, know-how, proprietary processes, formulae, algorithms, models, and methodologies; in each case used in or necessary for the conduct of the business of the Company and each of its Subsidiaries, as currently conducted.

Section 3.19 INSURANCE. All fire and casualty, general liability, business interruption, product liability, sprinkler and water damage insurance policies and other forms of insurance maintained by the Company or any of its Subsidiaries have been made available to Acquired Corporation. Each such policy is in full force and effect

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and all premiums due thereon have been paid in full. None of such policies shall terminate or lapse (or be affected in any other materially adverse manner) by reason of the consummation of the transactions contemplated by this Agreement.

Section 3.20 RESTRICTIONS ON BUSINESS. Except for this Agreement, there is no agreement (other than agreements disclosed in response to Section 3.6(h)), judgment, injunction, order or decree binding upon the Company or any of its Subsidiaries which has or could reasonably be expected to have the effect of prohibiting or impairing in any material respect any business practice of the Company or any of its Subsidiaries, acquisition of property by the Company or any of its Subsidiaries or the conduct of business by the Company or any of its Subsidiaries as currently conducted.

Section 3.21. PROXY STATEMENT. The information supplied or to be supplied by the Company for inclusion or incorporation by reference in the proxy statement/prospectus (as amended or supplemented, the “Proxy Statement/Prospectus”) to be sent to the stockholders of the Company in connection with the meeting of the stockholders of the Company to consider the Merger (the “Company Stockholders Meeting”), or to be included or supplied by or on behalf of the Company for inclusion in any filing with the SEC shall not, on the date the Proxy Statement/Prospectus (or any amendment thereof or supplement thereto) is first mailed to stockholders or at the time of the Company Stockholders Meeting or at the time any filing is filed with the SEC or as of the Effective Time, contain any statement which, at such time and in light of the circumstances under which it shall be made, is false or misleading with respect to any material fact, or omit to state any material fact necessary in order to make the statements made therein not false or misleading; or omit to state any material fact necessary to correct any statement in any earlier communication with respect to the solicitation of proxies for the Company Stockholders Meeting which has become false or misleading. If at any time prior to the Company Stockholders Meeting any event relating to the Company or any of its respective affiliates, officers or directors should be discovered by the Company which should be set forth in a supplement to the Proxy Statement/Prospectus, the Company shall promptly inform Acquired Corporation. The Proxy Statement/Prospectus shall comply in all material respects as to form and substance with the requirements of the Securities Act, the Exchange Act and the rules and regulations thereunder. Notwithstanding the foregoing, the Company makes no representation or warranty with respect to any information supplied by Acquired Corporation which is contained in any of the foregoing documents.

Section 3.22 INTERESTED PARTY TRANSACTIONS. Except as set forth in Section 3.22 of the Disclosure Schedule, since December 31, 2002, no event has occurred that would be required to be reported as a Certain Relationship or Related Transaction pursuant to Statement of Financial Accounting Standards No. 57.

Section 3.23 NO EXISTING DISCUSSIONS. As of the date of this Agreement, the Company is not engaged, directly or indirectly, in any discussions or negotiations with any other party in violation of Section 6.13 of this Agreement.

Section 3.24 RESERVED.

Section 3.25 BROKERS; SCHEDULE OF FEES. No broker, finder or investment banker (other than First Albany Capital, Inc., whose brokerage, finder’s or other fees will be paid by Acquired Corporation, and Sanders Morris Harris, Inc., the Company’s investment banker in connection with the Merger, whose fee will be paid by the Company) is entitled to any brokerage, finder’s or other fee or commission in connection with the transactions contemplated by this Agreement based upon arrangements made by or on behalf of the Company or any of its Subsidiaries.

Section 3.26 MOREPENMAX, INC.

(a) Neither the Company’s 49% equity ownership of MorepenMax, Inc. (“MorepenMax”), nor the current number of directors of MorepenMax that the Company has the right to appoint, can be reduced

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without the Company’s consent. (b) The MorepenMax joint venture agreement (the “Joint Venture Agreement”) between the Company and Morepen Laboratories Ltd., a company incorporated under the laws of India, cannot be amended without the Company’s consent. (c) Morepen Laboratories Ltd. is in full compliance with the agreement, which contains the Company’s exclusive right, which has not been violated, to sell and distribute products thereunder. (d) The Company has no liability to MorepenMax or Morepen Laboratories Ltd. under the agreement for further capital contributions or as a stockholder, joint venturer or otherwise for any amount in excess of forty nine-thousand dollars ($49,000), which has already been contributed. (e) The activities of MorepenMax are in full compliance with all federal and state laws, rules and regulations (including those of regulatory agencies) governing the manufacture and distribution of drugs. (f) Except as set forth in (d) above, the Company has no liability to MorepenMax or creditors thereof or claimants therefrom, including without limitation for tort or products liability. (g) MorepenMax has maintained and shall maintain products liability insurance in amounts customary and sufficient for the business activities of MorepenMax.

Section 3.27 STOCKHOLDERS AGREEMENT. Other than the Voting and Support Agreement dated January 27, 2004, there is no voting, buy-sell, control or other agreement by and between any of the stockholders of the Company.

ARTICLE IV

REPRESENTATIONS AND WARRANTIES OF ACQUIRED CORPORATION

Acquired Corporation represents and warrants to the Company that, except as set forth in the written disclosure schedule prepared by Acquired Corporation which is dated as of the date of this Agreement and arranged in sections corresponding to the numbered and lettered sections contained in this Article IV and was previously delivered to the Company in connection herewith (the “Acquired Corporation Disclosure Schedule”) (disclosure in any section of the Acquired Corporation Disclosure Schedule qualifying the corresponding section in this Article IV and other sections of this Article IV to the extent such disclosure reasonably appears to be applicable to such sections):

Section 4.1 ORGANIZATION AND QUALIFICATION; SUBSIDIARIES. Each of the Acquired Corporation and its Subsidiaries is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has the requisite corporate power and authority necessary to own, lease and operate the properties it purports to own, lease or operate and to carry on its business as it is now being conducted or presently proposed to be conducted. Each of the Acquired Corporation and its Subsidiaries is duly qualified or licensed as a foreign corporation to do business, and is in good standing, in each jurisdiction where the character of the properties owned, leased or operated by it or the nature of its activities makes such qualification or licensing necessary, except for such failures to be so duly qualified or licensed and in good standing that could not reasonably be expected to have an Acquired Corporation Material Adverse Effect. A true, complete and correct list of all of the Acquired Corporation’s Subsidiaries, together with the jurisdiction of incorporation of each Subsidiary, the authorized capitalization of each Subsidiary, and the percentage of each Subsidiary’s outstanding capital stock owned by the Acquired Corporation or another Subsidiary or affiliate of the Acquired Corporation (excluding nominal qualifying directors’ share ownership information relating to the Acquired Corporation’s Subsidiaries), is set forth in Section 4.1 of the Acquired Corporation Disclosure Schedule. The Acquired Corporation does not directly or indirectly own any equity or similar interest in, or any interest convertible into or exchangeable or exercisable for any equity or similar interest in, any corporation, partnership, limited liability company, joint venture or other business association or entity, other than a Subsidiary disclosed in such Section 4.1, excluding securities in any publicly traded company held for investment by the Acquired Corporation and comprising less than one percent of the outstanding stock of such company.

Section 4.2 CERTIFICATE OF INCORPORATION AND BY-LAWS. The Acquired Corporation has heretofore made available to Company a true, complete and correct copy of its Certificate of Incorporation, as

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amended to date (the “Acquired Corporation Charter”), and By-Laws, as amended to date (the “Acquired Corporation By-Laws”), and has furnished to Company true, complete and correct copies of the charter and By-Laws (or equivalent organizational documents), each as amended to date, of each of its Subsidiaries (the “Acquired Corporation Documents”). The Acquired Corporation Charter, Acquired Corporation By-Laws and the Acquired Corporation Documents are in full force and effect. The Acquired Corporation is not in violation of any of the provisions of the Acquired Corporation Charter or Acquired Corporation By-Laws and the Acquired Corporation’s Subsidiaries are not in violation of any of the provisions of their respective Acquired Corporation Documents.

Section 4.3 CAPITALIZATION.

(a) The Acquired Corporation is authorized to issue three classes of stock: common stock without par value (the “Acquired Corporation Common Stock”), non-voting common stock without par value (the “Acquired Corporation Non-Voting Common Stock”) and preferred stock with a par value of one cent each (the “Acquired Corporation Preferred Stock” and collectively with the Acquired Corporation Common Stock and the Acquired Corporation Non-Voting Common Stock, the “Acquired Corporation Stock”). The total number of shares which the Acquired Corporation is authorized to issue is 30,000,000. The total number of shares of Acquired Corporation Preferred Stock which the Acquired Corporation is authorized to issue is 9,477,258, the total number of shares of Acquired Corporation Common Stock which the Acquired Corporation is authorized to issue is 15,522,742, and the total number of shares of Acquired Corporation Non-Voting Common Stock which the Acquired Corporation is authorized to issue is 5,000,000. The Acquired Corporation Preferred Stock has been issued in five series, designated as series A through E convertible preferred stock. As of the date hereof, the Acquired Corporation has issued and outstanding, or issued into escrow, 4,205,930 shares of Acquired Corporation Common Stock, zero shares of Acquired Corporation Non-Voting Common Stock, 1,317,391 shares of Series A Preferred Stock, 1,858,239 shares of Series B Preferred Stock, 2,564,102 shares of Series C Preferred Stock, 2,217,769 shares of Series D Preferred Stock, 988,441 shares of Series E Preferred Stock. As of the date hereof (i) 11,316,812 shares of Acquired Corporation Stock are reserved for issuance and (ii) no shares of Acquired Corporation Stock are issued and held in the treasury of the Acquired Corporation. The Acquired Corporation has not amended its certificate of incorporation since the date it filed its Fifth Amended and Restated Certificate of Incorporation on June 22, 2001, and a subsequent amendment filed on February 21, 2003.

(b) No person holds outstanding options, warrants or other rights to purchase shares of Acquired Corporation Stock.

(c) Except as described in Section 4.3(a) of this Agreement or as set forth in Section 4.3(b) of the Acquired Corporation Disclosure Schedule, no capital stock of the Acquired Corporation or any of its Subsidiaries or any security convertible or exchangeable into or exercisable for such capital stock, is issued, reserved for issuance or outstanding as of the date of this Agreement. Except as described in Section 4.3(a) of this Agreement or as set forth in Section 4.3(b) of the Acquired Corporation Disclosure Schedule, there are no options, preemptive rights, warrants, calls, rights, commitments, agreements, arrangements or understandings of any kind to which the Acquired Corporation or any of its Subsidiaries is a party, or by which the Acquired Corporation or any of its Subsidiaries is bound, obligating the Acquired Corporation or any of its Subsidiaries to issue, deliver or sell, or cause to be issued, delivered or sold, additional shares of capital stock of the Acquired Corporation or any of its Subsidiaries or obligating the Acquired Corporation or any of its Subsidiaries to grant, extend or accelerate the vesting of or enter into any such option, warrant, call, right, commitment, agreement, arrangement or understanding. Except as set forth in Section 4.3(c) of the Acquired Corporation Disclosure Schedule, there are no stockholder agreements, voting trusts, proxies or other similar agreements, arrangements or understandings to which the Acquired Corporation or any of its Subsidiaries is a party, or by which it or they are bound, obligating the Acquired Corporation or any of its Subsidiaries with respect to any shares of capital stock of the Acquired Corporation or any of its Subsidiaries. There are no rights or obligations, contingent or otherwise (including rights of first refusal in favor of the Acquired Corporation), of the Acquired Corporation or any of its Subsidiaries, to repurchase,

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redeem or otherwise acquire any shares of capital stock of the Acquired Corporation or any of its Subsidiaries or to provide funds to or make any investment (in the form of a loan, capital contribution or otherwise) in any such Subsidiary or any other entity. There are no registration rights or other agreements, arrangements or understandings to which the Acquired Corporation or any of its Subsidiaries is a party, or by which it or they are bound, obligating the Acquired Corporation or any of its Subsidiaries with respect to any shares of Acquired Corporation Stock or shares of capital stock of any such Subsidiary.

(d) All outstanding shares of the Acquired Corporation’s capital stock are duly authorized, validly issued, fully paid and nonassessable and not subject to or issued in violation of any purchase option, call option, right of first refusal, pre-emptive right, subscription right or any similar right under any provision of the CBCA, the Acquired Corporation Charter or the Acquired Corporation By-Laws or any agreement to which the Acquired Corporation is a party or otherwise bound. None of the outstanding shares of the Acquired Corporation’s capital stock have been issued in violation of any federal or state securities laws. No material change in the Acquired Corporation’s capitalization has occurred since December 31, 2003. All of the outstanding shares of capital stock of each of the Acquired Corporation’s Subsidiaries are duly authorized, validly issued, fully paid and nonassessable, and all such shares (other than directors’ qualifying shares in the case of foreign Subsidiaries) are owned by the Acquired Corporation or a Subsidiary of the Acquired Corporation free and clear of all Liens. There are no accrued and unpaid dividends with respect to any outstanding shares of capital stock of the Acquired Corporation or any of its Subsidiaries.

Section 4.4 AUTHORITY RELATIVE TO THIS AGREEMENT. Subject only to the approvals described below, the Acquired Corporation has all necessary corporate power and authority to execute and deliver this Agreement and each instrument required hereby to be executed and delivered by it at the Closing and to perform its obligations hereunder and to consummate the transactions contemplated hereby. The execution and delivery by the Acquired Corporation of this Agreement and each instrument required hereby to be executed and delivered at the Closing by the Acquired Corporation and the consummation by the Acquired Corporation of the transactions contemplated hereby have been duly and validly authorized by all necessary corporate action on the part of the Acquired Corporation, subject only to the approval of this Agreement and the Merger by the Board of Directors and stockholders of Acquired Corporation and holders of certain notes of Acquired Corporation. This Agreement has been duly and validly executed and delivered by the Acquired Corporation and, assuming the due authorization, execution and delivery of this Agreement by the Company and the foregoing approvals, constitutes the legal, valid and binding obligation of the Acquired Corporation, enforceable against the Acquired Corporation in accordance with its terms.

Section 4.5 ANTI-TAKEOVER STATUTE NOT APPLICABLE. No Takeover Statute under the laws of the State of Connecticut is applicable to the Acquired Corporation, the shares of Acquired Corporation Stock, the Merger or any of the other transactions contemplated by this Agreement.

Section 4.6 AGREEMENTS, CONTRACTS AND COMMITMENTS. Except as disclosed in Section 4.6 of the Acquired Corporation Disclosure Schedule:

(a) Other than leases listed in Section 4.14 of the Acquired Corporation Disclosure Schedule, neither the Acquired Corporation nor any of its Subsidiaries has any agreements, contracts or commitments which (i) require payment by the Acquired Corporation or any of its Subsidiaries in excess of $100,000 or (ii) require the making of any charitable contribution in excess of $50,000;

(b) No purchase contracts or purchase commitments of the Acquired Corporation or any of its Subsidiaries have a duration in excess of the normal, ordinary and usual requirements of the business of the Acquired Corporation or its Subsidiary, as applicable;

(c) There are no outstanding sales contracts or sales commitments of the Acquired Corporation or any of its Subsidiaries which have a duration in excess of the normal, ordinary and usual practices of the business of the Acquired Corporation, and there are no outstanding contracts, bids or sales or service proposals quoting prices or terms which would not reasonably be expected to result in a normal profit;

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(d) Except for (i) nondisclosure agreements entered into in the ordinary course; (ii) agreements for the trial, evaluation, purchase, sale, license, distribution, maintenance or support of Acquired Corporation products entered into in the ordinary course; (iii) agreements which require payment by or to the Acquired Corporation or any of its Subsidiaries not in excess of $100,000; (iv) agreements which do not provide for any term extension or expansion of the rights granted with respect to the Acquired Corporation Intellectual Property owned by the Acquired Corporation as a result of the Merger; or (v) Real Property Leases for individual properties listed in Section 4.14 of the Acquired Corporation Disclosure Schedule comprising less than 5,000 square feet, there are no contracts or agreements of the Acquired Corporation or any of its Subsidiaries which do not expire or which the Acquired Corporation may not terminate within one year after the date of this Agreement or which may be renewed at the option of any person other than the Acquired Corporation so as to expire more than one year after the date of this Agreement;

(e) Except for (i) nondisclosure agreements entered into in the ordinary course or (ii) agreements for the trial, evaluation, purchase, sale, license, distribution, maintenance or support of Acquired Corporation products entered into in the ordinary course, neither the Acquired Corporation nor any of its Subsidiaries has (A) any contracts or agreements with officers, employees, agents, consultants, advisors, salesmen, sales representatives, distributors or dealers which require payment by or to the Acquired Corporation or any of its Subsidiaries in excess of $100,000 and which are not cancelable by it on notice of not longer than thirty days and without liability, penalty or premium or (B) any contracts, agreements or arrangements providing for the payment of any bonus or commission based on sales or earnings, in each case where the cost to the Acquired Corporation will exceed $100,000;

(f) Neither the Acquired Corporation nor any of its Subsidiaries is in default, nor is there any known basis for any valid claim of default, under any contract made or obligation owed by it, except for such defaults that would not reasonably be likely to have, in the aggregate, an Acquired Corporation Material Adverse Effect;

(g) Neither the Acquired Corporation nor any of its Subsidiaries has any employee to whom it is paying compensation at the annual rate of more than $100,000;

(h) Neither the Acquired Corporation nor any of its Subsidiaries is restricted by agreement from carrying on its business in any material respect anywhere in the world by any agreement under which the Acquired Corporation (i) is restricted from selling, licensing or otherwise distributing any of its technology or products or providing services to customers or potential customers or any class of customers, including resellers or other distributors, in any geographic area, during any period of time, or in segment of any market or line of business; (ii) is required to give favored pricing to any customers or potential customers or any class of customers (that is, required to give pricing to such customers or potential customers or classes of customers that is at least as good or better to that offered to others) or to provide exclusive or favored access to any product features, excluding exclusive customizations, to any customers or potential customers or any class of customers (it being understood that agreements to provide updates, enhancements or new versions as they become available shall not be considered “favorable access,” nor shall agreements to provide alpha, beta or other similar restricted release versions of products); (iii) has agreed to purchase a material minimum amount of goods or services; or (iv) has agreed to purchase goods or services exclusively from a certain party;

(i) Neither the Acquired Corporation nor any of its Subsidiaries is under any liability or obligation with respect to the return of inventory or merchandise in the possession of wholesalers, distributors, resellers, retailers or other customers, except for such obligations or liabilities that would not reasonably be likely to have, in the aggregate, an Acquired Corporation Material Adverse Effect;

(j) Neither the Acquired Corporation nor any of its Subsidiaries has any debt obligation for borrowed money (other than capital leases), including guarantees of or agreements to acquire any such debt obligation of others (other than guarantees by the Acquired Corporation of obligations of its Subsidiaries);

(k) The Acquired Corporation and its Subsidiaries do not have contracts for capital expenditures exceeding $1,000,000 in the aggregate;

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(l) Neither the Acquired Corporation nor any of its Subsidiaries has any contract, agreement or commitment currently in force relating to the disposition or acquisition of assets not in the ordinary course of business;

(m) Neither the Acquired Corporation nor any of its Subsidiaries has any contract, agreement or commitment for the purchase of any ownership interest in any corporation, partnership, joint venture or other business enterprise;

(n) Neither the Acquired Corporation nor any of its Subsidiaries has any outstanding loan to Mr. Mercadante or to Dale Ribaudo (“Mr. Ribaudo”). As to persons other than Mr. Mercadante and Mr. Ribaudo, neither the Acquired Corporation nor any of its Subsidiaries has any outstanding loan (other than any loan for employee relocation or any loan not in excess of $50,000) to any such person other than to the Acquired Corporation or a wholly owned Subsidiary of the Acquired Corporation in an amount that exceeds $50,000;

(o) Neither the Acquired Corporation nor any of its Subsidiaries has any power of attorney outstanding or any material obligations or liabilities (whether absolute, accrued, contingent or otherwise), as guarantor (other than guarantees by the Acquired Corporation of obligations of its Subsidiaries), surety, co-signer, endorser or co-maker in respect of any obligation of any person, corporation, partnership, joint venture, association, organization or other entity, or any capital maintenance, keep-well or similar agreements or arrangements;

(p) Neither the Acquired Corporation nor any of its Subsidiaries has any agreements, contracts or arrangements containing any provision requiring the Acquired Corporation to indemnify another party (excluding indemnities contained in agreements for the trial, evaluation, purchase, sale, distribution, maintenance, support or license of products entered into in the ordinary course of business consistent with past practice and in any Real Property Leases) or, other than in the case of settlement agreements entered into prior to the date of this Agreement with current or former officers or employees of the Acquired Corporation in their individual capacity, containing any covenant not to bring legal action against any third party;

(q) The Acquired Corporation has made available to Company true, complete and correct copies of each contract listed in Section 4.6 of the Acquired Corporation Disclosure Schedule (collectively, the “Company Material Contracts”); and

(r) (i) Neither the Acquired Corporation nor any of its Subsidiaries has breached, is in default under, or has received written notice of any breach of or default under, any Company Material Contract, which breach or default remains uncured, (ii) to the Acquired Corporation’s knowledge, no other party to any Company Material Contract has breached or is in default of any of its obligations thereunder, which breach or default remains uncured, (iii) each Company Material Contract is in full force and effect and (iv) each Company Material Contract is a legal, valid and binding obligation of the Acquired Corporation or its Subsidiary and each of the other parties thereto, enforceable in accordance with its terms.

Section 4.7 NO CONFLICT; REQUIRED FILINGS AND CONSENTS.

(a) The execution and delivery by the Acquired Corporation of this Agreement do not, the execution and delivery by the Acquired Corporation of any instrument required hereby to be executed and delivered by the Acquired Corporation at the Closing will not, and the performance of its agreements and obligations under this Agreement by the Acquired Corporation will not, (i) conflict with or violate the Acquired Corporation Charter or Acquired Corporation By-Laws or any Acquired Corporation Documents, (ii) conflict with or violate any law, rule, regulation, order, judgment or decree applicable to the Acquired Corporation or any of its Subsidiaries or by which its or any of their respective properties is bound or affected, (iii) result in any breach of or constitute a default (or an event that with notice or lapse of time or both would become a default), or impair the Acquired Corporation’s or any of its Subsidiaries’ rights or

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alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, payment, acceleration or cancellation of, or result in the creation of a Lien on any of the properties or assets (including intangible assets) of the Acquired Corporation or any of its Subsidiaries pursuant to, any note, bond, mortgage, indenture, contract, agreement, lease, license, permit, franchise or other instrument or obligation to which the Acquired Corporation or any of its Subsidiaries is a party or by which the Acquired Corporation or any of its Subsidiaries or its or any of their respective properties is bound or affected, or (iv) give rise to or result in any person having, or having the right to exercise, any pre-emptive rights, rights of first refusal, rights to acquire or similar rights with respect to any capital stock of the Acquired Corporation or any of its Subsidiaries or any of their respective assets or properties, other than, in the case of (iii) above, such breaches, defaults, impairments, rights of termination, amendment, acceleration or cancellation, or Liens that would not be reasonably expected to have, in the aggregate, an Acquired Corporation Material Adverse Effect.

(b) The execution and delivery by the Acquired Corporation of this Agreement do not, the execution and delivery by the Acquired Corporation of any instrument required hereby to be executed and delivered by the Acquired Corporation at the Closing will not, and the performance of its agreements and obligations under this Agreement by the Acquired Corporation will not, require any consent, approval, order, license, authorization, registration, declaration or permit of, or filing with or notification to, any Governmental Entity, except (i) as may be required by the HSR Act, (ii) such consents, approvals, orders, licenses, authorizations, registrations, declarations, permits, filings, and notifications as may be required under applicable U.S. federal and state securities laws, (iii) the filing of the Certificate of Merger or other documents as required by the NRS and the CBCA, and (iv) such other consents, approvals, orders, registrations, declarations, permits, filings and notifications which, if not obtained or made, could not reasonably be expected to have a material adverse effect.

Section 4.8 COMPLIANCE; PERMITS.

(a) (i) To the best of the knowledge of Acquired Corporation and its Subsidiaries are and have been in material compliance with and are not in material default or violation of (and have not received any notice of material non-compliance, default or violation with respect to) any law, rule, regulation, order, judgment or decree applicable to Acquired Corporation or any of its Subsidiaries or by which any of their respective properties is bound or affected (and Acquired Corporation is not aware of any such material non-compliance, default or violation thereunder), including but not limited to: employment, labor, health and safety, including, but not limited to all United States Food and Drug Administration guidelines and OSHA regulations in connection with any oxygen filling stations, storage, distribution or sale by Acquired Corporation or any Subsidiary, Medicare/Medicaid fraud and abuse and environmental laws.

(ii) To the best of the knowledge of Acquired Corporation and its Subsidiaries are and have been in material compliance with all other laws, statutes, ordinances, orders, rules, regulations, policies and guidelines promulgated, and all judgments, decisions and orders entered, by any Federal, state, local or foreign court or governmental authority or instrumentality which are applicable or relate to the business or properties of Acquired Corporation or any Subsidiary, including, without limitation, health and healthcare industry regulations, third-party reimbursement laws (including Medicare and Medicaid), Title VII of the Civil Rights Act of 1964, as amended, the Fair Labor Standards Act, as amended, the Occupational Safety and Health Act of 1970, as amended, the Americans with Disabilities Act of 1990, the Controlled Substances Act, the Federal Food, Drug and Cosmetic Act (as amended by the Prescription Drug Marketing Act of 1987) and the Health Insurance Portability & Accountability Act of 1996 as amended.

(iii) To the best of the knowledge of Acquired Corporation, neither Acquired Corporation nor any Subsidiary thereof nor the officers, directors, employees or agents of any of them, have engaged in any activities which are in violation of Medicare, Medicaid or any other “State Health Care Program” (as

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defined in Section 1128(h) of the Social Security Act (“SSA”)) or “Federal Health Care Program” (as defined in SSA Section 1128B(f)) under § 1320a–7, 1320a-7a, 1320a-7b, or 1395nn of Title 42 of the Code, the federal Civilian Health and Medical Plan of the Uniformed Services (“CHAMPUS”) statute, or the regulations promulgated pursuant to such statutes or regulations or related state or local statutes or which are prohibited by any private accrediting organization from which Acquired Corporation or any Subsidiary seeks accreditation or by generally recognized professional standards of care or conduct, including but not limited to the following activities: (i) knowingly and willfully making or causing to be made a false statement or representation of a material fact in any application for any benefit or payment; (ii) knowingly and willfully making or causing to be made any false statement or representation of a material fact for use in determining rights to any benefit or payment; or (iii) presenting or causing to be presented a claim for reimbursement under CHAMPUS, Medicare, Medicaid or any other State Health Care Program of Federal Health Care Program that is (A) for an item or service that the person presenting or causing to be presented knows or should know was not provided as claimed, (B) for an item or service and the person presenting knows or should know that the claim is false or fraudulent, (C) knowingly and willfully offering, paying, soliciting or receiving any remuneration (including any kickback, bribe, or rebate), directly or indirectly, overtly or covertly, in cash or in kind in return for referring, or to induce the referral of, an individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made in whole or in part by CHAMPUS, Medicare, Medicaid, or any other State Health Care Program or Federal Health Care Program, or in return for, or to induce, the purchase, lease, or order, or the arranging for or recommending of the purchase, lease, or order, or any good, facility, service, or item for which payment may be made in whole or in part by CHAMPUS, Medicare, Medicaid or any other State Health Care Program or Federal Health Care Program certification, or (D) knowingly and willfully making or causing to be made or inducing or seeking to induce the making of any false statement or representation (or omitting to state a material fact required to be stated therein or necessary to make the statements contained therein not misleading) or a material fact with respect to the conditions or operations of a facility in order that the facility may qualify for CHAMPUS, Medicare, Medicaid or any other State Health Care Program or Federal Health Care Program certification, or information required to be provided under SSA § 1124A.

(b) The Acquired Corporation and its Subsidiaries hold all permits, licenses, easements, variances, exemptions, consents, certificates, authorizations, registrations, orders and other approvals from Governmental Entities that are material to the operation of the business of the Acquired Corporation and its Subsidiaries taken as a whole as currently conducted (collectively, the “Acquired Corporation Permits”). The Acquired Corporation Permits are in full force and effect, have not been violated in any material respect and, to the best knowledge of the Acquired Corporation, no suspension, revocation or cancellation thereof has been threatened, and there is no action, proceeding or investigation pending or, to the Acquired Corporation’s knowledge, threatened, seeking the suspension, revocation or cancellation of any Acquired Corporation Permits. No Acquired Corporation Permit shall cease to be effective as a result of the consummation of the transactions contemplated by this Agreement.

(c) Except as set forth in Section 4.8(c) to the Acquired Corporation Disclosure Schedule or as would not, individually or in the aggregate, reasonably be expected to have an Acquired Corporation Material Adverse Effect, to the best knowledge of Acquired Corporation:

(i) all necessary clearances or approvals from Governmental Entities for all drug and device products which are manufactured and/or sold by Acquired Corporation and its Subsidiaries have been obtained and Acquired Corporation and its Subsidiaries are in substantial compliance with the most current form of each applicable clearance or approval with respect to the manufacture, storage, distribution, promotion and sale by Acquired Corporation and its Subsidiaries of such products;

(ii) none of Acquired Corporation, its Subsidiaries, or any of their officers, employees or agents (during the term of such person’s employment by Acquired Corporation or any of its Subsidiaries or while acting as an agent of Acquired Corporation or any of its Subsidiaries, or, to the knowledge of

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Acquired Corporation, prior to such employment) has made any untrue statement of a material fact or fraudulent statement to the Food and Drug Administration (“FDA”), the U.S. Nuclear Regulatory Commission (the “NRC”) or any similar Governmental Entities, failed to disclose a material fact required to be disclosed to the FDA, NRC or similar Governmental Entities, or committed an act, made a statement or failed to make a statement that would reasonably be expected to provide a basis for the FDA, NRC or similar Governmental Entities to invoke its policy respecting “Fraud, Untrue Statements of Material Facts, Bribery, and Illegal Gratuities” or similar governmental policy, rule, regulation or law;

(iii) as to each article of drug, device, cosmetic or vitamin manufactured (directly or indirectly) and/or distributed by Acquired Corporation and its Subsidiaries, such article is not adulterated or misbranded within the meaning of the Food, Drug and Cosmetic Act or any similar governmental act or law of any jurisdiction; and

(iv) none of Acquired Corporation, its Subsidiaries or any of their officers, or to the knowledge of Acquired Corporation, employees or agents (during the term of such person’s employment by Acquired Corporation or any of its Subsidiaries or while acting as an agent of Acquired Corporation or any of its Subsidiaries, or, to the knowledge of Acquired Corporation, prior to such employment), has been convicted of any crime or engaged in any conduct for which debarment or similar punishment is mandated or permitted by any applicable law.

Section 4.9 ABSENCE OF CERTAIN CHANGES OR EVENTS. Since December 31, 2003, the Acquired Corporation has conducted its business in the ordinary course consistent with past practice and, since such date, there has not occurred: (i) any change, development, event or other circumstance, situation or state of affairs that has had or would reasonably be expected to have an Acquired Corporation Material Adverse Effect; (ii) any amendments to or changes in the Acquired Corporation Charter or Acquired Corporation By-Laws; (iii) any damage to, destruction or loss of any asset of the Acquired Corporation or any of its Subsidiaries (whether or not covered by insurance) that could reasonably be expected to have an Acquired Corporation Material Adverse Effect; (iv) any change by the Acquired Corporation in its accounting methods, principles or practices; (v) any revaluation by the Acquired Corporation of any of its assets, including writing down the value of inventory or writing off notes or accounts receivable other than in the ordinary course of business consistent with past practice, in terms of both frequency and amount, and in any event in excess of $100,000; or (vi), except as set forth in Section 4.9 of the Acquired Corporation Disclosure Schedule, any sale of a material amount of assets (tangible or intangible) of the Acquired Corporation.

Section 4.10 NO UNDISCLOSED LIABILITIES.

(a) Except as reflected in the unaudited balance sheet of Acquired Corporation for the quarter ended December 31, 2003 (the “Acquired Corporation Balance Sheet”), neither the Acquired Corporation nor any of its Subsidiaries has any liabilities (absolute, accrued, contingent or otherwise) which are required by GAAP to be set forth on a consolidated balance sheet of the Acquired Corporation and its consolidated subsidiaries or in the notes thereto, other than (i) any liabilities and obligations incurred since December 31, 2003 in the ordinary course of business consistent with past practice, (ii) any liabilities or obligations incurred in connection with the transactions contemplated by this Agreement and (iii) liabilities that, individually and in the aggregate, have not had, and would not reasonably be expected to have, an Acquired Corporation Material Adverse Effect.

(b) Neither the Acquired Corporation nor any of its Subsidiaries is a party to, or has any commitment to become a party to, any joint venture, partnership agreement or any similar contract (including any contract relating to any transaction, arrangement or relationship between or among the Acquired Corporation or any of its Subsidiaries, on the one hand, and any unconsolidated affiliate, including any structured finance, special purpose or limited purpose entity or person, on the other hand) where the purpose or intended effect of such arrangement is to avoid disclosure of any material transaction involving the Acquired Corporation or any of its Subsidiaries in the Acquired Corporation’s consolidated financial statements.

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(c) Neither the Acquired Corporation nor any of its Subsidiaries is a party to, or has any commitment to become a party to, any tax shelter arrangement as described in Internal Revenue Service final regulations (T.D. 9046).

Section 4.11 ABSENCE OF LITIGATION; INVESTIGATIONS. Except as set forth on Section 4.11 of the Acquired Corporation Disclosure Schedule:

There are no material claims, actions, suits, proceedings or, to the knowledge of the Acquired Corporation, governmental investigations, inquiries or subpoenas (a) pending against the Acquired Corporation or any of its Subsidiaries or any properties or assets of the Acquired Corporation or of any of its Subsidiaries or (b) to the knowledge of the Acquired Corporation, threatened against the Acquired Corporation or any of its Subsidiaries, or any properties or assets of the Acquired Corporation or of any of its Subsidiaries, or (c) whether filed or threatened, that have been settled or compromised by the Acquired Corporation or any Subsidiary within the three years prior to the date of this Agreement. Neither the Acquired Corporation nor any Subsidiary of the Acquired Corporation is subject to any outstanding order, writ, injunction or decree that would reasonably be expected to be material or would reasonably be expected to prevent or delay the consummation of the transactions contemplated by this Agreement. There has not been since January 1, 2000 nor are there currently any internal investigations or inquiries being conducted by the Acquired Corporation, its Board of Directors (or any committee thereof) or any third party at the request of any of the foregoing concerning any financial, accounting, tax, conflict of interest, self-dealing, fraudulent or deceptive conduct or other misfeasance or malfeasance issues.

Section 4.12 EMPLOYEE BENEFIT PLANS, OPTIONS AND EMPLOYMENT AGREEMENTS.

(a) Section 4.12(a) of the Acquired Corporation Disclosure Schedule sets forth a complete and accurate list of all Employee Benefit Plans maintained, or contributed to, by the Acquired Corporation, any of the Acquired Corporation’s Subsidiaries or any of their ERISA Affiliates or to which the Acquired Corporation, any of the Acquired Corporation’s Subsidiaries or any of their respective ERISA Affiliates is obligated to contribute, or under which any of them has or may have any liability for premiums or benefits (collectively, the “Acquired Corporation Employee Plans”).

(b) With respect to each Acquired Corporation Employee Plan, the Acquired Corporation has made available to Company complete and accurate copies of (i) such Acquired Corporation Employee Plan (or a written summary of any unwritten plan) together with all amendments, (ii) in the case of any plan for which Forms 5500 are required to be filed, the most recent annual report (Form 5500) with schedules attached, (iii) in the case of any plan that is intended to be qualified under Section 401(a) of the Code, the most recent determination letter from the IRS, (iv) each trust agreement, group annuity contract, administration and similar material agreements, investment management or investment advisory agreements, (v) the most recent summary plan descriptions and employee handbook, or other similar material employee communications, (vi) all personnel, payroll and employment manuals and policies, and (vii) the most recent financial statements for each Acquired Corporation Employee Plan that is funded.

(c) Each Acquired Corporation Employee Plan has been administered in all material respects in accordance with ERISA, the Code and all other applicable laws and the regulations thereunder and materially in accordance with its terms and each of the Acquired Corporation, the Acquired Corporation’s Subsidiaries and their ERISA Affiliates have in all material respects met their obligations with respect to each Acquired Corporation Employee Plan and have timely made (or timely will make) all required contributions thereto. All material filings and reports as to each Acquired Corporation Employee Plan required to have been submitted to the Internal Revenue Service or to the United States Department of Labor have been timely submitted. With respect to the Acquired Corporation Employee Plans, no event has occurred, and, to the knowledge of the Acquired Corporation, there exists no condition or set of circumstances in connection with which Company, the Acquired Corporation or any of its Subsidiaries or any plan participant could be subject to any material liability (including penalties or taxes) under ERISA,

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the Code or any other applicable law, nor will the negotiation or consummation of the transactions contemplated by this Agreement give rise to any such material liability.

(d) With respect to the Acquired Corporation Employee Plans, there are no material benefit obligations for which contributions have not been made or properly accrued and there are no benefit obligations which have not been accounted for by reserves, or otherwise properly footnoted in accordance with the requirements of GAAP, on the financial statements of the Acquired Corporation. The assets of each Acquired Corporation Employee Plan which is funded are reported at their fair market value on the books and records of such Employee Benefit Plan.

(e) No Acquired Corporation Employee Plan has assets that include securities issued by the Acquired Corporation, any of the Acquired Corporation’s Subsidiaries or any of their ERISA Affiliates.

(f) All the Acquired Corporation Employee Plans that are intended to be a Qualified Plan have received determination, opinion or advisory letters from the Internal Revenue Service to the effect that such Acquired Corporation Employee Plans are qualified and the plans and trusts related thereto are exempt from federal income taxes under Sections 401(a) and 501(a), respectively, of the Code, or the Acquired Corporation has remaining a period of time under applicable U.S. Department of the Treasury regulations or IRS pronouncements in which to apply for such a letter and to make any amendments necessary to obtain a favorable determination as to the qualified status of each such Qualified Plan. To the Acquired Corporation’s knowledge, no such determination, opinion or advisory letter has been revoked and revocation has not been threatened, and no such Employee Benefit Plan has been amended or operated since the date of its most recent determination letter or application therefor in any respect, and no act or omission has occurred, that would adversely affect its qualification or materially increase its cost. There has been no termination, partial termination or discontinuance of contributions to any Qualified Plan that will result in material liability to the Acquired Corporation. Each Acquired Corporation Employee Plan which is required to satisfy Section 401(k)(3) or Section 401(m)(2) of the Code has been tested for compliance with, and satisfies in all material respects the requirements of Section 401(k)(3) and Section 401(m)(2) of the Code, as the case may be, for each plan year ending prior to the Effective Date for which testing is required to be completed.

(g) Neither the Acquired Corporation, any of the Acquired Corporation’s Subsidiaries nor any of their ERISA Affiliates has (i) ever maintained an Acquired Corporation Employee Plan which was ever subject to Section 412 of the Code or Title IV of ERISA or (ii) ever been obligated to contribute to a “multiemployer plan” (as defined in Section 4001(a)(3) of ERISA). No Acquired Corporation Employee Plan is funded by, associated with or related to a “voluntary employees’ beneficiary association” within the meaning of Section 501(c)(9) of the Code.

(h) To the extent permitted by applicable law, each Acquired Corporation Employee Plan (other than the Acquired Corporation Stock Plans or an employment, severance, change in control or similar agreement with an individual) is amendable and terminable unilaterally by the Acquired Corporation and any of the Acquired Corporation’s Subsidiaries party thereto or covered thereby at any time without material liability to the Acquired Corporation or any of its Subsidiaries as a result thereof, other than for benefits accrued as of the date of such amendment or termination and routine administrative costs.

(i) Other than as required under Section 601 et seq. of ERISA, none of the Acquired Corporation Employee Plans promises or provides health or other welfare benefits (excluding normal claims for benefits under the Acquired Corporation’s group life insurance, accidental death and dismemberment insurance and disability plans and policies) or coverage to any person following retirement or other termination of employment. Section 4.12(i) of the Acquired Corporation Disclosure Schedule lists each Acquired Corporation Employee Plan which provides benefits after termination of employment (other than medical benefits required to be continued under Section 4980B of the Code and part 6 of Subtitle B of Title I of ERISA) and the amount, if any, by which the present value of benefits accrued under each such Acquired Corporation Employee Plan exceeds the fair market value of the assets of each such Acquired Corporation Employee Plan.

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(j) There is no action, suit, proceeding, claim, arbitration, audit or investigation pending or, to the knowledge of the Acquired Corporation, threatened, with respect to any Acquired Corporation Employee Plan, other than claims for benefits in the ordinary course. No Acquired Corporation Employee Plan is or within the last three calendar years has been the subject of, or has received notice that it is the subject of, examination by a government agency or a participant in a government sponsored amnesty, voluntary compliance or similar program.

(k) Except as set forth in Section 4.12(k) of the Acquired Corporation Disclosure Schedule, to the knowledge of the Acquired Corporation, each individual who has received compensation for the performance of services on behalf of the Acquired Corporation, any of the Acquired Corporation’s Subsidiaries or its ERISA Affiliates has been properly classified as an employee or independent contractor in accordance with applicable law.

(l) Each Acquired Corporation Employee Plan maintained or covering employees outside the United States, and the books and records thereof, is in material compliance with all applicable laws, rules and regulations of each applicable jurisdiction. Section 4.12(l) of the Acquired Corporation Disclosure Schedule lists each country in which the Acquired Corporation or any of its affiliates has operations and the number of employees in each such country.

(m) Section 4.12(m) of the Acquired Corporation Disclosure Schedule sets forth a true, complete and correct list of (i) all employment agreements with employees of the Acquired Corporation or any of its Subsidiaries obligating (or potentially obligating) the Acquired Corporation or any of its Subsidiaries to make annual cash payments in an amount equal to or exceeding $50,000; (ii) all employees of the Acquired Corporation or any of its Subsidiaries who have executed a non-competition agreement with the Acquired Corporation or any of its Subsidiaries; (iii) all severance agreements, programs and policies of the Acquired Corporation or any of its Subsidiaries with or relating to its employees, in each case with potential obligations equal to or exceeding $50,000, excluding programs and policies required to be maintained by law; and (iv) all plans, programs, agreements and other arrangements of the Acquired Corporation or any of its Subsidiaries pursuant to which payments (or acceleration of benefits or vesting of options or lapse of repurchase rights) may be required upon, or may become payable directly or indirectly as a result of or in connection with, the negotiation or consummation of the transactions contemplated by, or the execution of, this Agreement. True, complete and correct copies of each of the foregoing agreements to which any employee of the Acquired Corporation is a party have been made available to Company.

(n) All contributions required to be made with respect to any Acquired Corporation Employee Plan on or prior to the Effective Date have been or will be timely made or are reflected on the Acquired Corporation’s balance sheet. There are no pending, threatened or reasonably anticipated claims by or on behalf of any Plan, by any employee or beneficiary covered under any such Acquired Corporation Employee Plan, or otherwise involving any such Plan (other than routine claims for benefits).

(o) The negotiation or consummation of the transactions contemplated by this Agreement will not, either alone or in combination with another event, (i) except as set forth in Section 4.12 of the Acquired Corporation Disclosure Schedule, entitle any current or former employee or officer of the Acquired Corporation or any Subsidiary of the Acquired Corporation to severance pay, or any other payment from the Acquired Corporation or any of its Subsidiaries or (ii) accelerate the time of payment or vesting of any rights, a lapse of repurchase rights or increase the amount of compensation due any such employee or officer. There is no Acquired Corporation Employee Plan or other contract, agreement, plan or arrangement that, individually or collectively, could give rise to the payment of any amount that would not be deductible pursuant to Sections 280G (determined without regard to Section 280G(b)(4) of the Code) or 162(m) of the Code.

Section 4.13 LABOR MATTERS. (a) The Acquired Corporation and each of its Subsidiaries are in compliance in all material respects with all applicable laws respecting employment, employment practices and occupational safety and health, terms and conditions of employment and wages and hours, and are not engaged in any unfair labor practices; (b) there are no actions, suits, claims or grievances pending or, to the knowledge of the

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Acquired Corporation or any of its Subsidiaries, threatened, between the Acquired Corporation or any of its Subsidiaries and any of their respective employees, consultants or independent contractors, which actions, suits, claims or grievances have or would reasonably be expected to have an Acquired Corporation Material Adverse Effect; (c) neither the Acquired Corporation nor any of its Subsidiaries is a party to any collective bargaining agreement or other labor union contract applicable to persons employed by the Acquired Corporation or its Subsidiaries, nor does the Acquired Corporation or any of its Subsidiaries know of any activities or proceedings of any labor union to organize any such employees; and (d) to the knowledge of the Acquired Corporation, there are no labor disputes, strikes, slowdowns, work stoppages, lockouts, or threats thereof, by or with respect to any employees of, or consultants or independent contractors to, the Acquired Corporation or any of its Subsidiaries. No employee of the Acquired Corporation or any of its Subsidiaries (i) to the Acquired Corporation’s knowledge is in violation of any term of any patent disclosure agreement, non-competition agreement, or any restrictive covenant to a former employer relating to the right of any such employee to be employed by the Acquired Corporation or any of its Subsidiaries because of the nature of the business conducted or presently proposed to be conducted by the Acquired Corporation or any of its Subsidiaries or to the use of trade secrets or proprietary information of others, or (ii) in the case of any key employee or group of key employees, has given notice as of the date of this Agreement to the Acquired Corporation or any of its Subsidiaries that such employee or any employee in a group of key employees intends to terminate his or her employment with the Acquired Corporation. Neither the Acquired Corporation nor any of its Subsidiaries has any material liability for (i) a plant closing, as defined in the WARN Act, or (ii) a mass layoff, as defined in the WARN Act. Neither the Acquired Corporation nor any of its Subsidiaries is currently engaged in any layoffs or employment terminations sufficient in number to trigger application of any similar state, local or foreign law.

Section 4.14 PROPERTIES; ENCUMBRANCES. Acquired Corporation and each of its Subsidiaries has good and valid title to, or a valid leasehold interest in, all the properties and assets which it purports to own or lease (real, tangible, personal and mixed), including all the properties and assets reflected in the Acquired Corporation Balance Sheet (except for personal property sold since the date of the Acquired Corporation Balance Sheet in the ordinary course of business consistent with past practice). All properties and assets reflected in the Acquired Corporation Balance Sheet are free and clear of all Liens, except for Liens reflected on the Acquired Corporation Balance Sheet and Liens for current taxes not yet due and other Liens that do not materially detract from the value or impair the use of the property or assets subject thereto. Section 4.14 of the Acquired Corporation Disclosure Schedule sets forth a true, complete and correct list of all real property owned, leased, subleased or licensed by the Acquired Corporation and the location of such premises. Acquired Corporation and each of its Subsidiaries is and has been in material compliance with the provisions of each lease or sublease for the real property which is set forth in Section 4.14 of the Acquired Corporation Disclosure Schedule.

Section 4.15 TAXES. Except as set forth in Section 4.15 of the Acquired Corporation Disclosure Schedule:

(a) The Acquired Corporation and each of its Subsidiaries have filed with the appropriate taxing authorities all Tax Returns required to be filed by them, except to the extent that the failure to file would not reasonably be likely to have, in the aggregate, an Acquired Corporation Material Adverse Effect, and all such Tax Returns were true, complete and correct. All Taxes shown to be due on such Tax Returns have been timely paid. There are no Tax Liens on any assets of the Acquired Corporation or any Subsidiary thereof other than liens relating to Taxes not yet due and payable. Neither the Acquired Corporation nor any of its Subsidiaries has granted any outstanding waiver of any statute of limitations with respect to, or any outstanding extension of a period for the assessment of, any Tax. The accruals and reserves for Taxes (exclusive of any accruals for “deferred taxes” or similar items that reflect timing differences between tax and financial accounting principles) reflected in the Acquired Corporation Balance Sheet are adequate to cover all Taxes accruable through the date thereof (including interest and penalties, if any, thereon and Taxes being contested) in accordance with GAAP applied on a consistent basis with the Acquired Corporation Balance Sheet. All liabilities for Taxes attributable to the period commencing on the date following the date of the Acquired Corporation Balance Sheet were incurred in the ordinary course of business and are consistent in type and amount with Taxes attributable to similar prior periods.

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(b) The Acquired Corporation and each of its Subsidiaries have timely withheld with respect to its employees all federal and state Taxes required to be withheld, except to the extent that the failure to withhold would not reasonably be likely to have, in the aggregate, an Acquired Corporation Material Adverse Effect. Neither the Acquired Corporation nor any of its Subsidiaries has received any written notice of any Tax deficiency outstanding, proposed or assessed against the Acquired Corporation or any of its Subsidiaries. Neither the Acquired Corporation nor any of its Subsidiaries has received any written notice of any audit examination, deficiency, refund litigation, proposed adjustment or matter in controversy with respect to any Tax Return of the Acquired Corporation or any of its Subsidiaries. Neither the Acquired Corporation nor any of its Subsidiaries has filed any consent under Section 341(f) of the Code or agreed to have Section 341(f)(2) of the Code apply to any disposition of a subsection (f) asset (as defined in Section 341(f)(4) of the Code) owned by the Acquired Corporation. Neither the Acquired Corporation nor any of its Subsidiaries is a party to or bound by any tax indemnity, tax sharing or tax allocation agreements with any entity other than its Subsidiaries or Acquired Corporation. Except for the group of which the Acquired Corporation and its Subsidiaries are now currently members, neither the Acquired Corporation nor any of its Subsidiaries has ever been a member of an affiliated group of corporations within the meaning of Section 1504 of the Code. Neither the Acquired Corporation nor any of its Subsidiaries is liable for the Taxes of any person under Treasury Regulation 1.1502-6 (or any similar provision of state, local or foreign law) as a transferee or successor, by contract or otherwise.

(c) The Acquired Corporation made available to Company (i) complete and correct copies of all income Tax Returns, examination reports and statements of deficiencies assessed against or agreed to by the Acquired Corporation or any of its Subsidiaries with respect to all taxable years for which the statutes of limitation have not expired.

(d) None of the assets of the Acquired Corporation or any of its Subsidiaries: (i) is property that is required to be treated as being owned by any other person pursuant to the provisions of former Section 168(f)(8) of the Code; (ii) is “tax-exempt use of property” within the meaning of Section 168(h) of the Code; or (iii) directly or indirectly secures any debt the interest on which is tax exempt under Section 103(a) of the Code.

(e) Neither the Acquired Corporation nor any of its Subsidiaries has agreed nor is it required to make any material adjustment under Section 481 of the Code by reason of a change in accounting method or otherwise prior to the Effective Date.

(f) Neither the Acquired Corporation nor any of its Subsidiaries is, or has been, a United States real property holding corporation (as defined in Section 897(c)(2) of the Code) during the applicable period specified in Section 897(c)(1)(A)(ii) of the Code.

(g) Neither the Acquired Corporation nor any of its Subsidiaries has constituted either a “distributing corporation” or a “controlled corporation” (within the meaning of Section 355(a)(1)(A) of the Code) in a distribution of stock qualifying for tax-free treatment under Section 355 of the Code (A) in the two years prior to the date of this Agreement or (B) in a distribution which could otherwise constitute part of a “plan” or “series of related transactions” (within the meaning of Section 355(e) of the Code) in connection with the Merger.

(h) Neither the Acquired Corporation nor any of its Subsidiaries has taken any action or knows of any fact, agreement, plan or other circumstance that is reasonably likely to prevent the Merger as qualifying as a “reorganization” within the meaning of Section 368(a) of the Code.

Section 4.16 ENVIRONMENTAL MATTERS. Except as set forth in Section 4.16 of the Acquired Corporation Disclosure Schedule (i) the Acquired Corporation and its Subsidiaries are and have been in material compliance with all Environmental Laws; (ii) there has been no release or threatened release of any Hazardous Substance on, upon, into or from any site currently or heretofore owned, leased or otherwise used by the Acquired Corporation or its Subsidiaries, except for such releases that would not reasonably be likely to have, in the aggregate, an Acquired Corporation Material Adverse Effect; (iii) there have been no Hazardous Substances

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generated by the Acquired Corporation or its Subsidiaries that have been disposed of or come to rest at any site that has been included in any published U.S. federal, state or local “superfund” site list or any other similar list of hazardous or toxic waste sites published by any Governmental Entity within or outside the United States, except as would not reasonably be likely to have, in the aggregate, an Acquired Corporation Material Adverse Effect; and (iv) there are no underground storage tanks located on, no PCBs or PCB-containing equipment used or stored on, and no hazardous waste as defined by the Resource Conservation and Recovery Act, as amended, stored on, any site owned or operated by the Acquired Corporation or its Subsidiaries, except for the storage of hazardous waste in compliance with Environmental Law and except for such storage that would not reasonably be likely to have, in the aggregate, an Acquired Corporation Material Adverse Effect. The Acquired Corporation and its Subsidiaries have made available to Company true and correct copies of all material environmental records, reports, notifications, certificates of need, permits, pending permit applications, correspondence, engineering studies, and environmental studies or assessments relating to the business of the Acquired Corporation and its Subsidiaries or any of their respective properties and

Section 4.17 INTELLECTUAL PROPERTY.

(a) Section 4.17(a)(i) of the Acquired Corporation Disclosure Schedule sets forth as of the date hereof a true, complete and correct list of all U.S. and foreign (i) patents and pending patent applications owned by the Acquired Corporation or any of its Subsidiaries as of the date of this Agreement; (ii) trademark registrations (including internet domain registrations) and pending trademark applications owned by the Acquired Corporation or any of its Subsidiaries as of the date of this Agreement; and (iii) copyright registrations and pending copyright applications owned by the Acquired Corporation or any of its Subsidiaries as of the date of this Agreement (collectively the “Acquired Corporation Intellectual Property”). All of the Acquired Corporation Intellectual Property is owned solely by the Acquired Corporation or one of its Subsidiaries.

(b) The Acquired Corporation or one or more of its Subsidiaries owns, or has a valid right to use all of the Acquired Corporation Intellectual Property (as defined below) that is used in the business of the Acquired Corporation and its Subsidiaries as currently conducted.

(c) The Acquired Corporation Intellectual Property that is or has been used in the business of the Acquired Corporation or any of its Subsidiaries as currently or previously conducted, is (and at the time of any previous use, was), to the Acquired Corporation’s knowledge, subsisting (except with respect to applications), and has not expired or been cancelled, or abandoned.

(d) There is no pending or, to the Acquired Corporation’s knowledge, threatened (and at no time within the two years prior to the date of this Agreement has there been pending any) material suit, arbitration or other adversarial proceeding before any court, government agency or arbitral tribunal or in any jurisdiction alleging that any activities or conduct of the Acquired Corporation’s or any of its Subsidiaries’ business infringes or will infringe upon, violate or constitute the unauthorized use of the Intellectual Assets of any third party or challenging the ownership, validity, enforceability or registrability of any Acquired Corporation Intellectual Property owned by the Acquired Corporation or any of its Subsidiaries. The Acquired Corporation is not party to any settlements, covenants not to sue, consents, decrees, stipulations, judgments, or orders resulting from suits, actions or similar legal proceedings which (i) materially restrict the Acquired Corporation’s or any of its Subsidiaries’ rights to use any Acquired Corporation Intellectual Property owned by and material to the business of the Acquired Corporation or any of its Subsidiaries as currently conducted, (ii) materially restrict the conduct of the business of the Acquired Corporation or any of its Subsidiaries as currently conducted in order to accommodate any third party’s rights to such third party’s Intellectual Assets, or (iii) permit third parties to use any Acquired Corporation Intellectual Property owned by and material to the business of the Acquired Corporation or any of its Subsidiaries as currently conducted.

(e) The conduct of the business of the Acquired Corporation and its Subsidiaries as currently conducted does not infringe upon any rights of any third party to such third party’s Intellectual Assets. The Acquired

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Corporation and its Subsidiaries have taken reasonable measures to protect the proprietary nature of the Acquired Corporation Intellectual Property owned by the Acquired Corporation or such Subsidiary that is material to the business of the Acquired Corporation and its Subsidiaries as currently conducted (other than trade secrets with respect to which the Acquired Corporation knowingly made a reasonable judgment to not keep such trade secrets confidential and other than rights to Intellectual Assets where the Acquired Corporation knowingly made a reasonable judgment not to seek to secure registration of the applicable rights). To the Acquired Corporation’s knowledge, no third party is misappropriating, infringing, diluting or violating any rights to Intellectual Property owned by Acquired Corporation or any of its Subsidiaries that is material to the business of the Acquired Corporation and its Subsidiaries as currently conducted, and no Intellectual Property misappropriation, infringement, dilution or violation suits, arbitrations or other adversarial proceedings have been brought before any court, government agency or arbitral tribunal against any third party by the Acquired Corporation or any of its Subsidiaries which remain unresolved.

(f) The Acquired Corporation and each of its operating Subsidiaries has, and uses reasonable efforts to enforce, a policy of requiring each relevant employee who participates in the development of Acquired Corporation Intellectual Property to execute a confidentiality and assignment of proprietary rights agreement substantially in the Acquired Corporation’s standard form as set forth in Section 4.17(f) of the Acquired Corporation Disclosure Schedule, and, except (i) as may be made under nondisclosure agreements or other agreements containing nondisclosure obligations, and (ii) for confidential information or trade secrets that the Acquired Corporation knowingly made a reasonable judgment not to keep such confidential information and trade secrets confidential, there has been no disclosure to any third party by the Acquired Corporation or any of its Subsidiaries of material confidential information or material trade secrets of the Acquired Corporation or any of its Subsidiaries related to any material proprietary product currently being marketed, sold, licensed or developed by the Acquired Corporation or any of its Subsidiaries (each such product owned by the Acquired Corporation or its Subsidiaries, a “Acquired Corporation Proprietary Product”). All consultants and independent contractors who have made material contributions to the development of any Acquired Corporation Proprietary Product (including all consultants and independent contractors who have designed, written, tested or worked on any software code contained in any Acquired Corporation Proprietary Product) have assigned to the Acquired Corporation or one or more of its Subsidiaries (or a third party that has assigned its rights in such Acquired Corporation Proprietary Product to the Acquired Corporation or one or more of its Subsidiaries) all of their right, title and interest (other than moral rights, if any) in and to the portions of such Acquired Corporation Proprietary Product developed by them in the course of their work for the Acquired Corporation or one or more of its Subsidiaries (or applicable third party). Assignments of the patents and patent applications listed in Section 4.17(a) of the Acquired Corporation Disclosure Schedule to the Acquired Corporation or one or more of its Subsidiaries have been duly executed and filed with the United States Patent and Trademark Office.

(g) Neither the Acquired Corporation nor any of its Subsidiaries has (i) granted or is obligated to grant access to any of its source code contained in any Acquired Corporation Proprietary Product, (ii) made its source code contained in any Acquired Corporation Proprietary Product subject to any open source license, or (iii) licensed or has the right to obtain any source code, object code or any open license of any third party contained in any Acquired Corporation Proprietary Product (including in any such case any conditional right to access or under which the Acquired Corporation has established any escrow arrangement for the storage and conditional release of any source code, object code or open license).

(h) None of the Acquired Corporation Proprietary Products contains any third party software code that is, in whole or in part, subject to the provisions of any open source or quasi-open source license agreement under which the Acquired Corporation or any of its Subsidiaries is obligated to make the source code for such Acquired Corporation Proprietary Product generally available to the public.

(i) The Acquired Corporation does not have and will not have any obligation to pay any third party any royalties or other fees in excess of $100,000 in any calendar year for the use of Acquired Corporation Intellectual Property and no obligation to pay such royalties or other fees will result from the consummation of the transactions contemplated by this Agreement.

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(j) Neither the Acquired Corporation nor any of its Subsidiaries is in violation of any material license, sublicense, agreement or instrument to which the Acquired Corporation or any of its Subsidiaries is party or otherwise bound under which the Acquired Corporation or its Subsidiaries derive rights to Acquired Corporation Intellectual Property that is material to the Acquired Corporation’s or its Subsidiaries’ business as currently conducted, nor will the consummation by the Acquired Corporation of the transactions contemplated hereby result in any loss or impairment of ownership by the Acquired Corporation or any of its Subsidiaries of, or the right of any of them to use, any Acquired Corporation Intellectual Property that is material to the business of the Acquired Corporation and its Subsidiaries as currently conducted, nor, to the Acquired Corporation’s knowledge, require the consent of any Governmental Entity or third party with respect to any such Acquired Corporation Intellectual Property. Neither the Acquired Corporation nor any of its Subsidiaries is a party to any agreement under which a third party would be entitled to receive or expand a license or any other right to any Intellectual Asset of Acquired Corporation or any of Acquired Corporation’s affiliates as a result of the consummation of the transactions contemplated by this Agreement.

(k) For purposes of this Agreement, “Acquired Corporation Intellectual Property” shall mean trademarks, service marks, trade names, and internet domain names, together with all goodwill, registrations and applications related to the foregoing; patents and industrial design registrations or applications (including any continuations, divisionals, continuations-in-part, renewals, reissues, re-examinations and applications for any of the foregoing); works of authorship protected by copyright registrations; copyrights (including any registrations and applications for any of the foregoing); mask works rights and trade secrets and other confidential information, know-how, proprietary processes, formulae, algorithms, models, and methodologies; in each case used in or necessary for the conduct of the business of the Acquired Corporation and each of its Subsidiaries, as currently conducted.

Section 4.18 INSURANCE. All fire and casualty, general liability, business interruption, product liability, sprinkler and water damage insurance policies and other forms of insurance maintained by the Acquired Corporation or any of its Subsidiaries have been made available to Acquired Corporation. Each such policy is in full force and effect and all premiums due thereon have been paid in full. None of such policies shall terminate or lapse (or be affected in any other materially adverse manner) by reason of the consummation of the transactions contemplated by this Agreement.

Section 4.19 RESTRICTIONS ON BUSINESS. Except for this Agreement, there is no agreement (other than agreements disclosed in response to Section 4.6(h)), judgment, injunction, order or decree binding upon the Acquired Corporation or any of its Subsidiaries which has or could reasonably be expected to have the effect of prohibiting or impairing in any material respect any business practice of the Acquired Corporation or any of its Subsidiaries, acquisition of property by the Acquired Corporation or any of its Subsidiaries or the conduct of business by the Acquired Corporation or any of its Subsidiaries as currently conducted.

Section 4.20 NO EXISTING DISCUSSIONS. As of the date of this Agreement, the Acquired Corporation is not engaged, directly or indirectly, in any discussions or negotiations with any other party in violation of Section 6.13 of this Agreement.

Section 4.21 (Reserved.)

Section 4.22 BROKERS; SCHEDULE OF FEES. No broker, finder or investment banker (other than First Albany Capital, Inc., whose brokerage, finder’s or other fees will be paid by Acquired Corporation, and Sanders Morris Harris, Inc., the Company’s investment banker in connection with the Merger, whose fee will be paid by the Company) is entitled to any brokerage, finder’s or other fee or commission in connection with the transactions contemplated by this Agreement based upon arrangements made by or on behalf of the Acquired Corporation or any of its Subsidiaries.

Section 4.23 OFF-BALANCE SHEET ARRANGEMENTS. Acquired Corporation has not undertaken any type of off-balance sheet arrangement prohibited by the Sarbanes-Oxley Act.

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ARTICLE V

CONDUCT OF BUSINESS

Section 5.1 CONDUCT OF BUSINESS PENDING THE MERGER. Except (i) as expressly contemplated by this Agreement, (ii) as described in Section 5.1 of the Disclosure Schedule or (iii) to the extent Acquired Corporation and the Company shall otherwise consent in writing, Acquired Corporation and the Company covenant and agree that, during the period from the date of this Agreement and continuing until the earlier of the termination of this Agreement or the Effective Date, Acquired Corporation and the Company shall conduct their businesses and that of their Subsidiaries, each group taken as a whole, only in, and neither Acquired Corporation nor the Company shall take any action except in, and neither shall cause its Subsidiaries to take any action except in, the ordinary course of business and in a manner consistent with past practice and in compliance in all material respects with all applicable laws and regulations; and Acquired Corporation and the Company shall use all reasonable efforts to preserve substantially intact the respective business organization thereof and of its Subsidiaries, each group taken as a whole, to keep available the services of the current officers, employees and consultants thereof, and to preserve the present relationships thereof with customers, suppliers, distributors and other persons with which they or any of their Subsidiaries has significant business relations. Acquired Corporation and the Company agree that the individuals identified in Section 5.1(a) of the Disclosure Schedule shall be authorized to provide the agreement of each to the various acts of Acquired Corporation and the Company contemplated by this Section 5.1 during the period from the date of this Agreement until the earlier of the termination of this Agreement or the Effective Date. In addition, except (i) as expressly contemplated by this Agreement, (ii) as described in Section 5.1 of the Disclosure Schedule or (iii) to the extent Acquired Corporation and the Company shall otherwise consent in writing, neither Acquired Corporation nor the Company shall, nor shall they permit their respective Subsidiaries to, during the period from the date of this Agreement and continuing until the earlier of the termination of this Agreement or the Effective Date, do any of the following:

(a) amend or otherwise change their respective corporate charters or bylaws or those of their respective Subsidiaries;

(b) issue, sell, pledge, redeem, accelerate rights under, dispose of or encumber, or authorize the issuance, sale, pledge, redemption, acceleration of rights under, disposition or encumbrance of, any shares of capital stock of any class, or any options, warrants, convertible securities or other rights of any kind to acquire any shares of capital stock, or any other ownership interest (including any phantom interest) in Acquired Corporation or the Company, any of their Subsidiaries or affiliates;

(c) sell, pledge, dispose of or encumber any assets of Acquired Corporation, the Company or any of their Subsidiaries or suffer to exist any Lien thereupon (other than (i) sales of assets not to exceed $150,000 in the aggregate or non-exclusive licenses in the ordinary course of business and in a manner consistent with past practice, (ii) dispositions of obsolete or worthless assets; (iii) sales of immaterial assets not in excess of $75,000 in the aggregate) or sales of inventory in the ordinary course of business;

(d) (i) declare, set aside, make or pay any dividend or other distribution (whether in cash, stock or property or any combination thereof) in respect of any of its capital stock, except that a direct or indirect wholly owned Subsidiary of Acquired Corporation or the Company may declare and pay a dividend to its parent, (ii) split, combine or reclassify any of its capital stock or issue or authorize or propose the issuance of any other securities in respect of, in lieu of or in substitution for shares of its capital stock, or (iii) amend the terms or change the period of exercisability of, purchase, repurchase, redeem or otherwise acquire, or permit any Subsidiary to purchase, repurchase, redeem or otherwise acquire, any of its securities or any securities of its Subsidiaries, or any option, warrant or right, directly or indirectly, to acquire any such securities, or propose to do any of the foregoing;

(e) (i) acquire (by merger, consolidation or acquisition of stock or assets or otherwise) any corporation, partnership or other business organization or division thereof; (ii) incur any indebtedness for borrowed money or issue any debt securities or assume, guarantee or endorse or otherwise as an accommodation become responsible for, the obligations of any person, or make any loans or advances or capital

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contributions to or investments in any other person, except in the ordinary course of business and consistent with past practice; (iii) enter into, amend or waive any right under any material contract, agreement or joint venture other than in the ordinary course of business consistent with past practice, or any contract or agreement not entered into in the ordinary course of business consistent with past practices, or enter into, renew, fail to renew, amend or terminate any lease relating to real property, or open or close any facility comprising more than 5,000 square feet; (iv) adopt or implement any new stockholder rights plan; (v) authorize any capital expenditures or purchase of fixed assets which are in excess of $25,000 in the aggregate for all such expenditures and purchases for Acquired Corporation or the Company and its respective Subsidiaries taken as a whole; (vi) modify its standard warranty terms for its products or amend or modify any product warranties in effect as of the date of this Agreement in any manner that is adverse to the Company or any Subsidiary, other than extensions of warranties in the ordinary course of business; (vii) mortgage or pledge any of its assets, tangible or intangible, or create or suffer to exist any Lien thereupon, except in the ordinary course of business consistent with past practice; or (viii) enter into or amend any contract, agreement, commitment or arrangement to effect any of the matters prohibited by this Section 5.1(e);

(f) increase the compensation payable or to become payable to its directors, officers or employees (other than increases payable to non-officer employees made in the ordinary course of business consistent with past practice), make any loan, advance or capital contribution (other than loans or advances of reasonable relocation expenses), or grant any severance or termination pay (provided that Acquired Corporation or its Subsidiaries may grant such severance or termination pay in an aggregate amount no greater than $250,000) to, or enter into or amend any Company Employee Plan or Acquired Corporation Employee Plan or other plan, contract, agreement or arrangement that would be a Company Employee Plan or Acquired Corporation Employee Plan, establish, adopt, enter into or amend any collective bargaining agreement or other plan, agreement, trust, fund, policy or arrangement for the benefit of any current or former directors, officers or employees of Acquired Corporation or the Company or any of their Subsidiaries, pay any discretionary bonuses to any officer of Acquired Corporation or the Company, materially change any actuarial assumption or other assumption used to calculate funding obligations with respect to any pension or retirement plan, or change the manner in which contributions to any such plan are made or the basis on which such contributions are determined, except, in each case, as may be required by law or contractual commitments which are existing as of the date of this Agreement and listed in Section 3.13 of the Disclosure Schedule or 4.12 of the Acquired Corporation Disclosure Schedule;

(g) take any action to change accounting policies or procedures (including procedures with respect to revenue recognition, payments of accounts payable and collection of accounts receivable), change any assumption underlying, or method of calculating, any bad debt contingency or other reserve, except in each case as required under GAAP;

(h) make any material Tax election inconsistent with past practice or settle or compromise any material federal, state, local or foreign Tax liability or agree to an extension of a statute of limitations, fail to file any Tax Return when due (or, alternatively, fail to file for available extensions) or fail to cause such Tax Returns when filed to be complete and accurate; or fail to pay any material Taxes when due;

(i) pay, discharge or satisfy any claims, liabilities or obligations (absolute, accrued, asserted or unasserted, contingent or otherwise), other than the payment, discharge or satisfaction in the ordinary course of business and consistent with past practice of liabilities reflected or reserved against in the Company Balance Sheet or Acquired Corporation Balance Sheet or incurred in the ordinary course of business and consistent with past practice;

(j) fail to pay accounts payable and other obligations in the ordinary course of business;

(k) accelerate the collection of receivables or modify the payment terms of any receivables other than in the ordinary course of business consistent with past practices;

(l) sell, securitize, factor or otherwise transfer any accounts receivable;

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(m) adopt a plan of complete or partial liquidation, dissolution, merger, consolidation, restructuring, recapitalization or other reorganization of the Company or any Subsidiary (other than the Merger or as expressly provided in this Agreement);

(n) revalue in any material respect any of its assets, including writing down the value of inventory or writing off notes or accounts receivable, except as required under GAAP;

(o) as to Company and its Subsidiaries, enter into any agreement, contract or commitment of any type referred to in Section 3.6, or take, or agree in writing or otherwise to take, any of the actions described in Sections 5.1(a) through (n) above, or any action which would make any of the representations or warranties of the Company contained in this Agreement untrue or incorrect or prevent any of them from performing or cause any of them not to perform its covenants hereunder, in each case, such that the conditions set forth in Sections 7.2(a) or 7.2(b), as the case may be, would not be satisfied;

(p) as to Acquired Corporation and its Subsidiaries, enter into any agreement, contract or commitment of any type referred to in Section 4.6, or take, or agree in writing or otherwise to take, any of the actions described in Sections 5.1(a) through (n) above, or any action which would make any of the representations or warranties of Acquired Corporation contained in this Agreement untrue or incorrect or prevent either of them from performing or cause either of them not to perform its covenants hereunder, in each case, such that the conditions set forth in Sections 7.3(a) or 7.3(b), as the case may be, would not be satisfied.

Section 5.2 COOPERATION. Subject to compliance with applicable law, from the date of this Agreement until the earlier of the termination of this Agreement in accordance with its terms or the Effective Date, (a) the Company and Acquired Corporation shall confer with one another on a regular and frequent basis with one or more representatives to report operational matters that are material and the general status of ongoing operations and (b) each of Acquired Corporation and the Company shall promptly provide the other party or its counsel with copies of all filings made by such party with any Governmental Entity in connection with this Agreement, the Merger and the transactions contemplated hereby, including any correspondence to and from the SEC (excluding any requests for confidential treatment of any documents included in any filing with the SEC) in connection herewith.

ARTICLE VI

ADDITIONAL AGREEMENTS

Section 6.1 ACCESS TO INFORMATION; CONFIDENTIALITY.

(a) Acquired Corporation and the Company shall (and shall cause their Subsidiaries and the respective officers, directors, employees, auditors and agents of all of the foregoing to) afford to each other’s officers, employees, financial advisors, legal counsel, accountants, consultants and other representatives reasonable access during normal business hours throughout the period prior to the Effective Date to all properties, contracts, books and records, and all other documents and data (other than privileged documents); provided, that Acquired Corporation shall address all requests to Mr. LaGamba or his designee, and the Company shall address all such requests to Mr. Ribaudo. During such period, each of Acquired Corporation and the Company shall furnish promptly to each other a copy of each report, schedule and other document filed or received by it pursuant to the requirements of federal securities laws.

(b) Each of the Company and the Acquired Corporation represents, warrants, covenants and agrees that it (and its Subsidiaries and its and their respective representatives) has at all times held and shall hold in confidence all non-public information acquired from the other party or the other party’s representatives in accordance with the terms of this paragraph. Except as and to the extent required by law, no such party, Subsidiary or representative, as aforesaid (any of the foregoing, a “Restricted Party”) has disclosed or used, or will disclose or use, and each Restricted Party has directed and will direct its representatives not to disclose or use to the detriment of the other party or its Subsidiaries or representatives, as aforesaid (any of the foregoing, a “Protected Party”), any Confidential Information (as defined below) with respect to such

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Protected Party furnished, or to be furnished, by any such Protected Party or its respective representatives to such Restricted Party or its representatives at any time or in any manner other than in connection with its evaluation of the Merger and the transactions associated therewith. For purposes of this Paragraph, “Confidential Information” means any information about such Protected Party, unless (i) such information is already known to such Restricted Party or its representatives or to others not bound by a duty of confidentiality or such information becomes publicly available through no fault of such Restricted Party or its representatives, (b) the use of such information is necessary or appropriate in making any filing or obtaining any consent or approval required for the consummation of the Merger, or (c) the furnishing or use of such information is required by or necessary or appropriate in connection with legal proceedings. Upon the written request of such Protected Party, such Restricted Party will promptly return to such Protected Party or destroy any Confidential Information in its possession and certify in writing to such Protected Party that it has done so.

(c) The Company and the Acquired Corporation intend to negotiate a joint press release to be issued upon to the execution and delivery of this Agreement. Other than such release, except as and to the extent required by law or by the listing rules of Nasdaq, each such party represents, warrants, covenants and agrees that neither it nor any Subsidiary or representative as aforesaid has, and that without the prior written consent of the other party, neither party will, and each has directed and will direct its representatives not to make, directly or indirectly, any public comment, statement, or communication with respect to, or otherwise to disclose or to permit the disclosure of the existence of discussions regarding, a possible transaction between the parties or any of the terms, conditions, or other aspects of the Merger or any transactions associated therewith. If either party is required by law to make any such disclosure, it must first provide to the other party the content of the proposed disclosure, the reasons that such disclosure is required by law, and the time and place that the disclosure will be made.

Section 6.2 SEC FILINGS. The Company shall make any necessary filing with respect to the Merger under the Securities Act and the Exchange Act and the rules and regulations thereunder, and from the date hereof to the Closing shall otherwise comply with the Securities Act and the Exchange Act by, among other things, filing all reports required thereby.

Section 6.3 STOCKHOLDERS MEETING.

(a) Acquired Corporation. Acquired Corporation, acting through its Board of Directors, shall take all actions in accordance with applicable law and the Acquired Corporation’s Charter and By-Laws to promptly and duly call, give notice of, convene and hold as promptly as practicable, and in any event on or before June 30, 2004, a meeting of its stockholders for the purpose of considering and voting upon the approval of this Agreement and the Merger. Unless this Agreement has been properly terminated, Acquired Corporation’s Board of Directors shall recommend adoption and approval of this Agreement and the Merger by the stockholders of the Acquired Corporation. The Acquired Corporation shall use its commercially reasonable efforts to solicit from its stockholders proxies in favor of the proposal to adopt and approve this Agreement and the Merger and to secure the vote or consent of the stockholders of the Acquired Corporation that are required by its Charter or the CBCA. At the Acquired Corporation’s stockholders meeting, Mr. Mercadante hereby agrees to, and to cause his family members and Affiliates controlled by him or them, and all Acquired Corporation shares over which he exercises sole or shared voting control to, consent to this Agreement and the Merger.

(b) The Company.

(i) The Company, acting through its Board of Directors, shall take all actions in accordance with applicable law, the Company Charter, the Company By-Laws and the rules of The Nasdaq Small-Cap Market to promptly and duly call, give notice of, convene and hold as promptly as practicable, and in any event on or before June 30, 2004, a meeting of its stockholders (the “Company Stockholders

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Meeting”) for the purpose of considering and voting upon the approval of this Agreement and the Merger. Unless this Agreement has been properly terminated, the Company’s Board of Directors shall recommend adoption and approval of this Agreement and the Merger by the stockholders of the Company and include such recommendation in the Proxy Statement. The Company shall use its commercially reasonable efforts to solicit from its stockholders proxies in favor of the proposal to adopt and approve this Agreement and the Merger and to secure the vote or consent of the stockholders of the Company that are required by the rules of The Nasdaq Small-Cap Market or the NRS. At the Company Stockholders Meeting, Mr. Taneja hereby agrees to, and to cause his family members and Affiliates controlled by him or them, and all Company shares over which he exercises sole or shared voting control to, consent to this Agreement and the Merger. Notwithstanding anything to the contrary contained in this Agreement, the Company, after consultation with Acquired Corporation, may adjourn or postpone the Company Stockholders Meeting to the extent necessary to ensure that any required supplement or amendment to the Proxy Statement is provided to the Company’s stockholders or, if as of the time for which the Company Stockholders Meeting is originally scheduled (as set forth in the Proxy Statement), there are insufficient shares of Company Common Stock represented (either in person or by proxy) to constitute a quorum necessary to conduct the business of the Company Stockholders Meeting.

(ii) Unless this Agreement has been terminated as permitted by this Agreement, the Company shall call, give notice of, convene and hold the Company Stockholders Meeting in accordance with this Section 6.3 and shall submit the proposal to adopt and approve this Agreement and the Merger to its stockholders for the purpose of acting upon such proposal whether or not (i) the Company’s Board of Directors at any time subsequent to the date of this Agreement determines that the proposal is no longer advisable or recommends that the stockholders of the Company reject such proposal, or (ii) any other actual, potential or purported merger or acquisition proposal has been commenced, disclosed, announced or submitted to the Company. The Company shall use reasonable efforts to ensure that all proxies solicited by the Company in connection with the Company Stockholders Meeting are solicited, in compliance with the NRS, the Company Charter, the Company By-Laws, the rules of The Nasdaq Small-Cap Market and all other applicable legal requirements.

(iii) Following the Company Stockholders Meeting and at or prior to the Closing, the Company shall deliver to Acquired Corporation a certificate of its Corporate Secretary setting forth the voting results from the Company Stockholders Meeting.

Section 6.4 LEGAL CONDITIONS TO MERGER. Each of Acquired Corporation and the Company will use its commercially reasonable efforts to comply promptly with all legal requirements which may be imposed with respect to the Merger (which efforts shall include furnishing all information required under the HSR Act and in connection with approvals of or filings with any other Governmental Entity) and will promptly cooperate with and furnish information to each other in connection with any such requirements imposed upon any of them or any of their Subsidiaries in connection with the Merger. Each of Acquired Corporation and the Company will, and will cause its Subsidiaries to, take all reasonable actions necessary to obtain (and will cooperate with each other in obtaining) any consent, authorization, order or approval of, or any exemption by, any Governmental Entity required to be obtained or made by Acquired Corporation, the Company or any of their Subsidiaries in connection with the Merger or the taking of any action contemplated thereby or by this Agreement. Notwithstanding the foregoing, neither Acquired Corporation nor the Company nor any of their affiliates shall be required to (i) sell or dispose of or hold separately (through a trust or otherwise) any assets or businesses or interests in any assets or businesses of Acquired Corporation, the Company or their respective affiliates or make any other change in any portion of the Company’s or its business or incur any other limitation on the conduct of the Company’s or its business to obtain such consents, authorizations, orders, approvals and exemptions or agree to do, or submit to orders providing for, any of the foregoing, in each case whether before or after the Effective Date, except in each case for any such action that would not reasonably be expected to result in a Company Material Adverse Effect or an Acquired Corporation Material Adverse Effect or (ii) if any governmental body that has the authority to enforce any Antitrust Law seeks, or authorizes its staff to seek, a preliminary injunction

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or restraining order to enjoin consummation of the Merger, take any action which Acquired Corporation or the Company reasonably believes would be prohibited or restricted under such preliminary injunction or restraining order.

Section 6.5 PUBLIC ANNOUNCEMENTS.

(a) Acquired Corporation and the Company shall consult with each other before issuing any press release or making any public statement with respect to the Merger or this Agreement and shall not issue any such press release or make any such public statement, except as may be required by applicable law or by obligations pursuant to any listing agreement with the Nasdaq, as determined by the Company, without the prior written consent of the other party, which shall not be unreasonably withheld or delayed.

(b) Notwithstanding anything to the contrary contained in this Agreement, the parties (and each employee, representative or other agent of the parties) may disclose to any and all persons, without limitation of any kind, the tax treatment and any facts that may be relevant to the tax structure of the transactions contemplated hereby beginning on the earliest of (i) the date of the public announcement by the parties of discussions relating to the transactions contemplated hereby, (ii) the date of public announcement by the parties of the transactions contemplated hereby or (iii) the date of the execution of this Agreement; PROVIDED, HOWEVER, that nothing in this Section 6.5(b) shall permit either party (or any employee, representative or agent thereof) to disclose (A) any information that is not necessary to understand the tax treatment and tax structure of such transactions (including the identity of the parties and any information that could lead another to determine the identity of the parties), or (B) any other information to the extent that such disclosure could result in a violation of any applicable law.

Section 6.6 EMPLOYEE BENEFITS; 401(k) PLAN.

(a) From and after the Effective Date, the Surviving Corporation shall recognize the prior service with Acquired Corporation or the Company or their Subsidiaries of each employee of Acquired Corporation, the Company or their Subsidiaries as of the Effective Date (the “Company Employees”) in connection with all employee benefit plans, programs or policies (including vacation) of Acquired Corporation or its affiliates in which Company Employees are eligible to participate following the Effective Date, for purposes of eligibility, vesting and levels of benefits (but not for purposes of benefit accruals or benefit amounts under any defined benefit pension plan or to the extent that such recognition would result in duplication of benefits). From and after the Effective Date, Surviving Corporation will use its commercially reasonable efforts to offer to employees of the Surviving Corporation a group health plan similar to Acquired Corporation’s current plan. From and after the Effective Date, Surviving Corporation will provide the benefits described in Section 6.6 of the Disclosure Schedule to the Company Employees, in each instance in accordance with Section 6.6 of the Disclosure Schedule.

(b) Prior to the Effective Date, the Company shall take such actions as Acquired Corporation may reasonably request so as to enable the Surviving Corporation to effect such actions relating to the Company 401(k) Plan (the “401(k) Plan”) as Acquired Corporation may deem necessary or appropriate (after reasonable consultation with the Company), including terminating the 401(k) Plan prior to the Effective Date, subject to the terms of the 401(k) Plan and applicable law and provided that such action does not preclude the immediate participation of the Company Employees in any successor plan.

Section 6.7 CONSENTS. Acquired Corporation and the Company shall use their reasonable commercially reasonable efforts to obtain all necessary consents, waivers and approvals under any of their material agreements, contracts, licenses or leases in connection with the Merger required to prevent the occurrence of an event that could reasonably be expected to have a Company Material Adverse Effect or an Acquired Corporation Material Adverse Effect prior to the Effective Date or after the Effective Date.

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Section 6.8 INDEMNIFICATION AND INSURANCE.

(a) From and after the Effective Date, Surviving Corporation shall, to the fullest extent permitted under applicable law assume the obligations of Acquired Corporation and the Company pursuant to any indemnification agreements between Acquired Corporation or the Company and its respective directors and officers in effect prior to the date of this Agreement (or indemnification agreements in Acquired Corporation’s or the Company’s customary form as of the date hereof for directors joining their respective Board of Directors prior to the Effective Date) and any indemnification provisions under Acquired Corporation’s or the Company’s Charter or By-Laws as in effect immediately prior to the Effective Date.

(b) For a period of six years after the Effective Date, Surviving Corporation shall use its commercially reasonable efforts to maintain in effect, subject to customary terms and conditions, policies of directors’ and officers’ and fiduciary liability insurance for the directors serving either the Company or the Acquired Corporation immediately prior to the Effective Date, as well as those directors serving the Surviving Corporation after the Effective Date, which policies shall provide substantially the same coverage and shall contain substantially the terms and conditions as the policies that covered such directors immediately prior to the Effective Date; provided that the Surviving Corporation shall in no event be required to pay for any policy that has a cost in excess of 200% of the cost of the policies in effect as of the date hereof; provided further that with respect to directors that do not continue to serve the Surviving Corporation after the Effective Date, the Surviving Corporation shall only be required to provide coverage for claims arising from facts or events which occurred at or before the Effective Date.

Section 6.9 REASONABLE EFFORTS. Subject to the other terms and conditions of this Agreement, each of the parties agrees to use its commercially reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by this Agreement.

Section 6.10 NOTIFICATION OF CERTAIN MATTERS. Acquired Corporation shall give prompt notice to the Company, and the Company shall give prompt notice to Acquired Corporation, upon any director or officer of Acquired Corporation or the Company (as applicable) becoming aware of the occurrence, or failure to occur, of any event, which occurrence or failure to occur would be reasonably likely to cause any of the conditions set forth in Article VII not to be satisfied. Notwithstanding the provisions of this Section 6.10, the delivery of any notice pursuant to this Section 6.10 will not limit or otherwise affect the remedies available hereunder to the party receiving such notice or the conditions to such party’s obligation to consummate the Merger.

Section 6.11 TAKEOVER STATUTES. Notwithstanding any other provision in this Agreement, in no event shall any approval of the Merger and this Agreement by the Board of Directors of the Company under § 78.411 et seq. of the NRS, or the Board of Directors of Acquired Corporation under § 33-843 et seq. of the CBCA be withdrawn, revoked or modified by such Board of Directors. The foregoing provision shall not be deemed to reflect that the parties have determined such Takeover Statutes to be applicable. If any Takeover Statute is or may become applicable to the Merger or any of the other transactions contemplated by this Agreement, Acquired Corporation, the Company and their respective Boards of Directors shall promptly grant such approvals and take such lawful actions as are necessary so that such transactions may be consummated as promptly as practicable on the terms contemplated by this Agreement or the Merger, as the case may be, and otherwise take such lawful actions to eliminate or minimize the effects of such statute, and any regulations promulgated thereunder, on such transactions.

Section 6.12 TAX-FREE REORGANIZATION TREATMENT. Acquired Corporation and the Company intend that the Merger will qualify as a reorganization within the meaning of Section 368(a) of the Code, and each shall, and shall cause their respective subsidiaries to, use its commercially reasonable efforts to cause the Merger to so qualify. Neither Acquired Corporation nor the Company shall knowingly take any action, or knowingly fail to take any action, that would be reasonably likely to jeopardize the qualification of the Merger as a reorganization within the meaning of Section 368(a) of the Code.

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Section 6.13 EXCLUSIVITY.

(a) Each of the Company and the Acquired Corporation represents, warrants, covenants and agrees that since January 29, 2004 it has not, without the other’s prior approval, either directly or through any of their officers, directors, affiliates, employees, representatives, subsidiaries or agents, directly or indirectly, solicited, initiated or participated in any way in discussions or negotiations with, or provided any information or assistance to, or entered into any agreements with, any person or entity concerning any acquisition of such companies, any securities of the respective party or any part of the assets or property of the parties outside the ordinary course of the companies’ businesses, or any merger, consolidation, liquidation, dissolution or similar transaction involving the parties, or assisted and participated in, facilitated or encouraged any effort or attempt by any other person or entity to do or seek to do any of the foregoing. Either party will immediately notify the other regarding any contact between the notifying party, any Subsidiary or its or their representatives and any other person or entity regarding any such offer or proposal or any related inquiry.

(b) Each of the Company and Acquired Corporation agrees that, during the term of this Agreement, it shall not, and shall not authorize or permit any of its Subsidiaries or any of its or its Subsidiaries’ directors, officers, employees, agents or representatives, directly or indirectly, to solicit, initiate, encourage or facilitate, or furnish or disclose non-public information in furtherance of, any inquiries or the making of any proposal with respect to any recapitalization, restructuring, merger, consolidation or other business combination involving the Company or Acquired Corporation, or acquisition of any capital stock (other than upon exercise of stock options which are outstanding as of the date hereof) or any material portion of the assets (except for acquisitions of assets in the ordinary course of business consistent with past practice) of the Company or Acquired Corporation, or its respective Subsidiaries, or any or any other transaction similar to any of the foregoing with respect to such party or any of its Subsidiaries, or any agreement to enter into any of the foregoing, other than pursuant to the Merger (any of the foregoing, a “Competing Transaction”), or negotiate, explore or otherwise engage in discussions with any person (other than each other or their respective directors, officers, employees, agents and representatives) with respect to any Competing Transaction or enter into any agreement, arrangement or understanding requiring or causing it to abandon, terminate or fail to consummate the Merger or any of the other Transactions contemplated by this Agreement; provided that, prior to the Effective Date, if the Company and Acquired Corporation receives a written proposal for a Competing Transaction (x) that was not initiated, solicited or encouraged after the date of this Agreement by it, its Subsidiaries or any of its or their directors, officers, employees, agents or representatives and does not violate or breach any confidentiality, exclusivity or standstill agreement executed by it prior to the date of this Agreement (provided that it may amend any standstill or similar provision of any such agreement solely to provide or make clear that such third party may deliver to the Board of Directors (the “Board”) of the Company or Acquired Corporation, as the case may be, a written proposal for a Competing Transaction) and (y) that the Board or a special committee thereof determines in good faith by majority vote could reasonably be expected to result in a third party making a proposal for a Superior Transaction (as defined in Section 6.13(c)), and subject to compliance with the last two sentences of this Section 6.13(b), the Company or Acquired Corporation, as the case may be, may (A) furnish information with respect to the Company or Acquired Corporation, as the case may be, to the person making such proposal pursuant to a customary confidentiality agreement the terms of which shall be no less favorable to the Company or Acquired Corporation than the confidentiality provisions entered into by the Company or Acquired Corporation on or after January 1, 2003 that is most favorable to it, and (B) participate in discussions or negotiations with such person regarding such proposal. In no event shall the Company or Acquired Corporation furnish (or authorize any of its Subsidiaries, or any of its or its Subsidiaries’ directors, officers, employees, agents or representatives, directly or indirectly, to furnish) to any competitor or potential competitor thereof or of its Subsidiaries information about the Company or Acquired Corporation as the case may be or any of its Subsidiaries unless the Board or a special committee thereof determines in its reasonable judgment, after consultation with management, that disclosure of such information would not be materially competitively disadvantageous thereto or to its Subsidiaries, including, without limitation, pricing, volume, sales and marketing information (“Sensitive Information”); provided

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that the Company or Acquired Corporation may provide Sensitive Information to a competitor or potential competitor thereof if confirmatory review of Sensitive Information is the only remaining condition to the Company and such competitor or potential competitor entering into an Acquisition Agreement (as defined in Section 6.13(c)) with respect to a Superior Transaction that has been approved by the Board and approved (subject only to such confirmatory review) by the board of directors (or similar governing body) of such competitor or potential competitor. The Company and Acquired Corporation shall, and shall cause its Subsidiaries and their respective directors, officers, employees, agents and representatives immediately to cease all existing activities, discussions and negotiations with any parties conducted heretofore with respect to any of the foregoing. Neither the Board of the Company or Acquired Corporation nor any committee thereof shall (A) withdraw or modify, or propose publicly to withdraw or modify, in a manner adverse to the other parties, its recommendation (the “Board Recommendation”) in favor of the Merger or (B) approve or recommend, or propose publicly to approve or recommend, any Competing Transaction. Notwithstanding the foregoing, in the event that prior to the Effective Date the Board of Company or Acquired Corporation receives the advice of its outside legal counsel that failure to do so will result in breach of its fiduciary duties to the stockholders of the Company or Acquired Corporation, as the case may be, under applicable law, such Board may (subject to this and the following sentences of this Section 6.13(b)) withdraw or modify the Board Recommendation, provided that it gives the other parties five days’ prior written notice of its intention to do so. Any such withdrawal or modification of the Board Recommendation shall not change the approval of the Board for purposes of causing any state takeover statute or other state law to be inapplicable to the transactions contemplated hereby, or change the obligation of the Company or Acquired Corporation to present the Merger for approval and adoption by stockholders of such party. From and after the execution of this Agreement, the Company and Acquired Corporation shall immediately advise each other in writing of the receipt, directly or indirectly, of any inquiries, discussions, negotiations, or proposals relating to a Competing Transaction (including the specific terms thereof and the identity of the other party or parties involved) and promptly furnish to each other a copy of any such proposal or inquiry in addition to any information provided to or by any third party relating thereto. The Company and Acquired Corporation shall keep each other fully apprised of the status of any proposal relating to a Competing Transaction on a current basis, including, without limitation, promptly providing to each other any Sensitive Information provided to any competitor or potential competitor pursuant to this paragraph (b).

(c) If prior to the Effective Date the Board of Company or Acquired Corporation shall determine in good faith, after consultation with its financial and legal advisors, that any bona fide written proposal from a third party for a Competing Transaction received after the date hereof that was not initiated, solicited or encouraged by it or any of its Subsidiaries or their respective directors, officers, employees, agents or representatives in violation of this Agreement and that does not violate or breach any confidentiality, exclusivity or standstill agreement executed by it prior to the date of this Agreement (as any such agreement may be amended in accordance with Section 6.13(b)) is more favorable to its stockholders from a financial point of view than the transactions contemplated by this Agreement (including any adjustment to the terms and conditions of such transaction proposed in writing by the other merging party under this Agreement in response to such Competing Transaction), is likely to and capable of being consummated, and is in the best interest of the stockholders of the Company or Acquired Corporation, as the case may be, and the Company or Acquired Corporation, as the case may be, has received (x) advice of its outside legal counsel that failure to enter into such a Competing Transaction will constitute a breach of its Board’s fiduciary duties under applicable law and (y) a written opinion (a copy of which has been delivered to the other merging party under this Agreement) from its Financial Advisor (First Albany Capital in the case of Acquired Corporation and Sanders Morris Harris, Inc. in the case of the Company (or any other nationally recognized investment banking firm), that the Competing Transaction is more favorable from a financial point of view to the stockholders of the Company or Acquired Corporation, as the case may be than the transactions contemplated by this Agreement (including any adjustment to the terms and conditions of such transaction proposed in writing by Purchaser) (a “Superior Transaction”), the Company or Acquired Corporation which has made such determination and been so advised may terminate this Agreement and enter into a letter of intent, agreement-in-principle, acquisition agreement or other similar agreement (each, an “Acquisition

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Agreement”) with respect to such Superior Transaction provided, that, prior to any such termination, (i) the Company or Acquired Corporation, as the case may be, has provided such other parties written notice that it intends to terminate this Agreement pursuant to this Section 6.13(c), identifying the Superior Transaction then determined to be more favorable and the parties thereto and delivering a copy of the Acquisition Agreement for such Competing Transaction in the form to be entered into, and (ii) at least five full business days after it has provided the notice referred to in clause (i) above (provided that the opinions referred to in clauses (x) and (y) above shall continue in effect without revision or modification), delivers to such other parties (A) a written notice of termination of this Agreement pursuant to this Section 6.13(c), and (B) a wire transfer of same day funds in the amount of the Termination Fee as provided in Section 8.3(b), and (C) the Company or Acquired Corporation, as the case may be, receives a written acknowledgment from the terminating party and from the other party to a Superior Transaction that such terminating party and such other party have irrevocably waived any right to contest such payments.

Section 6.14 INDEMNIFICATION.

(A) Survival; Right to Indemnification Not Affected by Knowledge

The waiver of any condition based on the accuracy of any representation or warranty, or on the performance of or compliance with any covenant or obligation, will not affect the right to indemnification, payment of Damages, or other remedy based on such representations, warranties, covenants, and obligations.

(B) Indemnification and Payment of Damages by Company

The Company will indemnify and hold harmless Acquired Corporation, and their respective representatives, stockholders, controlling persons, and affiliates (collectively, the “Familymeds Indemnified Persons”) for, and will pay to the Familymeds Indemnified Persons the amount of, any loss, liability, claim, damage (including incidental and consequential damages), expense (including costs of investigation and defense and reasonable attorneys’ fees) or diminution of value, whether or not involving a third-party claim (collectively, “Damages”), arising, directly or indirectly, from or in connection with:

(a) any Breach of any representation or warranty made by the Company in this Agreement (without giving effect to any supplement to the Disclosure Schedule), the Disclosure Schedule, the supplements to the Disclosure Schedule, or any other certificate or document delivered by the Company pursuant to this Agreement;

(b) any Breach of any representation or warranty made by the Company in this Agreement as if such representation or warranty were made at and as of the Effective Date without giving effect to any supplement to the Disclosure Schedule, other than any such Breach that is disclosed in a supplement to the Disclosure Schedule and is expressly identified in the certificate delivered pursuant to Section 7.2(a) as having caused the condition specified in Section 7.2(a) not to be satisfied; and

(c) any Breach by the Company of any covenant or obligation of the Company in this Agreement.

Except as set forth in subsection (E) below, the remedies provided in this Section 6.14(B) will not be exclusive of or limit any other remedies that may be available to the Familymeds Indemnified Persons.

(C) Indemnification and Payment of Damages by Acquired Corporation

The Acquired Corporation will indemnify and hold harmless the Company and its respective representatives, stockholders, controlling persons, and affiliates (collectively, the “Company Indemnified Persons”) for, and will pay to the Company Indemnified Persons the amount of, any Damages, arising, directly or indirectly, from or in connection with:

(a) any Breach of any representation or warranty made by the Acquired Corporation in this Agreement (without giving effect to any supplement to the Acquired Corporation Disclosure Schedule), the Acquired Corporation Disclosure Schedule, the supplements to the Acquired Corporation Disclosure Schedule, or any other certificate or document delivered by the Acquired Corporation pursuant to this Agreement;

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(b) any Breach of any representation or warranty made by the Acquired Corporation in this Agreement as if such representation or warranty were made at and as of the Effective Date without giving effect to any supplement to the Acquired Corporation Disclosure Schedule, other than any such Breach that is disclosed in a supplement to the Acquired Corporation Disclosure Schedule and is expressly identified in the certificate delivered pursuant to Section 7.3(a) as having caused the condition specified in Section 7.3(a) not to be satisfied; and

(c) any Breach by a Familymeds Party of any covenant or obligation of such Familymeds Party in this Agreement.

Except as set forth in subsection (E) below, the remedies provided in this Section 6.14(C) will not be exclusive of or limit any other remedies that may be available to the Company Indemnified Persons.

(D) (Reserved.)

(E) Limitations on Amount and Form of Indemnification

The Company will have no liability (for indemnification or otherwise) with respect to the matters described in clause (a), clause (b) or clause (c) of Section 6.14(B) above, (i) until the total of all Damages with respect to such matters exceeds Two Hundred Fifty Thousand Dollars ($250,000.00), and then only for the amount by which such Damages exceed Two Hundred Fifty Thousand Dollars ($250,000.00) or (ii) for any Damages with respect to such matters in excess of One Million Dollars ($1,000,000.00). The Acquired Corporation will have no liability (for indemnification or otherwise) with respect to the matters described in clause (a), clause (b) or clause (c) of Section 6.14(C) above, (i) until the total of all Damages with respect to such matters exceeds Two Hundred Fifty Thousand Dollars ($250,000.00), and then only for the amount by which such Damages exceed Two Hundred Fifty Thousand Dollars ($250,000.00) or (ii) for any Damages with respect to such matters in excess of One Million Dollars ($1,000,000.00). However, this Section 6.14(E) will not apply to any Breach of any representations and warranties of which the parties making the representation or warranty had Knowledge at any time prior to the date on which such representation and warranty is made or any intentional Breach of any covenant or obligation.

(F) Procedure for Indemnification—Third Party Claims

(a) Promptly after receipt by an indemnified party under this Section 6.14 of notice of the commencement of any Proceeding against it, such indemnified party will, if a claim is to be made against an indemnifying party under such Section, give notice to the indemnifying party of the commencement of such claim, but the failure to notify the indemnifying party will not relieve the indemnifying party of any liability that it may have to any indemnified party, except to the extent that the indemnifying party demonstrates that the defense of such action is prejudiced by the indemnifying party’s failure to give such notice.

(b) If any Proceeding referred to in the preceding paragraph (a) is brought against an indemnified party and it gives notice to the indemnifying party of the commencement of such Proceeding, the indemnifying party will be entitled to participate in such Proceeding and, to the extent that it wishes (unless (i) the indemnifying party is also a party to such Proceeding and the indemnified party determines in good faith that joint representation would be inappropriate, or (ii) the indemnifying party fails to provide reasonable assurance to the indemnified party of its financial capacity to defend such Proceeding and provide indemnification with respect to such Proceeding), to assume the defense of such Proceeding with counsel satisfactory to the indemnified party and, after notice from the indemnifying party to the indemnified party of its election to assume the defense of such Proceeding, the indemnifying party will not, as long as it diligently conducts such defense, be liable to the indemnified party under this Section 6.14 for any fees of other counsel or any other expenses with respect to the defense of such Proceeding, in each case subsequently incurred by the indemnified party in connection with the defense of such Proceeding, other than reasonable costs of investigation. If the indemnifying party assumes the defense of a Proceeding, (i) it will be conclusively established for purposes of this Agreement that the claims made in that Proceeding are within the scope of and subject to indemnification; (ii) no compromise or settlement of such claims may be

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effected by the indemnifying party without the indemnified party’s consent unless (A) there is no finding or admission of any violation of legal requirements or any violation of the rights of any person and no effect on any other claims that may be made against the indemnified party, and (B) the sole relief provided is monetary damages that are paid in full by the indemnifying party; and (iii) the indemnified party will have no liability with respect to any compromise or settlement of such claims effected without its consent. If notice is given to an indemnifying party of the commencement of any Proceeding and the indemnifying party does not, within ten days after the indemnified party’s notice is given, give notice to the indemnified party of its election to assume the defense of such Proceeding, the indemnifying party will be bound by any determination made in such Proceeding or any compromise or settlement effected by the indemnified party.

(c) Notwithstanding the foregoing, if an indemnified party determines in good faith that there is a reasonable probability that a Proceeding may adversely affect it or its affiliates other than as a result of monetary damages for which it would be entitled to indemnification under this Agreement, the indemnified party may, by notice to the indemnifying party, assume the exclusive right to defend, compromise, or settle such Proceeding, but the indemnifying party will not be bound by any determination of a Proceeding so defended or any compromise or settlement effected without its consent (which may not be unreasonably withheld).

(G) Procedure for Indemnification—Other Claims

A claim for indemnification for any matter not involving a third-party claim may be asserted by notice to the party from whom indemnification is sought.

(H) Capitalization Representation

In addition to any other remedy available under the other provisions of this Section 6.14, in the event that any of the Company’s representations and warranties in Section 3.3 of this Agreement are incorrect (notwithstanding their failure otherwise to survive the Merger under subsection 6.14(I) below), the Company shall issue (i) additional Merger Consideration to the Acquired Corporation Stockholders (pro rata their respective entitlement under Exhibit 2.1(b)) and (ii) additional Management Shares and Options to the Employees (pro rata their respective entitlement under Section 2.2 of this Agreement) in an amount equal to the additional consideration such Acquired Corporation Stockholders and Employees would have received had the correct number of issued and outstanding shares, in the Money Options and warrants of Company Common Stock been known at the Closing.

(I) Representations and Warranties

Except as provided in subsection 6.14(H) above, the representations and warranties and indemnification obligations under this Agreement shall not survive the Merger and shall terminate on the Effective Date.

ARTICLE VII

CONDITIONS TO THE MERGER

Section 7.1 CONDITIONS TO OBLIGATION OF EACH PARTY TO EFFECT THE MERGER. The respective obligations of each party to effect the Merger shall be subject to the satisfaction at or prior to the Effective Date of the following conditions:

(a) SEC FILINGS. The SEC shall have taken no action to question, disapprove or delay the Merger or the effectiveness or content of any such filing and no proceedings for such purpose shall have been initiated or threatened in writing by the SEC.

(b) EMPLOYMENT AGREEMENTS. All of the Officers (other than the Secretary) and the Co-Chairs of the Board of Directors shall have entered employment agreements in a form acceptable to such persons and the Company’s independent directors.

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(c) ANTITRUST APPROVALS. All necessary waiting periods (and all extensions thereof) applicable to the Merger under the Antitrust Laws shall have terminated or expired, all consents, approvals, authorizations and orders applicable to the Merger required under the Antitrust Laws shall have been received and become final and non-appealable, and any governmental body that has the authority to enforce any Antitrust Laws in those jurisdictions where such consents, approvals, authorizations and orders are so required shall have approved, cleared or decided neither to initiate proceedings or otherwise intervene in respect of the Merger.

(d) NO INJUNCTIONS OR RESTRAINTS; ILLEGALITY. No temporary restraining order, preliminary or permanent injunction or other order issued by any court of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Merger shall be in effect, nor shall any proceeding brought by any administrative agency or commission or other Governmental Entity seeking any of the foregoing be pending; and there shall not be any action taken, or any statute, rule, regulation or order enacted, entered, enforced or deemed applicable to the Merger which makes the consummation of the Merger illegal.

(e) GOVERNMENTAL ACTIONS. There shall not be pending or threatened any action or proceeding (or any investigation or other inquiry that would reasonably be expected to result in such an action or proceeding) by any Governmental Entity or administrative agency before any Governmental Entity, administrative agency or court of competent jurisdiction, nor shall there be in effect any judgment, decree or order of any Governmental Entity, administrative agency or court of competent jurisdiction, in each case, seeking to prohibit or limit Acquired Corporation from exercising all material rights and privileges pertaining to its majority ownership of the Surviving Corporation or the ownership or operation by Acquired Corporation of all or a material portion of the business or assets of Acquired Corporation, or seeking to compel Acquired Corporation to dispose of or hold separate all or any material portion of the business or assets of Acquired Corporation or the Surviving Corporation (or any of their Subsidiaries), as a result of the Merger or the transactions contemplated by this Agreement, except in each case for any such action, proceeding, investigation, inquiry, judgment, decree or order as would not reasonably be expected to result in a Company Material Adverse Effect or an Acquired Corporation Material Adverse Effect.

(f) LOCK UP AGREEMENT. Mr. LaGamba, Mr. Taneja, Mr. Mercadante and stockholders (including Mr. Mercadante) who are entitled to receive 90% of the Stock Consideration to be paid at the Closing shall have entered into the Lockup Agreement.

(g) AUTHORIZATIONS. The parties shall have received such governmental and third-party authorizations and consents as are necessary for the Merger.

(h) VENDORS. The Company shall have obtained confirmation from the following companies that they shall continue doing business with the Surviving Corporation after the Effective Date on at least the same terms that they were doing business with the Company prior to the Merger, the parties being in agreement that a failure to obtain any such confirmation would have a Company Material Adverse Effect: GlaxoSmithKline Financial, Inc., Eli Lilly & Co., Astra-Zeneca lp, Bristol-Myers Squibb, 3M Pharmaceuticals, Aventis Pharmaceuticals, Pfizer, Inc., Novartis Pharmaceuticals, JOM Pharmaceutical Services, Merck, Inc., P&G Pharmaceuticals, Amgen, Roche, Purdue Frederick, Schering Corp. and Abbott Labs. Notwithstanding anything to the contrary, if the Company shall not have terminated this Agreement prior to forty-five (45) days after the date hereof, then, after such date, this Section 7.1 (h) shall no longer be a condition to closing and neither party shall be permitted to terminate this Agreement based on this Section 7.1(h).

(i) FINANCING. Acquired Corporation and the Company shall have arranged for financing for the Surviving Corporation in the minimum amount of Sixty Million Dollars ($60,000,000.00) to refinance the Acquired Corporation’s and the Company’s, and their respective subsidiaries’, obligations on terms reasonably acceptable to both parties.

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(j) DISSENTERS RIGHTS.

(i) The Company shall not have received notice from its stockholders holding, jointly, in excess of 200,000 shares of Company Common Stock of their intent to exercise their dissenters’ rights of appraisal pursuant to the NRS.

(ii) Acquired Corporation shall not have received notice from its stockholders holding shares of Acquired Corporation Stock with a value in excess of $1,000,000, based on the appraisal to be conducted by First Albany prior the Effective Date, of their intent to exercise their dissenters’ rights of appraisal pursuant to the CBCA.

Section 7.2 ADDITIONAL CONDITIONS TO OBLIGATIONS OF ACQUIRED CORPORATION. The obligations of Acquired Corporation to effect the Merger are also subject to the following conditions:

(a) REPRESENTATIONS AND WARRANTIES. Each of the representations and warranties of the Company contained in this Agreement, including without limitation under Section 6.13, shall be true and correct (without giving effect to any qualification as to materiality or Company Material Adverse Effect contained in any specific representation or warranty), as of the date of this Agreement and as of the Effective Date, without giving effect to any supplement to the Disclosure Schedule, except (i) for changes contemplated or permitted by this Agreement, (ii) that the accuracy of representations and warranties that by their terms speak as of the date of this Agreement or other date will be determined as of such date and (iii) where any such failures of the representations and warranties to be true and correct in the aggregate will not have a Company Material Adverse Effect; and Acquired Corporation shall have received a certificate signed on behalf of the Company by the chief executive officer and chief financial officer of the Company to such effect.

(b) AGREEMENTS AND COVENANTS. The Company and Mr. Taneja shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by them at or prior to the Effective Date, including without limitation under Section 6.13; and Acquired Corporation shall have received a certificate signed by the chief executive officer and the chief financial officer of the Company to such effect.

(c) APPROVALS. The Company shall have undertaken all corporate action necessary for the consummation of the transaction, including without limitation that this Agreement and the Merger shall have been approved and adopted by the requisite vote of the Board of Directors and Stockholders of the Company.

(d) CORPORATE GOVERNANCE. The Company shall have adopted all applicable corporate governance measures required by the Sarbanes-Oxley Act and the Nasadaq and shall have delivered to Acquired Corporation copies of its audit committee charter, compensation committee charter and its code of ethics.

(e) ADDITIONAL DOCUMENTS. Each of the following documents shall have been delivered to Acquired Corporation: (a) an opinion of Shumaker, Loop & Kendrick, LLP reasonably satisfactory to Acquired Corporation and their counsel addressing issues customary to be addressed in a transaction of this type; (b) certificate of good standing and foreign qualification of the Company and each Subsidiary from each jurisdiction of incorporation or qualification; and (c) such agreements, instruments, certificates and other documents as Acquired Corporation may reasonably request for the purpose of facilitating the consummation or performance of any of the transactions contemplated in this Agreement.

Section 7.3 ADDITIONAL CONDITIONS TO OBLIGATION OF THE COMPANY. The obligation of the Company to effect the Merger is also subject to the following conditions:

(a) REPRESENTATIONS AND WARRANTIES. Each of the representations and warranties of Acquired Corporation contained in this Agreement, including without limitation under Section 6.13, shall be

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true and correct (without giving effect to any qualification as to materiality or Acquired Corporation Material Adverse Effect contained in any specific representation or warranty), as of the date of this Agreement and as of the Effective Date, without giving effect to any supplement to the Acquired Corporation Disclosure Schedule, except (i) for changes contemplated or permitted by this Agreement, (ii) that the accuracy of representations and warranties that by their terms speak as of the date of this Agreement or other date will be determined as of such date and (iii) where any such failure of the representations and warranties to be true and correct in the aggregate will not have an Acquired Corporation Material Adverse Effect; and the Company shall have received a certificate signed on behalf of Acquired Corporation by the chief executive officer and chief financial officer of Acquired Corporation to such effect.

(b) AGREEMENTS AND COVENANTS. Acquired Corporation shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by them at or prior to the Effective Date, including without limitation under Section 6.13; and the Company shall have received a certificate signed by the chief executive officer and the chief financial officer of Acquired Corporation to such effect.

(c) APPROVALS. The Acquired Corporation shall have undertaken all corporate action necessary for the consummation of the transaction, including without limitation that this Agreement and the Merger shall have been approved and adopted by the requisite vote of the Board of Directors and stockholders of Acquired Corporation and the holders of not less than 74% of the aggregate principal amount of Acquired Corporation’s 12% Convertible Subordinated Promissory Notes dated January 21, 2003.

(d) ADDITIONAL DOCUMENTS. Each of the following documents shall have been delivered to the Company: (a) an opinion of Rogin, Nassau, Caplan, Lassman & Hirtle, LLC reasonably satisfactory to the Company and its counsel addressing issues customary to be addressed in a transaction of this type; (b) certificate of existence of Acquired Corporation and (c) such agreements, instruments, certificates and other documents as the Company may reasonably request for the purpose of facilitating the consummation or performance of any of the transactions contemplated in this Agreement.

(e) FAIRNESS OPINION. The Company shall have received an opinion from its financial advisor, dated on or before the Effective Date, in form and substance acceptable to the Board of Directors of the Company, to the effect that as of such date, the Exchange Ratios and the Merger Consideration is fair from a financial point of view to the stockholders of the Company.

(f) WARRANTS. The Company shall have received evidence satisfactory to the Company that all options, warrants and other rights to purchase Acquired Corporation Stock shall have been terminated with no negative consequence to Acquired Corporation or the Company; provided, however, that

(i) the Acquired Corporation shall not be required to terminate prior to the Effective Date options to purchase an aggregate of no more than 50,000 shares of Acquired Corporation Common Stock held by employees other than the executive officers or directors of Acquired Corporation if the Acquired Corporation is unable to obtain such remaining terminations prior to the Effective Date, so long as Edgardo A. Mercadante, Dale Ribaudo and James Beaumariage, on a pro rata basis deliver to the Company 50,000 shares of the Company’s Common Stock (or such lesser number of shares into which such claimants may be entitled) held by them to satisfy any claims that might arise from former holders of options, warrants or other rights to purchase Acquired Corporation Stock which were not terminated prior to the Effective Date; and

(ii) if not terminated, the Company shall agree to assume the obligations of those certain stock purchase warrants dated October 29, 2003, issued by the Acquired Corporation to J.K. Baker, Larry E. Knotts and Marc Kloner for the purchase of an aggregate of 492,306 shares of nonvoting common stock of the Acquired Corporation on the express condition that the securities into which such warrants are convertible shall be Company Common Stock.

(g) ACQUIRED CORPORATION EMPLOYMENT AGREEMENTS. All change of control prohibitions or penalties contained in Acquired Corporation’s certificate of incorporation or any agreement

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set forth in the Acquired Corporation Disclosure Schedule to which Acquired Corporation is a party, including without limitation the employment agreements of Mr. Mercadante, Dale Ribaudo and James Beaumariage shall have been terminated without any negative consequence to the Acquired Corporation or the Company and without triggering the change of control provisions contained therein.

(h) SHAREHOLDERS AGREEMENT. All shareholders agreements to which Acquired Corporation is a party shall have been terminated.

7.4 COMMERCIALLY REASONABLE EFFORTS. The Company and Acquired Corporation shall use their commercially reasonable efforts to satisfy all of the conditions to the Merger.

ARTICLE VIII

TERMINATION

Section 8.1 TERMINATION. This Agreement may be terminated at any time prior to the Effective Date, notwithstanding approval thereof by the stockholders of the Company or Acquired Corporation:

(a) by mutual written consent duly authorized by the Boards of Directors of Acquired Corporation and the Company;

(b) by either Acquired Corporation or the Company if the Merger shall not have been consummated by July 30, 2004 (as such date may be extended in accordance with the terms of this Section 8.1(b), the “Outside Date”); provided, that the right to terminate this Agreement under this Section 8.1(b) shall not be available to any party whose failure to fulfill any obligation under this Agreement has been the principal cause of the failure of the Merger to occur on or before the Outside Date);

(c) by either Acquired Corporation or the Company if a court of competent jurisdiction or governmental, regulatory or administrative agency or commission shall have issued a nonappealable final order, decree or ruling or taken any other action having the effect of permanently restraining, enjoining or otherwise prohibiting the Merger (provided that the party seeking to terminate pursuant to this Section 8.1(c) shall have complied with its obligations under Section 6.4 and used its reasonable commercially reasonable efforts to have any such order, decree, ruling or other action vacated or lifted);

(d) by either Acquired Corporation or, if the Company and Mr. Taneja have not materially breached the provisions of Section 6.3, the Company, if at the Company Stockholders Meeting (giving effect to any adjournment or postponement thereof), the requisite vote of the stockholders of the Company in favor of this Agreement and the Merger shall not have been obtained; or, by either the Company or, if Mr. Mercadante has not materially breached the provisions of Section 6.15, the Acquired Corporation, if the requisite vote of the stockholders of Acquired Corporation in favor of this Agreement and the Merger shall not have been obtained;

(e) by Acquired Corporation, if the Company or Mr. Taneja shall have breached or failed to perform any of their respective representations, warranties, covenants or other agreements contained in this Agreement, which breach or failure to perform would cause the conditions set forth in Section 7.2(a) or Section 7.2(b) to not be satisfied and which breach or failure, if capable of being cured, shall not have been cured within 20 business days following receipt by the Company of written notice of such breach or failure from Acquired Corporation;

(f) by the Company, if Acquired Corporation or Mr. Mercadante shall have breached or failed to perform any of its representations, warranties, covenants or other agreements contained in this Agreement, which breach or failure to perform would cause the conditions set forth in Sections 7.3(a) or 7.3(b), to not be satisfied and which breach or failure, if capable of being cured, shall not have been cured within 20 business days following receipt by Acquired Corporation of written notice of such breach from the Company;

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(g) by Acquired Corporation, if the Company’s Board of Directors (or any committee thereof) shall have approved or recommended to the stockholders of the Company an acquisition proposal by any third party;

(h) by Acquired Corporation, if the Company or Mr. Taneja shall have breached in any material respect its or his obligations under Section 6.3;

(i) by the Company, if Acquired Corporation or Mr. Mercadante shall have breached in any material respect his obligations under Section 6.3;

(j) by the Company, if Acquired Corporation’s Board of Directors (or any committee thereof) shall have approved or recommended to the stockholders of Acquired Corporation an acquisition proposal by any third party; or

(k) by the Company or the Acquired Corporation pursuant to Section 6.13 of this Agreement.

Section 8.2 EFFECT OF TERMINATION. In the event of the termination of this Agreement pursuant to Section 8.1, this Agreement shall forthwith become void and there shall be no liability on the part of any party hereto or any of its affiliates, directors, officers or stockholders except (i) that the provisions of Sections 3.25, 4.22, 6.1(b) and (c), 6.13, 8.2, 8.3 and Article IX shall survive termination and (ii) nothing herein shall relieve any party from liability for any willful breach of this Agreement

Section 8.3 FEES AND EXPENSES.

(a) All commercially reasonable legal, accounting, investment banking and other fees, tail coverage for Acquired Company director and officer liability insurance, costs and expenses incurred at any time by the Company or the Acquired Corporation in connection with pursuing or consummating the transactions contemplated hereby shall be paid by the Surviving Corporation; provided, that the investment banking fees of First Albany Capital, Inc. shall be paid by Acquired Corporation; and provided further, that should the transaction contemplated hereby not close, each party will be responsible for and bear all of its own such fees, costs and expenses.

(b) If either the Company or the Acquired Corporation terminate this Agreement in breach of this Agreement (the “Breaching Party”), the Breaching Party shall pay to the other party (the “Non-Breaching Party”) a termination fee (“the Termination Fee”) in the amount set forth in subsection (c) below in cash within five days of the date of termination or, in the event of a termination pursuant to Section 6.13, as provided in Section 6.13 above. Further, if either Mr. LaGamba or Mr. Taneja fail to execute either the Lockup Agreement or their respective employment agreements (as approved by the independent directors of the Company) on or before Closing and the Agreement is terminated by either party as a result thereof, the Company shall pay to the Acquired Corporation the Termination Fee in cash within five days of the termination. Similarly, if either Mr. Mercadante or stockholders who are entitled to receive more than 10% of the Stock Consideration to be paid at the Closing fail to execute the Lockup Agreement, or if Mr. Mercadante fails to execute his employment agreement (as approved by the independent directors of the Company), on or before Closing, and the Agreement is terminated by either party as a result thereof, the Acquired Corporation shall pay to the Company the Termination Fee in cash within five days of the termination. If none of Mr. Mercadante, Mr. Taneja or Mr. LaGamba are willing to execute employment agreements as approved by the independent directors of the Company, and this Agreement is terminated as a result thereof, neither the Company nor Acquired Corporation shall be required to pay the Termination Fee.

(c) The Termination Fee shall be equal to five percent (5%) of the market price of all issued and outstanding shares of the Company based the ten-day weighted average of the Company Common Stock. For the purposes of this Section 8.3(c), the ten-day weighted average shall be determined by (i) multiplying the closing bid price for the Company Common Stock, as reported by the Nasdaq, for each of the ten trading days immediately prior to the date of termination by the volume of shares traded during the corresponding day, (ii) adding the result of each such daily calculation, (iii) dividing such sum by ten (10) and (iv) dividing such quotient by the average daily number of shares traded during such ten-day period.

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ARTICLE IX

GENERAL PROVISIONS

Section 9.1 (Reserved.)

Section 9.2 NOTICES. All notices and other communications given or made pursuant hereto shall be in writing and shall be deemed to have been duly given or made if and when delivered personally or by overnight courier to the parties at the following addresses or sent by electronic transmission, with confirmation received, to the telecopy numbers specified below (or at such other address or telecopy number for a party as shall be specified by like notice):

If to Acquired Corporation:

Mr. Edgardo A. Mercadante

Familymeds Group, Inc.

312 Farmington Avenue

Farmington, Connecticut 06032

With a copy to:

Steven D. Bartelstone, Esq.

Rogin, Nassau, Caplan, Lassman & Hirtle LLC

CityPlace I, 22d Floor

185 Asylum Street

Hartford, Connecticut 06103

and

If to the Company:

Mr. Jugal K. Taneja

DrugMax, Inc.

25400 US Highway 19 North, Suite 137

Clearwater, Florida 33763

With a copy to:

Gregory C. Yadley, Esq.

Shumaker, Loop & Kendrick, LLP

101 E. Kennedy Boulevard, Suite 2800

Tampa, Florida 33602

After the Effective Date, notice to either the Acquired Corporation or the Company shall go to both Messrs. Taneja and Mercadante at their respective addresses set forth above.

Any such notice or communication shall be deemed to have been delivered and received (i) in the case of personal delivery, on the date of such delivery, (ii) in the case of facsimile, on the date sent if confirmation of receipt is received and such notice is also promptly mailed by registered or certified mail (return receipt requested), (iii) in the case of a nationally-recognized overnight courier in circumstances under which such courier guarantees next business day delivery, on the next business day after the date when sent and (iv) in the case of mailing, on the third business day following that on which the piece of mail containing such communication is posted.

Section 9.3 CERTAIN DEFINITIONS. For purposes of this Agreement, the term:

(a) “affiliate” means a person that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, the first mentioned person;

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(b) “Antitrust Law” means the Sherman Act, as amended, the Clayton Act, as amended, the HSR Act, the Federal Trade Commission Act, as amended, the EC Merger Regulations and all other federal, state and foreign statutes, rules, regulations, orders, decrees, administrative and judicial doctrines, and other Laws that are designed or intended to prohibit, restrict or regulate actions having the purpose or effect of monopolization or restraint of trade;

(c) “beneficial owner” with respect to any shares of Company Common Stock means a person who shall be deemed to be the beneficial owner of such shares pursuant to Rule 13d-3 under the Exchange Act;

(d) “Breach”, as used in Section 6.14 of this Agreement, of a representation, warranty, covenant, obligation, or other provision of this Agreement or any instrument delivered pursuant to this Agreement will be deemed to have occurred if there is or has been (a) any inaccuracy in or breach of, or any failure to perform or comply with, such representation, warranty, covenant, obligation, or other provision, or (b) any claim (by any person) or other occurrence or circumstance that is or was inconsistent with such representation, warranty, covenant, obligation, or other provision, and the term “Breach” means any such inaccuracy, breach, failure, claim, occurrence, or circumstance.

(e) “business day” means any day other than a Saturday or Sunday or any day on which banks in the State of Connecticut are required or authorized to be closed;

(f) “control” including the terms “controlled by” and “under common control with”) means the possession, directly or indirectly or as trustee or executor, of the power to direct or cause the direction of the management or policies of a person, whether through the ownership of stock, as trustee or executor, by contract or credit arrangement or otherwise;

(g) “Include” or “including” means “include, without limitation” or “including, without limitation,” as the case may be, and the language following “include” or “including” shall not be deemed to set forth an exhaustive list;

(h) “Intellectual Assets” means trademarks, service marks, trade names, and internet domain names, together with all goodwill, registrations and applications related to the foregoing; patents and industrial design registrations or applications (including any continuations, divisionals, continuations-in-part, renewals, reissues, re-examinations and applications for any of the foregoing); works of authorship protected by copyright registrations; copyrights (including any registrations and applications for any of the foregoing); mask works rights and trade secrets and other confidential information, know-how, proprietary processes, formulae, algorithms, models, and methodologies;

(i) “knowledge” with respect to Acquired Corporation and the Company, respectively, means the actual knowledge, after reasonable investigation, of any of the individuals identified for the respective parties in Section 9.3(g)(i) of the Disclosure Schedule;

(j) “person” means an individual, corporation, partnership, association, trust, unincorporated organization, other entity or group (as defined in Section 13(d)(3) of the Exchange Act);

(k) “proceeding” means any action, arbitration, audit, hearing, investigation, litigation, or suit (whether civil, criminal, administrative, investigative, or informal) commenced, brought, conducted, or heard by or before, or otherwise involving, any governmental or quasi-governmental authority of any nature (including any governmental agency, branch, department, official, or entity and any court or other tribunal) or arbitrator; and

(l) “Subsidiary” means, with respect to any party, any corporation or other organization, whether incorporated or unincorporated, of which (A) such party or any other Subsidiary of such party is a general partner (excluding partnerships, the general partnership interests of which held by such party or any Subsidiary of such party do not have a majority of the voting interest in such partnership), (B) such party or any Subsidiary of such party owns a majority of the outstanding equity or voting securities or interests or (C) such party or any Subsidiary of such party has the right to elect at least a majority of the board of directors or others performing similar functions with respect to such corporation or other organization. Notwithstanding the foregoing, MorepenMax, Inc. shall be deemed a “Subsidiary” of the Company.

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Section 9.4 AMENDMENT. This Agreement may be amended by the parties hereto by action taken by or on behalf of their respective Boards of Directors at any time prior to the Effective Date; PROVIDED, HOWEVER, that, after approval of the Merger by the stockholders of Acquired Corporation or the Company, no amendment may be made which by law requires further approval by such stockholders without such further approval. This Agreement may not be amended except by an instrument in writing signed by the parties hereto.

Section 9.5 EXTENSION; WAIVER. At any time prior to the Effective Date, the parties hereto, by action taken or authorized by their respective president or chief executive officer, may to the extent legally allowed, (a) extend the time for the performance of any of the obligations or other acts of any other party hereto, (b) waive any inaccuracies in the representations and warranties of any other party hereto contained herein or in any document delivered pursuant hereto or (c) waive compliance with any of the agreements or conditions of any other party hereto contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party.

Section 9.6 HEADINGS. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement.

Section 9.7 SEVERABILITY. If any term or other provision of this Agreement is invalid, illegal or incapable of being enforced by any rule of law, or public policy, all other conditions and provisions of this Agreement shall nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner adverse to any party. Upon such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner to the end that the transactions contemplated hereby are fulfilled to the fullest extent possible.

Section 9.8 ENTIRE AGREEMENT; NO THIRD PARTY BENEFICIARIES. This Agreement (including the documents and instruments referred to herein) (a) constitutes the entire agreement and supersedes all prior agreements and understandings, both written and oral, among the parties, or any of them, with respect to the subject matter hereof, and (b) is not intended to confer upon any person other than the parties hereto any rights or remedies hereunder, other than the persons intended to benefit from the provisions of Section 6.8 (Indemnification and Insurance), who shall have the right to enforce such provisions directly.

Section 9.9 ASSIGNMENT. This Agreement shall not be assigned by operation of law or otherwise.

Section 9.10 INTERPRETATION. When a reference is made in this Agreement to Sections, such reference shall be to a Section of this Agreement unless otherwise indicated. The table of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement.

Section 9.11 FAILURE OR INDULGENCE NOT WAIVER; REMEDIES CUMULATIVE. No failure or delay on the part of any party hereto in the exercise of any right hereunder shall impair such right or be construed to be a waiver of, or acquiescence in, any breach of any representation, warranty or agreement herein, nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or of any other right. All rights and remedies existing under this Agreement are cumulative to, and not exclusive of, any rights or remedies otherwise available.

Section 9.12 GOVERNING LAW. This Agreement shall be governed by, and construed in accordance with, the internal laws of the State of Connecticut, without regard to the conflict of law provisions thereof.

Section 9.13 COUNTERPARTS. This Agreement may be executed in two or more counterparts, and by the different parties hereto in separate counterparts, each of which when executed shall be deemed to be an original but all of which taken together shall constitute one and the same agreement.

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Section 9.14 WAIVER OF JURY TRIAL. EACH OF ACQUIRED CORPORATION, MR. MERCADANTE, THE COMPANY AND MR. TANEJA HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THE ACTIONS OF ANY PARTY HERETO IN THE NEGOTIATION, ADMINISTRATION, PERFORMANCE AND ENFORCEMENT OF THIS AGREEMENT.

Section 9.15 SPECIFIC PERFORMANCE. The parties agree that irreparable damage would occur and that the parties would not have any adequate remedy at law in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement, this being in addition to any other remedy to which they are entitled at law or in equity.

[Signature Page Follows]

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EX-2.8

Exhibit 2.8

FIRST AMENDMENT TO AGREEMENT AND PLAN OF MERGER

This FIRST AMENDMENT, dated as of July 1, 2004 (this “Amendment”), by and among DrugMax, Inc., a Nevada corporation (the “Company”), Familymeds Group, Inc., a Connecticut corporation (the “Acquired Corporation”), and, to the extent specifically provided herein, Jugal K. Taneja, an individual with an address of 25400 US Highway 19 North, Suite 137, Clearwater, Florida 33763(“Mr. Taneja”), and Edgardo A. Mercadante, an individual with an address of 312 Farmington Avenue, Farmington, Connecticut 06032 (“Mr. Mercadante”), amends that certain Agreement and Plan of Merger dated as of March 19, 2004 by and among the Company, the Acquired Corporation, Mr. Taneja and Mr. Mercadante (the “Merger Agreement”).

NOW THEREFORE, in consideration of the mutual covenants herein contained and such other consideration as the parties hereto acknowledge having received, the parties, intending to be legally bound, hereby agree as follows:

1. Definitions. Capitalized terms used herein and not otherwise defined shall have the meanings ascribed to them in the Merger Agreement.

2. Post-Merger Ownership. The introductory paragraph to Article II of the Merger Agreement is deleted in its entirety.

3. Merger Consideration. When the term “Acquired Corporation Stockholders” is used in the Merger Agreement and this Amendment, it shall mean the stockholders of the Acquired Corporation as of the record date set for the Acquired Corporation’s stockholders meeting at which the approval of the merger will be set to a vote. Notwithstanding anything to the contrary in the Merger Agreement, 10,470,507 shares of Company Common Stock shall be issued in consideration for all of the shares of the Acquired Corporation’s stock and notes and shall be allocated among (A) the Acquired Corporation’s Stockholders, (B) holders of warrants to purchase the Acquired Corporation’s series E redeemable convertible preferred stock (the “Warrant Holders”), and (C) holders of the convertible promissory notes in the original principal amount of $4,000,000 convertible into the Acquired Corporation’s series E redeemable convertible preferred stock (the “Note Holders”), as follows:

a. The allocation of the shares will be based on the weighted average closing bid price of the Company Common Stock during the ten trading days immediately preceding the merger;

b. The Note Holders will receive the initial principal amount of their notes plus interest in the aggregate amount of $8 million in Company Common Stock at the closing in full satisfaction of their debt;

c. The Warrant Holders shall have exercised their warrants (by surrendering a portion of their warrants in lieu of paying cash) and purchased the Acquired Corporation’s series E redeemable convertible preferred stock (the “Series E

Stock”) immediately prior to the Merger and will receive Company Common Stock pro rata with the other holders of Series E Stock;

d. The number of Company Common Stock shares remaining after the distribution to the Note Holders, if any, will be distributed, on a pro rata basis, to the holders of Series E Stock (including the Warrant Holders), on a fully diluted basis assuming the exercise of all outstanding warrants to purchase Series E Stock, in an amount sufficient to cover their aggregate liquidation preference as of the Effective Date;

e. The number of Company Common Stock shares remaining, if any, will be distributed, on a pro rata basis, to the holders of the Acquired Corporation’s series D redeemable convertible preferred stock and series C convertible preferred stock in an amount sufficient to cover their aggregate liquidation preference as of the Effective Date;

f. The number of Company Common Stock shares remaining, if any, will be distributed, on a pro rata basis, to the holders of the Acquired Corporation’s series A and B redeemable convertible preferred stock in an amount sufficient to cover their aggregate liquidation preference as of the Effective Date;

g. The number of Company Common Stock shares remaining, if any, will be distributable, on a pro rata basis, to the common stockholders; and

h. the amount to be distributed to the Acquired Corporation’s series A, B, D and E stockholders will include all accrued dividends on such series through the effective date, if any. The holders of the Acquired Corporation common stock and series C preferred stock are not entitled to any accrued dividends.

Further, the Acquired Corporation shall prepare Exhibit 2.1(b) to the Merger Agreement (which, pursuant to the Merger Agreement, is to be attached to the Merger Agreement at the Closing) to reflect the foregoing allocation.

4. Acquired Corporation Stock. Section 2.1(d) of the Merger Agreement is deleted in its entirety and replaced with the following:

(b) Acquired Corporation Stock. Notwithstanding anything to the contrary in the Merger Agreement, at least 20 days prior to the Closing, the board of directors of the Acquired Corporation shall (i) approve the immediate and full vesting of all outstanding options granted to the Acquired Corporation’s employees or directors that have not previously terminated or expired, or that will not terminate or expire prior to the Closing, (ii) identify and notify in writing each employee or director holding such options that such options have become fully vested and that the employee or director has the right to exercise those options no later than ten days prior to the Effective Date (the “Option Date”), and (iii) terminate all options that have not been exercised by such employees or directors on or prior to the Option Date. The Acquired Corporation shall provide the

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Company with reasonable evidence that all such option have terminated prior to the Effective Date.

5. Warrants. Notwithstanding anything to the contrary in the Merger Agreement, the Warrants to be issued at the Closing shall be allocated among the recipients of the Company Common Stock as set forth in Section 2 above, in the same proportions as the number of shares of Company Common Stock that they are to receive at the Closing.

6. Employee Shares. Section 2.2 of the Merger Agreement is hereby deleted and replaced in its entirety by the following:

Section 2.2 EMPLOYEE SHARES. On the Effective Date, the Company shall grant to the Acquired Corporation’s employees and directors listed on Exhibit 2.2 to this Agreement that agree to continue to serve the Company as either employees or directors after the Effective Date (the “Employees”), restricted shares of the Company’s common stock (collectively, the “Management Shares”). The aggregate number of Management Shares to be issued to such Employees shall equal the sum of (A) 1,010,000 shares, which shall be issued to Mr. Mercadante, and (B) such additional number of shares as shall be determined at the closing of the merger by dividing $3,500,000 by the weighted average closing bid price of DrugMax common stock during the ten trading days immediately preceding the merger. The Management Shares shall be allocated among the Employees pursuant to the schedule attached as Exhibit 2.2 to this Agreement, which the Acquired Corporation shall prepare and deliver to the Company immediately prior to the Closing. The Management Shares shall be subject to a restricted stock agreement to be delivered by the Company to each Employee on the Effective Date. The restricted stock agreement to be used for executive officers (including Edgardo Mercadante, Dale Ribaudo, James Beaumariage and Allison Kiene) shall be in substantially the form attached to this Agreement as Exhibit 2.2(a), and the restricted stock agreement to be used for all other Employees shall be in substantially the form attached to this Agreement as Exhibit 2.2(b) (the “Employee Restricted Shares Agreement”).

Further, all references in the Merger Agreement to “Management Shares and Options” shall be deleted and replaced by a reference to “Management Shares.”

7. Registration. Notwithstanding anything to the contrary in the Merger Agreement, the Company shall register the shares of Company Common Stock beneficially owned or to be issued at Closing to Mr. Mercadante, Mr. Ribaudo, Mr. Beaumariage, Ms. Kiene, Mr. Taneja, Mr. LaGamba and Mr. Laird pursuant to the terms of the Lock Up and Registration Rights Agreement, and the Company shall register the shares of Company Common Stock to be issued to all of the other Employees pursuant to the terms of their respective restricted stock agreements. Further, the form of Lock Up and Registration Rights Agreement that was attached as Exhibit 2.3 is hereby deleted in its entirety and replaced with the form of Lock Up and Registration Rights Agreement attached hereto as Exhibit 7.

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8. Adjustments. Section 2.6 of the Merger Agreement is hereby deleted and replaced in its entirety by the following:

Section 2.6 ADJUSTMENTS. In the event that prior to the Effective Date the Company Common stock shall be changed into a different number of shares or a different class of shares by reason of any recapitalization or reclassification, stock dividends, combination, stock split, or reverse stock split of the Company Common Stock, an appropriate and proportionate adjustment shall be made in the number of Management Shares and the Company Common Stock and Warrants into which the Acquired Corporation Stock shall be converted.

9. Capitalization. Section 3.3 (a) of the Merger Agreement is hereby deleted and replaced in its entirety by the following:

(a) The authorized capital stock of the Company consists of 24,000,000 shares of Company Common Stock and 2,000,000 shares of preferred stock. As of March 17, 2004, (i) 8,185,642 shares of Company Common Stock are issued and outstanding; (ii) 2,083,901 shares of Company Common Stock are reserved for issuance upon exercise of options and warrants; (iii) no shares of Company Common Stock are issued and held in the treasury of the Company; and (iv) no shares of preferred stock are or have been issued or outstanding nor have the rights of such preferred stock been defined nor has the issuance of such preferred stock ever been authorized. As of June 27, 2004, the aggregate number of shares of Company Common Stock subject to Company Stock Options as defined in subsection (b) below is 2,220,479. The aggregate number of shares of Company Common Stock subject to warrants or other rights as described in subsection (c) below is 150,000.

10. Stockholders Meeting. All references in Sections 6.3(a) and 6.3(b) of the Merger Agreement to “June 30, 2004,” shall be deleted and replaced by a reference to “August 31, 2004.”

11. Lock Up Agreement. Section 7.1(f) of the Merger Agreement is deleted in its entirety and replaced by the following:

(f) LOCK UP AGREEMENT. Jugal Taneja, William LaGamba, Phil Laird, Edgardo Mercadante, Dale Ribaudo, James Beaumariage, Allison Kiene and stockholders and note holders of the Acquired Corporation who are entitled to receive, in the aggregate, at least 90% of the Stock Consideration to be paid at the Closing shall have entered into the Lockup Agreement.

12. Warrants. Section 7.3f(i) of the Merger Agreement is deleted in its entirety and replaced by the following:

(i) if not terminated, the Company shall agree to assume the obligations of those certain stock purchase warrants dated October 29, 2003, issued by the Acquired Corporation to J.K. Baker, Larry E. Knotts and Marc Kloner for the purchase of an aggregate of 492,306 shares of nonvoting common stock of the Acquired Corporation on the express condition that the securities into which such warrants are convertible shall be Company Common Stock, the exercise price of

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such warrants shall be $9.75 per share of Company Common Stock and the termination of such warrants shall be as set forth in the existing warrants.

13. Assumed Warrants. Section 7.3(f)(ii) of the Merger Agreement is deleted in its entirety.

14. Termination. The reference in Sections 8.1(b) of the Merger Agreement to “July 30, 2004,” shall be deleted and replaced by a reference to “August 31, 2004.”

15. Fees and Expenses. Section 8.3(b) of the Merger Agreement is deleted in its entirety and replaced by the following:

(b) If either the Company or the Acquired Corporation terminate this Agreement in breach of this Agreement (the “Breaching Party”), the Breaching Party shall pay to the other party (the “Non-Breaching Party”) a termination fee (“the Termination Fee”) in the amount set forth in subsection (c) below in cash within five days of the date of termination or, in the event of a termination pursuant to Section 6.13, as provided in Section 6.13 above. Further, if either Mr. LaGamba, Mr. Taneja or Mr. Laird fail to execute the Lockup Agreement on or before Closing and the Agreement is terminated by either the Acquired Corporation or the Company as a result thereof, the Company shall pay to the Acquired Corporation the Termination Fee in cash within five days of the termination. Similarly, if either Mr. Mercadante, Mr. Ribaudo, Mr. Beaumariage, Ms. Kiene or the stockholders of the Acquired Corporation who collectively are entitled to receive at least 90% of the Stock Consideration to be paid at the Closing fail to execute the Lockup Agreement on or before Closing, and the Agreement is terminated by either the Acquired Corporation or the Company as a result thereof, the Acquired Corporation shall pay to the Company the Termination Fee in cash within five days of the termination.

16. Representations. Article IV of the Merger Agreement is hereby revised by adding a Section 4.24 which provides that “All of the Acquired Corporation Stockholders are “accredited,” as such term is defined by Regulation D of the Securities Act of 1933.”

17. Employment Agreements. A new Section 6.15 shall be added to Article VI of the Merger Agreement that provides that:

Section 6.15. Immediately after the Merger, Messrs. Mercadante, Taneja, LaGamba and Ribaudo shall enter into new employment agreements with the Company on terms mutually acceptable to such employees and the board of directors of the Company, after the merger, and Messrs. Mercadante and Taneja hereby agree to negotiate the terms of such employment agreements in good faith, and, in connection therewith, Messrs. Mercadante and Taneja hereby waive any and all rights that any of them may have to receive any benefit, payment or compensation (including without limitation the right to put shares to either the Company or the Acquired Corporation) arising out of the change of control of the Company or the Acquired Corporation caused by the Merger. However, the foregoing waiver will not affect either Mr. Mercadante or Mr. Taneja’ right to

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receive any severance pay to which he or she is entitled upon the termination of his employment by the Company; provided that, notwithstanding anything to the contrary in their respective employment agreements or otherwise, the Merger shall not, in and of itself, be deemed to be a termination of employment, shall not be deemed to constitute “Cause” or “Good Reason” or any comparable term under their employment agreements, or otherwise entitle them to terminate their employment. Messrs. Mercadante and Taneja agree to deliver any other documents necessary to establish this waiver. It is further agreed that Messrs. Taneja and Mercadante shall receive substantially identical compensation in their new employment agreements and that Messrs. LaGamba and Ribaudo will receive substantially identical compensation in their new employment agreements, whatever those terms might be as agreed upon by the board of directors of the Company after the Merger.

Further, Section 7.1(b) of the Merger Agreement is hereby deleted in its entirety and replaced by the following:

Dale Ribaudo, James Beaumariage, Allison Kiene, William LaGamba and Phil Laird shall have entered into the Lock Up and Registration Rights Agreement, thereby waiving in writing any and all rights they may have, by way of their present employment agreements or otherwise, to obtain a change of control bonus caused by the Merger.

18. Closing Conditions. Section 7.3 of the Merger Agreement is further amended by adding a subparagraph (i) that states:

(i) As contemplated by Section 2.3 of this Agreement, the Company Common Stock being issued at the Effective Dates to the Acquired Corporation Stockholders, the Warrant Holders, the Note Holders and the Employees in connection with the Merger will be 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. Accordingly, such shares will be considered restricted shares pursuant to Rule 144 of the Securities Act, may not be resold by the holders until the shares can be resold pursuant to an exemption from registration under the Securities Act or until the Company registers the resale of the shares, and will bear a restrictive legend to this effect. The Closing of the Merger is specifically conditioned upon the availability of such exemptions from registration. Acquired Corporation hereby agrees to cooperate in establishing an appropriate exemption from registration.

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19. Amended and Restated Articles of Incorporation of DrugMax, Inc. Article Three Section 3.01 of Exhibit 1.4 of the Merger Agreement is deleted in its entirety and replaced with:

SECTION 3.01. AUTHORIZED CAPITAL STOCK. The total number of shares of capital stock the corporation is authorized to issue is Fifty Million (50,000,000) shares, each having a par value of $0.001, of which (i) forty-five Million (45,000,000) shares shall be designated as “Common Stock” and (ii) Five Million (5,000,000) shares shall be designated as “Preferred Stock.”

20. Miscellaneous.

a. Each of the Company and the Acquired Corporation hereby represent and warrant to one another that their execution and delivery of this Amendment have been duly and validly approved and acknowledged by all necessary corporate action on the part of the applicable party and that this Amendment constitutes a valid and binding obligation of the respective party in accordance with its terms.

b. This Amendment may be executed in two or more counterparts, each of which shall be deemed to be an original, but all of which shall constitute one and the same agreement. Any facsimile signature of any party hereto shall constitute a legal, valid and binding execution hereof by such party until such original signature is received.

c. Except as expressly amended hereby, the Merger Agreement shall continue to be, and shall remain, unaltered and in full force and effect in accordance with its terms. To the extent that any term or provision of this Amendment is or may be deemed expressly inconsistent with any term or provision in the Merger Agreement or any other document executed in connection therewith, the terms and provisions hereof shall control.

IN WITNESS WHEREOF, each of the parties hereto has caused this Amendment to be duly executed as of the day and year first above written.

DrugMax, Inc.		Familymeds Group, Inc.
By:	/s/ Jugal K. Taneja	By:	/s/ Edgardo A. Mercadante
Name:	Jugal K. Taneja	Name:	Edgardo A. Mercadante
Title:	Chief Executive Officer	Title:	President

/s/ Jugal K. Taneja	/s/ Jugal K. Taneja
Jugal K. Taneja	Edgardo A. Mercadante

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EX-10.8

Exhibit 10.8

FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT

BY AND BETWEEN

CONGRESS FINANCIAL CORPORATION (FLORIDA)

AND

DRUGMAX, INC., TOGETHER WITH ITS SUBSIDIARIES,

VALLEY DRUG COMPANY, VALLEY DRUG COMPANY SOUTH,

AND DISCOUNT Rx, INC.

THIS FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”) is entered into effective as of the 19th day of August, 2003, by and between DRUGMAX, INC., a Nevada corporation (“Borrower”), (together with its subsidiaries, VALLEY DRUG COMPANY, an Ohio corporation, VALLEY DRUG COMPANY SOUTH, a Louisiana corporation, and DISCOUNT Rx, Inc., a Louisiana corporation, also the “Borrower”), and CONGRESS FINANCIAL CORPORATION (FLORIDA), a Florida corporation (“Lender”).

W I T N E S S E T H:

WHEREAS, Borrower and Lender heretofore entered into that certain Loan and Security Agreement dated April 15, 2003 (the “Loan Agreement”) pursuant to which Lender agreed to make loans and provide other financial accommodations to Borrower; and

WHEREAS, Borrower has now requested Lender to include the assets acquired from Avery Pharmaceuticals. Inc. and certain changes be made to the Loan Agreement including changes to the Eligible Accounts, and the EBITDA financial covenant and Lender is willing to agree to such financing and such changes, subject to the terms and conditions set forth herein.

NOW, THEREFORE, for and in consideration of the above premises, the mutual covenants and agreements contained herein and other good and valuable consideration, the receipt whereof is hereby acknowledged, Borrower and Lender agree as follows:

1. Definitions. All capitalized terms contained herein shall have the meanings assigned to them in the Loan Agreement unless the context herein otherwise dictates or unless different meanings are specifically assigned to such terms herein.

2. Particular Amendments to Loan Agreement. The Loan Agreement is hereby amended as follows:

(a) Change to Subsection 1.20. Subsection 1.20 of the Loan Agreement is hereby amended to read in its entirety as follows:

1.20 “Eligible Accounts” shall mean Accounts created by Borrower which are and continue to be acceptable to Lender based on the criteria set forth below. In general, Accounts shall be Eligible Accounts if:

(a) such Accounts arise from the actual and bona fide sale and delivery of goods by Borrower or rendition of services by Borrower in the ordinary course of its business which transactions are completed in accordance with the terms and provisions contained in any documents related thereto;

(b) such Accounts are (i) neither unpaid more than thirty (30) days after the due date, nor more than sixty (60) days after the date of the original invoice for them, provided however, that (ii) notwithstanding subsection (i) hereof the Accounts listed on Schedule 1.20 hereof, each of which shall be subject to net 30 day terms, shall be considered Eligible Accounts so long as such Accounts are not unpaid more than sixty (60) days after the due date nor more than ninety (90) days after the date of the original invoice for them and otherwise meet the criteria for Eligible Accounts set forth in this Subsection 1.20;

(c) such Accounts comply with the terms and conditions contained in Section 7.2(b) of this Agreement;

(d) such Accounts do not arise from sales on consignment, guaranteed sale, sale and return, sale on approval, or other terms under which payment by the account debtor may be conditional or contingent;

(e) the chief executive office of the account debtor with respect to such Accounts is located in the United States of America, including Puerto Rico, or Canada (provided, that, at any time promptly upon Lender’s request, Borrower shall execute and deliver, or cause to be executed and delivered, such other agreements, documents and instruments as may be required by Lender to perfect the security interests of Lender in those Accounts of an account debtor with its chief executive office or principal place of business in Canada in accordance with the applicable laws of the Province of Canada in which such chief executive office or principal place of business is located and take or cause to be taken such other and further actions as Lender may request to enable Lender as secured party with respect thereto to collect such Accounts under the applicable Federal or Provincial laws of Canada) or, at Lender’s option, if the chief executive office and principal place of business of the account debtor with respect to such Accounts is

2

located other than in the United States of America, including Puerto Rico, or Canada, then if either: (i) the account debtor has delivered to Borrower an irrevocable letter of credit issued or confirmed by a bank satisfactory to Lender and payable only in the United States of America and in U.S. dollars, sufficient to cover such Account, in form and substance satisfactory to Lender and if required by Lender, the original of such letter of credit has been delivered to Lender or Lender’s agent and Borrower has complied with the terms of Section 5.2(f) hereof with respect to the assignment of the proceeds of such letter of credit to Lender or naming Lender as transferee beneficiary thereunder, as Lender may specify, or (ii) such Account is subject to credit insurance payable to Lender issued by an insurer and on terms and in an amount acceptable to Lender, or (iii) such Account is otherwise acceptable in all respects to Lender (subject to such lending formula with respect thereto as Lender may determine);

(f) such Accounts do not consist of progress billings (such that the obligation of the account debtors with respect to such Accounts is conditioned upon Borrower’s satisfactory completion of any further performance under the agreement giving rise thereto), bill and hold invoices or retainage invoices, except as to bill and hold invoices, if Lender shall have received an agreement in writing from the account debtor, in form and substance satisfactory to Lender, confirming the unconditional obligation of the account debtor to take the goods related thereto and pay such invoice;

(g) the account debtor with respect to such Accounts has not asserted a counterclaim, defense or dispute and Borrower does not owe any amounts to the account debtor with respect to such Accounts, and such account debtor does not claim that Borrower owes any amounts to such account debtor, that may give rise to any right of setoff or recoupment against such Accounts (but the portion of the Accounts of such account debtor in excess of the amount at any time and from time to time owed by Borrower to such account debtor or claimed owed by such account debtor may be deemed Eligible Accounts);

(h) there are no facts, events or occurrences which would impair the validity, enforceability or collectability of such Accounts or reduce the amount payable or delay payment thereunder;

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(i) such Accounts are subject to the first priority, valid and perfected security interest of Lender and any goods giving rise thereto are not, and were not at the time of the sale thereof, subject to any security interests or liens except those permitted in this Agreement that are subject to an intercreditor agreement in form and substance satisfactory to Lender between the holder of such security interest or lien and Lender;

(j) neither the account debtor nor any officer or employee of the account debtor with respect to such Accounts is an officer, employee, agent or other Affiliate of Borrower provided, however, that notwithstanding the foregoing, up to $500,000 in accounts receivable from T&L, Inc. d/b/a Advanced Pharmacy Solutions, a Florida corporation, to Valley Drug Company South and/or Valley Drug Company shall be considered Eligible Accounts hereunder for the period up to thirty (30) days from the original invoice date for such Accounts, such Accounts are subject to a first perfected security interest in the assets of the Affiliate by the Borrower with a collateral assignment to the Lender and such Accounts meet all other applicable requirements under this Agreement;

(k) the account debtors with respect to such Accounts are not any foreign government, the United States of America, any State, political subdivision, department, agency or instrumentality thereof, unless, if the account debtor is the United States of America, any State, political subdivision, department, agency or instrumentality thereof, upon Lender’s request, the Federal Assignment of Claims Act of 1940, as amended or any similar State or local law, if applicable, has been complied with in a manner satisfactory to Lender;

(l) there are no proceedings or actions which are threatened or pending against the account debtors with respect to such Accounts which might result in any material adverse change in any such account debtor’s financial condition (including, without limitation, any bankruptcy, dissolution, liquidation, reorganization or similar proceeding);

(m) such Accounts of a single account debtor or its affiliates do not constitute more than fifteen (15%) percent of all otherwise Eligible Accounts (but the portion of the Accounts not in excess of such percentage may be deemed Eligible Accounts);

(n) such Accounts are (i) not owed by an account debtor who has Accounts unpaid more than thirty (30) days after the due

4

date, nor more than sixty (60) days after the original invoice date for them, provided however, that (ii) notwithstanding subsection (i) hereof the Accounts listed on Schedule 1.20 hereof, each of which shall be subject to net 30 day terms, shall be considered Eligible Accounts so long as such Accounts are not unpaid more than sixty (60) days after the due date nor more than ninety (90) days after the date of the original invoice for them and otherwise meet the criteria for Eligible Accounts set forth in this Subsection 1.20, and in either case such Accounts constitute more than fifty percent (50%) of the total Accounts of such account debtor provided such percentage shall decrease by five percent (5%) per month beginning the month after the date of closing until the level of twenty-five percent (25%) of the total Accounts of such account debtor is reached at which time no further decreases shall occur;

(o) the account debtor is not located in a state requiring the filing of a Notice of Business Activities Report or similar report in order to permit Borrower to seek judicial enforcement in such State of payment of such Account, unless Borrower has qualified to do business in such state or has filed a Notice of Business Activities Report or equivalent report for the then current year or such failure to file and inability to seek judicial enforcement is capable of being remedied without any material delay or material cost;

(p) such Accounts are owed by account debtors whose total indebtedness to Borrower does not exceed the credit limit with respect to such account debtors as determined by Borrower from time to time in the ordinary course of business consistent with its current practices as of the date hereof and as is reasonably acceptable to Lender (but the portion of the Accounts not in excess of such credit limit may be deemed Eligible Accounts); and

(q) such Accounts are owed by account debtors deemed creditworthy at all times by Lender in good faith.

The criteria for Eligible Accounts set forth above may only be changed and any new criteria for Eligible Accounts may only be established by Lender in good faith based on either: (i) an event, condition or other circumstance arising after the date hereof, or (ii) an event, condition or other circumstance existing on the date hereof to the extent Lender has no written notice thereof from Borrower prior to the date hereof, in either case under clause (i) or (ii) which adversely affects or could reasonably be expected to adversely affect the Accounts in the good faith determination of Lender. Any Accounts which are not Eligible Accounts shall nevertheless be part of the Collateral.

5

(b) Change to Subsection 9.18. Subsection 9.18 of the Loan Agreement is hereby amended to read in its entirety as follows:

9.18 EBITDA. Borrower shall not, for any period set forth below (each a “Test Period”), permit its cumulative EBITDA to be less than the amount set forth opposite such Test Period:

Test Period	EBITDA
4/1/03 – 6/30/03	$	338,000
4/1/03 – 9/30/03	$	698,000
4/1/03 – 12/31/03	$	1,205,000
4/1/03 – 3/31/04	$	1,931,000
7/1/03 – 6/30/04	$	2,386,000
10/1/03 – 9/30/04	$	2,762,000
1/1/04 – 12/31/04	$	2,762,000
4/1/04– 3/31/05	$	2,762,000
7/1/04 – 6/30/05	$	2,900,000
10/1/04 – 9/30/05	$	2,900,000
1/1/05 – 12/31/05	$	2,900,000
4/1/05 – 3/31/06	$	2,900,000

3. Validity of Documents. The Financing Agreements as hereby amended are valid, in full force and of full legal effect, and are enforceable in accordance with their terms. There are no known defenses, counterclaims, offsets, demands or claims that Borrower has in connection with any of the Loans or any of the Financing Agreements that in either such case could be asserted to reduce or eliminate all or any part of Borrower’s obligations under the Financing Agreements or that could be asserted to mitigate or excuse Borrower’s defaults in payment or performance of the Obligations.

4. Ratification. Borrower and Lender confirm, ratify and approve all of the terms, covenants and conditions as are expressly amended in this Amendment. Borrower further restates, ratifies and confirms as accurate all its respective warranties and representations set forth in the Loan Agreement.

6. No Novation. Except as modified or amended herein, no other term, covenant or condition of the Loan Agreement shall be considered modified or amended, and this Amendment shall not be considered a novation.

IN WITNESS WHEREOF, Lender and Borrower have caused these presents to be duly executed as of the day and year first written above.

6

BORROWER
DRUGMAX, INC.
By:	/s/ Ronald J. Patrick
Name:	Ronald J. Patrick
Title:	VP of Finance
VALLEY DRUG COMPANY
By:	/s/ Ronald J. Patrick
Name:	Ronald J. Patrick
Title:	VP of Finance
VALLEY DRUG COMPANY SOUTH
By:	/s/ Ronald J. Patrick
Name:	Ronald J. Patrick
Title:	VP of Finance
DISCOUNT Rx, INC.
By:	/s/ Ronald J. Patrick
Name:	Ronald J. Patrick
Title:	VP of Finance

7

LENDER
CONGRESS FINANCIAL CORPORATION (FLORIDA)
By:	/s/ Pat Cloninger
Name:	Pat Cloninger
Title:	Vice President

8

EX-10.9

EXHIBIT 10.9

SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT

BY AND BETWEEN

CONGRESS FINANCIAL CORPORATION (FLORIDA)

AND

DRUGMAX, INC., TOGETHER WITH ITS SUBSIDIARIES,

VALLEY DRUG COMPANY, VALLEY DRUG COMPANY SOUTH,

AND DISCOUNT Rx, INC.

        THIS SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”) is entered into effective as of the 31^st day of March, 2004 (the “Effective Date”), by and among DRUGMAX, INC., a Nevada corporation (“Borrower”), (together with its subsidiaries, VALLEY DRUG COMPANY, an Ohio corporation, VALLEY DRUG COMPANY SOUTH, a Louisiana corporation, and DISCOUNT Rx, Inc., a Louisiana corporation, also the “Borrower”), and CONGRESS FINANCIAL CORPORATION (FLORIDA), a Florida corporation (“Lender”).

W I T N E S S E T H :

        WHEREAS, Borrower and Lender heretofore entered into that certain Loan and Security Agreement dated effective April 15, 2003 (the “Loan Agreement”) pursuant to which Lender agreed to make loans and provide other financial accommodations to Borrower; and

        WHEREAS, Borrower and Lender entered into that certain First Amendment to Loan and Security Agreement dated effective August 19, 2003 (“First Amendment”) pursuant to which certain changes were made to the Loan Agreement including changes to the EBITDA financial covenant; and

        WHEREAS, Borrower and Lender have now agreed that certain additional changes be made to the Loan Agreement including changes to the EBITDA financial covenant, addition of a limitation on capital expenditures, a minimum availability covenant and a modification to Eligible Accounts and Lender is willing to agree to such changes, subject to the terms and conditions set forth herein.

        NOW, THEREFORE, for and in consideration of the above premises, the mutual covenants and agreements contained herein and other good and valuable consideration, the receipt whereof is hereby acknowledged, Borrower and Lender agree as follows:

        1. Definitions. All capitalized terms contained herein shall have the meanings assigned to them in the Loan Agreement unless the context herein

otherwise dictates or unless different meanings are specifically assigned to such terms herein.

        2. Particular Amendments to Loan Agreement. The Loan Agreement is hereby amended as follows:

                        (a) Change to Subsection 1.19. Subsection 1.19 of the Loan Agreement is hereby amended to read in its entirety as follows:

1.19 “EBITDA” shall mean Borrower’s net income (loss) on a consolidated basis for any accounting period (excluding to the extent included therein any extraordinary and/or one time or unusual and non-recurring gains or any non-cash losses), after deducting all charges which should be deducted before arriving at the net income (loss) for such period, plus (i) the amount of the provision for federal, state and local income tax for such period, plus (ii) the amount of interest expense during such period for indebtedness for borrowed money, plus (iii) the amount of the provision for depreciation and amortization for such period determined in accordance with GAAP and, in the case of amounts described in clauses (i), (ii) and (iii), only to the extent deducted in determining net income for such period.

                        (b) Change to Subsection 1.20(b). Subsection 1.20(b) of the Loan Agreement is hereby amended to read in its entirety as follows:

(b) such Accounts are (i) neither unpaid more than thirty (30) days after the due date, nor more than sixty (60) days after the date of the original invoice for them, provided however, that (ii) notwithstanding subsection (i) hereof (A) the Accounts as specifically identified by Borrower as subject to net 30 day terms, shall be considered Eligible Accounts so long as such Accounts are not unpaid more than sixty (60) days after the due date nor more than ninety (90) days after the date of the original invoice for them and otherwise meet the criteria for Eligible Accounts set forth in this Subsection 1.20, and (B) as specifically approved on a case by case basis by the Lender in the Lender’s sole discretion, the Accounts subject to extended dating terms beyond 30 days but not to exceed thirteen (13) months if in existence on the date hereof, or not to exceed nine (9) months if created hereafter, shall be considered Eligible Accounts so long as such Account is not unpaid for more than thirty (30) days after the due date of the original invoice and which in the aggregate do not exceed $1,000,000 at any time; provided Borrower specifically request approval for each such Account in writing, in form and substance satisfactory to Lender, including the specific terms, the reason for the extended terms (such as an initial stocking order to a new customer or a new store opening of an existing customer) and provides appropriate credit history

2

and/or financial information on the Account as may be requested by the Lender.

                        (c) Change to Subsection 9.18. Subsection 9.18 of the Loan Agreement is hereby amended to read in its entirety as follows:

9.18 EBITDA. Borrower shall not, for any period set forth below (each a “Test Period”), permit its cumulative EBITDA to be less than the amount set forth opposite such Test Period:

Test Period	EBITDA
4/1/03 – 3/31/04	$1,650,000
7/1/03 – 6/30/04	$1,250,000
10/1/03 – 9/30/04	$1,400,000
1/1/04 – 12/31/04	$1,550,000
4/1/03 – 3/31/05	$1,800,000
7/1/04 – 6/30/05	$1,800,000
10/1/04 – 9/30/05	$1,800,000
1/1/05 – 12/31/05	$2,000,000
4/1/04 – 3/31/06 and thereafter	$2,000,000

                        (d) New Subsection 9.23. A new subsection 9.23 shall be added to the Loan Agreement to read in its entirety as follows:

9.23 Minimum Excess Availability. Borrower shall maintain minimum Excess Availability in the amount set forth below at all times during the period indicated:

Amount	Period
(i) $100,000	from May 1, 2004 to and including May 7, 2004
(ii) $200,000	from May 8, 2004 to and including May 14, 2004
(iii) $300,000	from May 15, 2004 to and including May 21, 2004
(iv) $400,000	from May 22, 2004 to and including May 28, 2004
(v) $500,000	from May 29, 2004 to and including September 30, 2004
(vi) $700,000	from October 1, 2004 to and including December 31, 2004
(vii) $900,000	from January 1, 2005 to and including March 31, 2005
(viii) $1,000,000	from April 1, 2005 to and including April 15, 2006

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                        (e) New Subsection 9.24. A new subsection 9.24 shall be added to the Loan Agreement to read in its entirety as follows:

9.24 Limitation on Capital Expenditures. Borrower shall not incur expenditures for fixed or capital assets or improvements, or for replacements, substitutions or additions thereto, which have a useful life of more than one (1) year, including but not limited to, the direct or indirect acquisition of such assets and obligations under capital leases incurred in respect of such fixed or capital assets during such period which exceed $400,000 in the aggregate, in any fiscal year, beginning on or after April 1, 2004, during the term of this Agreement.

        3. Amendment Fee. Borrower shall pay to Lender as an amendment fee the amount of $25,000, which shall be payable upon execution of this Amendment by the Borrower.

        4. Validity of Documents. The Financing Agreements as hereby amended are valid, in full force and of full legal effect, and are enforceable in accordance with their terms. There are no known defenses, counterclaims, offsets, demands or claims that Borrower has in connection with any of the Loans or any of the Financing Agreements that in either such case could be asserted to reduce or eliminate all or any part of Borrower’s obligations under the Financing Agreements or that could be asserted to mitigate or excuse Borrower’s defaults in payment or performance of the Obligations.

        4. Ratification. Borrower and Lender confirm, ratify and approve all of the terms, covenants and conditions as are expressly amended in this Amendment. Borrower further restates, ratifies and confirms as accurate all its respective warranties and representations set forth in the Loan Agreement, as amended by the First Amendment.

        6. No Novation. Except as modified or amended herein, no other term, covenant or condition of the Loan Agreement, as amended by the First Amendment, shall be considered modified or amended, and this Amendment shall not be considered a novation.

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IN WITNESS WHEREOF, Lender and Borrower have caused these presents to be duly executed as of the day and year first written above.

BORROWER

DRUGMAX, INC.

By: /s/ Jugal K. Taneja                

Name: Jugal K. Taneja                

Title: Chairman & CEO              

VALLEY DRUG COMPANY

By: /s/ Ronald J. Patrick                

Name: Ronald J. Patrick                

Title: CFO                                      

VALLEY DRUG COMPANY SOUTH

By: /s/ William LaGamba                

Name: William LaGamba                

Title: CEO                                         

DISCOUNT Rx, INC.

By: /s/ William LaGamba                

Name: William LaGamba                

Title: CEO                                         

LENDER

CONGRESS FINANCIAL CORPORATION

(FLORIDA)

By: /s/ Pat Cloninger                        

Name: Pat Cloninger                        

Title: Vice President                        

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

DrugMax, Inc.

Clearwater, FL

We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-111127) of DrugMax, Inc. of our reports dated June 18, 2004, except for Note 9, which is as of June 30, 2004, relating to the consolidated financial statements and financial statement schedule, which appear in this Form 10-K.

/s/ BDO Seidman, LLP

Miami, FL

July 13, 2004

EX-23.2

Exhibit 23.2

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statement of DrugMax, Inc. on Form S-8 (No. 333-111127) of our reports dated June 27, 2002, appearing in this Annual Report on Form 10-K of DrugMax, Inc. for the year ended March 31, 2004.

/s/ DELOITTE & TOUCHE LLP

Tampa, Florida

July 13, 2004

EX-31.1

EXHIBIT 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002 AS AMENDED

I, Jugal K. Taneja, certify that:

1.        I have reviewed this annual report on Form 10-K of DrugMax, Inc.;

2.        Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.        Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.        The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have:

a)        Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period of this annual report is being prepared;

b)        Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)        Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting;

5.        The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)        all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)        any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated:  July 13, 2004	By:	/s/    Jugal K. Taneja
		Jugal K. Taneja
		Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002, AS AMENDED

I, Ronald J. Patrick, certify that:

1.        I have reviewed this annual report on Form 10-K of DrugMax, Inc.;

2.        Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.        Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.        The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have:

a)        Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period of this annual report is being prepared;

b)        Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)        Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting;

5.        The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)        all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)        any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated:  July 13, 2004	By:	/s/    Ronald J. Patrick
		Ronald J. Patrick
		Chief Financial Officer and Principal Accounting Officer

EX-32.1

EXHIBIT 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of DrugMax, Inc. (the “Company”) on Form 10-K for the year ended March 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Jugal K. Taneja, Chairman and Chief Executive Officer of the Company, certify pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

(1)        The Report fully complies with requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)        The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ Jugal K. Taneja          

Jugal K. Taneja

Chief Executive Officer

July 13, 2004

EX-32.2

EXHIBIT 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of DrugMax, Inc. (the “Company”) on Form 10-K for the year ended March 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Ronald J. Patrick, Chief Financial Officer and Principal Accounting Officer of the Company, certify pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

(1)        The Report fully complies with requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)        The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ Ronald J. Patrick          

Ronald J. Patrick

Chief Financial Officer,

Principal Accounting Officer

July 13, 2004