**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-Q**





x
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934




FOR
      THE
      QUARTERLY PERIOD ENDED JUNE
      30,
      2007




OR





 ̈
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934




FOR
      THE
      TRANSITION PERIOD FROM _______________ TO
      _______________




**Commission
      File Number 1-15445**





**FAMILYMEDS
      GROUP, INC.**


**(Exact
      name of registrant as specified in its charter)**










**NEVADA**
            **34-1755390****(State
                or other jurisdiction of**
              **incorporation
                or organization)**
            **(I.R.S.
                Employer**
              **Identification
                No.)**




**2
      Bridgewater Road, Farmington, CT 06032**


**(Address
      of principal executive offices)**




**(860)
      676-1222**


**(Registrant’s
      telephone number, including area code)**




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




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
      the
      Securities Exchange Act of 1934).




Large
      accelerated filer  ̈   Accelerated
      filer  ̈ Non-accelerated
      filer x




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Securities Exchange Act of
      1934).    Yes  ̈ No x




As
      of
      November 15, 2007 there were 6,962,171 shares of common stock, par value $0.001
      per share, outstanding.









**FAMILYMEDS
      GROUP, INC. AND SUBSIDIARIES**


**FORM
      10-Q**


**FOR
      THE THREE MONTHS ENDED JUNE 30, 2007**


**TABLE
      OF CONTENTS**




**Page No.****PART
                  I -****FINANCIAL
                  INFORMATION**Item
                  1. Condensed Consolidated Financial Statements of Familymeds Group,
                  Inc.
                  and SubsidiariesCondensed
                  Consolidated Statement of Net Assets as of June 30, 2007 (Liquidation
                  Basis) (unaudited)
              1Condensed
                  Consolidated Balance Sheet as of December 30, 2006 (Going Concern
                  Basis)
                  (unaudited)
              2Condensed
                  Consolidated Statement of Changes in Net Assets for three months
                  ended
                  June 30, 2007 (Liquidation Basis) (unaudited)
              3Condensed
                  Consolidated Statements of Operations for three months ended March
                  31,
                  2007 and three and six months ended July 1, 2006 (unaudited)
              4Condensed
                  Consolidated Statements of Cash Flows for three months ended March
                  31,
                  2007 and six months ended July 1, 2006 (unaudited)
              5Notes
                  to (unaudited) Condensed Consolidated Financial Statements
              6Item
                  2. Management’s Discussion and Analysis of Financial Condition and Results
                  of Operations
              16Item
                  3. Quantitative and Qualitative Disclosures About Market Risk
              34Item
                  4. Controls and Procedures
              34**PART
                  II -****OTHER
                  INFORMATION**Item
                  1. Legal Proceedings
              34Item
                  1A. Risk Factors
              34Item
                  2. Unregistered Sales of Equity Securities and Use of
                  Proceeds
              35Item
                  3. Default upon Senior Securities
              35Item
                  4. Submission of Matters to a Vote of Security Holders
              35Item
                  5. Other Information
              35Item
                  6. Exhibits
              36**SIGNATURES**
              37




i


**PART
      I - FINANCIAL INFORMATION**




**Item
      1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**




**FAMILYMEDS
        GROUP, INC. AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENT OF NET ASSETS AS OF JUNE 30, 2007 (LIQUIDATION
        BASIS)**
 **(in
        thousands)**
 **(unaudited)**
 
 **June
                  30, 2007****ASSETS**Cash
                  and cash equivalents
              
              $
              20,147Restricted
                  cash
              
              
              3,000Trade
                  receivables, net of allowance for doubtful accounts of approximately
                  $3,733
              
              
              3,983Inventories,
                  net
              
              
              1,946Prepaid
                  expenses and other assets
              
              
              2,114Property
                    and equipment, net of accumulated depreciation and amortizationof
                    approximately
                    $9,009
              
              
              395Intangible
                    assets, net of accumulated amortization ofapproximately
                    $4,246
              
              
              72TOTAL
                  ASSETS
              
              
              31,657**LIABILITIES**Notes
                  payable
              
              
              10,000Promissory
                  notes payable
              
              
              121Accounts
                  payable
              
              
              10,214Accrued
                  expenses
              
              
              3,388Other
                  liabilities
              
              
              37TOTAL
                  LIABILITIES
              
              
              23,760**COMMITMENTS
                  AND CONTINGENCIES**
              
              
              -**NET
                  ASSETS IN LIQUIDATION**
              
              $
              7,897See
                  notes to condensed consolidated financial statements.
  1
 
 **FAMILYMEDS
        GROUP, INC. AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED BALANCE SHEET AS OF DECEMBER 30, 2006 (GOING CONCERN
        BASIS)**
 **(in
        thousands, except share data)**
 **(unaudited)**
  **December
                  30, 2006****ASSETS**CURRENT
                  ASSETS:Cash
                  and cash equivalents
              
              $
              845Trade
                  receivables, net of allowance for doubtful accounts of approximately
                  $3,720
              
              
              16,038Inventories,
                  net
              
              
              22,417Prepaid
                  expenses and other current assets
              
              
              1,553Total
                  current assets
              
              
              40,853PROPERTY
                    AND EQUIPMENT—Net of accumulated depreciation and amortizationof
                    approximately
                    $14,502
              
              
              6,269INTANGIBLE
                    ASSETS—Net of accumulated amortization ofapproximately
                    $20,657
              
              
              1,289OTHER
                  NONCURRENT ASSETS
              
              
              750TOTAL
                  ASSETS
              
              $
              49,161**LIABILITIES
                  AND STOCKHOLDERS’ DEFICIT**CURRENT
                  LIABILITIES:Notes
                  payable, net of discount of $2,247
              
              $
              6,753Promissory
                  notes payable
              
              
              76Revolving
                  credit facility
              
              
              37,467Accounts
                  payable
              
              
              14,843Accrued
                  expenses
              
              
              4,269Other
                  current liabilities
              
              
              59Total
                  current liabilities
              
              
              63,467COMMITMENTS
                  AND CONTINGENCIESSTOCKHOLDERS’
                  DEFICIT:Series
                  A convertible preferred stock, $1,000 par value, 500,000 authorized
                  and
                  none outstanding
              
              
              -Common
                  stock, $.001 par value, 200,000,000 shares authorized; 6,962,821
                  shares
                  issued and outstanding
              
              
              67Additional
                  paid in capital
              
              
              230,949Accumulated
                  deficit
              
              
              (245,322
              )Total
                  stockholders’ deficit
              
              
              (14,306
              )TOTAL
                  LIABILITIES AND STOCKHOLDERS' DEFICIT
              
              $
              49,161See
                  notes to condensed consolidated financial statements.
  2
 
 **FAMILYMEDS
        GROUP, INC. AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS (LIQUIDATION
        BASIS)**
 **(in
        thousands)**
 **(Unaudited)**
 
 **Period
                  from**
                **April
                  1 to****June
                  30, 2007**NET
                  REVENUES
              
              $
              19,927COST
                  OF SALES
              
              
              17,265Gross
                  margin
              
              
              2,662SELLING,
                  GENERAL AND ADMINISTRATIVE EXPENSES
              
              
              11,638DEPRECIATION
                  AND AMORTIZATION EXPENSE
              
              
              360OPERATING
                  LOSS
              
              
              (9,336
              )OTHER
                  INCOME (EXPENSE):Interest
                  expense
              
              
              (2,573
              )Interest
                  income
              
              
              18Other
                  income
              
              
              18Total
                  other expense, net
              
              
              (2,537
              )NET
                  LOSS
              
              
              (11,873
              )SHAREHOLDERS'
                  DEFICIT AT MARCH 31, 2007
              
              
              (14,907
              )Gain
                  on liquidation of pharmacy assets
              
              
              40,028Adjustment
                  to liquidation basis
              
              
              (5,351
              )NET
                  ASSETS IN LIQUIDATION, JUNE 30, 2007
              
              $
              7,897See
                  notes to condensed consolidated financial statements.
  3
 
 **FAMILYMEDS
        GROUP, INC. AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF OPERATIONS (Going Concern Basis)**
 **(in
        thousands, except per share data)**
 **(Unaudited)**
 
 **Three Months**
                **Ended**
              
              **Three Months**
                **Ended**
              
              **Six Months**
                **Ended****March 31, 2007**
              
              **July 1, 2006**
              
              **July 1, 2006**NET
                  REVENUES
              
              $
              52,396
              
              $
              60,743
              
              $
              116,783COST
                  OF SALES
              
              
              42,626
              
              
              48,870
              
              
              93,995Gross
                  margin
              
              
              9,770
              
              
              11,873
              
              
              22,788SELLING,
                  GENERAL AND ADMINISTRATIVE EXPENSES
              
              
              11,963
              
              
              14,454
              
              
              27,441GAIN
                  ON SALE OF PHARMACY ASSETS
              
              
              (3,100
              )
              
              -
              
              
              -DEPRECIATION
                  AND AMORTIZATION EXPENSE
              
              
              524
              
              
              889
              
              
              1,727OPERATING
                  INCOME (LOSS)
              
              
              383
              
              
              (3,470
              )
              
              (6,380
              )OTHER
                  INCOME (EXPENSE):Gain
                  on extinguishment of debt
              
              
              -
              
              
              13,086
              
              
              13,086Interest
                  expense
              
              
              (1,031
              )
              
              (1,407
              )
              
              (2,803
              )Interest
                  income
              
              
              -
              
              
              31
              
              
              41Other
                  income
              
              
              -
              
              
              1
              
              
              60Total
                  other income (expense), net
              
              
              (1,031
              )
              
              11,711
              
              
              10,384Income
                  (loss) from continuing operations
              
              
              (648
              )
              
              8,241
              
              
              4,004Loss
                  from discontinued operations
              
              
              -
              
              
              (403
              )
              
              (222
              )NET
                  INCOME (LOSS)
              
              $
              (648
              )
              $
              7,838
              
              $
              3,782BASIC
                  INCOME (LOSS) PER COMMON SHARE:Income
                  (loss) from continuing operations
              
              $
              (0.09
              )
              $
              1.25
              
              $
              0.61Loss
                  from discontinued operations
              
              
              -
              
              
              (0.06
              )
              
              (0.03
              )Net
                  income (loss)
              
              $
              (0.09
              )
              $
              1.20
              
              $
              0.58FULLY
                  DILUTED INCOME (LOSS) PER COMMON SHARE:Income
                  (loss) from continuing operations
              
              $
              (0.09
              )
              $
              1.24
              
              $
              0.61Loss
                  from discontinued operations
              
              
              -
              
              
              (0.06
              )
              
              (0.03
              )Net
                  income (loss)
              
              $
              (0.09
              )
              $
              1.19
              
              $
              0.58WEIGHTED
                  AVERAGE SHARES OUTSTANDING:Basic
              
              
              6,963
              
              
              6,606
              
              
              6,597Fully
                  diluted
              
              
              6,963
              
              
              6,633
              
              
              6,610See
                  notes to condensed consolidated financial statements.
  4
 
 **FAMILYMEDS
        GROUP, INC. AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS (Going Concern Basis)**
  **(in
        thousands)**
 **(Unaudited)**
 
 **Three Months**
                **Ended**
              
              **Six Months**
                **Ended****March 31, 2007**
              
              **July 1, 2006**CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income (loss)
              
              $
              (648
              )
              $
              3,782Adjustments
                  to reconcile net income (loss) to net cash used in operating
                  activities:Depreciation
                  and amortization
              
              
              524
              
              
              1,727Stock
                  compensation expense
              
              
              47
              
              
              301Noncash
                  interest expense
              
              
              126
              
              
              848Amortization
                  of deferred financing fees
              
              
              76
              
              
              124Provision
                  for doubtful accounts
              
              
              286
              
              
              (2
              )Gain
                  on extinguishment of debt
              
              
              -
              
              
              (13,086
              )Gain
                  on sale of pharmacy assets
              
              
              (3,100
              )
              
              -Effect
                  of changes in operating assets and liabilities:Trade
                  receivables
              
              
              2,248
              
              
              (2,638
              )Inventories
              
              
              2,223
              
              
              3,332Prepaid
                  expenses and other current assets
              
              
              54
              
              
              518Accounts
                  payable
              
              
              (1,932
              )
              
              4,265Accrued
                  expenses
              
              
              (767
              )
              
              (374
              )Other
              
              
              (4
              )
              
              (248
              )Net
                  cash used in operating activities
              
              
              (867
              )
              
              (1,451
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Purchases
                  of property and equipment
              
              
              (147
              )
              
              (2,715
              )Purchases
                  of pharmacy assets
              
              
              -
              
              
              (244
              )Proceeds
                  from sale of pharmacy assets
              
              
              5,130
              
              
              -Net
                  cash provided by (used in) investing activities
              
              
              4,983
              
              
              (2,959
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:(Repayment
                  of) proceeds from revolving credit facility, net
              
              
              (4,107
              )
              
              1,988Repayment
                  of promissory notes payable
              
              
              -
              
              
              (1,209
              )Payment
                  of deferred financing fees
              
              
              
              
              
              (21
              )Proceeds
                  from exercise of stock options
              
              
              -
              
              
              9Net
                  cash provided by (used in) financing activities
              
              
              (4,107
              )
              
              767NET
                  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
              
              
              9
              
              
              (3,643
              )CASH
                  AND CASH EQUIVALENTS—Beginning of period
              
              
              845
              
              
              6,681CASH
                  AND CASH EQUIVALENTS—End of period
              
              $
              854
              
              $
              3,038SUPPLEMENTAL
                  DISCLOSURES OF CASH FLOW INFORMATION:Cash
                  paid for interest
              
              $
              797
              
              $
              1,736Noncash
                  transactions—Subordinated
                  Convertible Debenture interest payments made in common
                  stock
              
              
              
              
              $
              229Retirement
                  of ABDC subordinated notes payable
              
              
              
              
              $
              23,089Issuance
                  of subordinated notes payable to Deerfield
              
              
              
              
              $
              10,000See
                  notes to condensed consolidated financial statements.
  5




**FAMILYMEDS
      GROUP** **,
      INC. AND SUBSIDIARIES**


**Notes
      to (Unaudited) Condensed Consolidated Financial Statements**




**NOTE
      1 - BUSINESS**




**1.**
            **ASSET
                SALE, PLAN OF COMPLETE LIQUIDATION AND DISSOLUTION, BUSINESS, DISCONTINUED
                OPERATIONS AND GOING
                CONCERN**




Familymeds
      Group, Inc. (“Familymeds,” the “Company,” or “we” and other similar pronouns) is
      a pharmacy and drug distribution provider formed by the merger on November
      12,
      2004 of DrugMax, Inc. and Familymeds Group, Inc.  Familymeds Group, Inc.
      was formerly known as DrugMax, Inc. and on July 10, 2006, the Company amended
      its Articles of Incorporation to change its name from DrugMax, Inc. to
      Familymeds Group, Inc. As of June 30, 2007, we operated 11 Company-owned
      locations including 9 pharmacies, one health and beauty location and one
      non-pharmacy mail order center.  The Company also franchises 7
      pharmacies.   The Company’s pharmacies are located in 4 states and
      operate under the Familymeds Pharmacy and Arrow Pharmacy & Nutrition Center
      brand names. The Company reports on a 52-53 week fiscal year.





Familymeds
      strategic plan had been to seek long term sustainable profits by increasing
      sales through organic growth, continued focus on same store sales growth and
      expansion of new pharmacies in clinic and Worksite settings. However, in light
      of the current competitive environment and the Company’s highly leveraged
      capital structure, the Board of Directors believed that the Company lacked
      the
      capital resources necessary in the long-term to compete effectively in its
      industry.  In an effort to maximize the value of the shareholders’
investment in the Company, the Board of Directors decided to examine certain
      financial and strategic alternatives to the Company remaining
      independent.




In
      October 2006, the Board of Directors retained JMP Securities LLC (“JMP
      Securities”) as its financial advisor to examine these alternatives and to
      contact certain potential strategic and financial partners with respect to
      a
      transaction with the Company.  With the Board of Directors frequent
      consultation and guidance throughout a process extending many months, management
      and JMP Securities considered a number of strategic alternatives for the Company
      and its business.  This included an analysis of the operating history and
      prospects for growth of the Company as a whole.




By
      December 2006, the Company received several written indications of interest
      and
      verbal expressions of continued interest.  The proposals were in the form
      of financing commitments, stock exchanges, and others in the form of asset
      purchases.




On
      February 7, 2007, our Board of Directors approved the Asset Purchase Agreement
      and the Plan of Complete Liquidation and Dissolution of the Company.  Its
      decision was based on a review of the Company’s past performance, projected
      future growth, ongoing liquidity constraints, vendor relations, industry
      outlook, and strategic alternatives.





***Plan
      of Complete Liquidation and Dissolution***





As
      discussed above, Familymeds’ Board of Directors approved the proposed Plan of
      Complete Liquidation and Dissolution of Familymeds (referred to herein as the
      “Plan of Complete Liquidation and Dissolution”) on February 7, 2007, subject to
      the approval of its shareholders which was obtained at the Special Meeting
      held
      March 30, 2007.





The
      Plan
      of Complete Liquidation and Dissolution provides that upon its approval by
      its
      shareholders, the Board of Directors, without further action by the Company’s
      shareholders, may:




·
            Dissolve
                Familymeds;




6





·
            liquidate
                the Company’s assets;




·
            pay,
                or provide for the payment of, any remaining, legally enforceable
                obligations of Familymeds; and




·
            distribute
                any remaining assets to the Company’s
                shareholders.





Therefore,
      effective April 1, 2007, the Company adopted the liquidation basis of accounting
      (“Liquidation Basis”) and the financial statements as of June 30, 2007 and for
      the period from April 1, 2007 to June 30, 2007 have been prepared on the
      liquidation basis. Accordingly, assets have been valued at estimated net
      realizable value and liabilities include estimate costs associated with carrying
      out the plan of liquidation. Upon adoption of Liquidation Basis the Company
      recorded adjustments to convert from the going concern basis to the Liquidation
      Basis which resulted in a decrease in carrying value of $4.8 million which
      is
      included in the condensed consolidated statement of changes in net assets for
      the period from April 1, 2007 to June 30, 2007. The adjustment was comprised
      of
      the following (in 000’s):




Adjust
                balance of notes payable to Deerfield
            
            $
            1,000Write
                down intangible and other long lived assets to their net realizable
                value
            
            
            2,455Accrual
                of legal settlements/wind-up costs
            
            
            1,315Income
                tax provision
            
            
            581Net
                adjustment to adopt liquidation basis of accounting
            
            $
            5,351





The
      condensed consolidated balance sheet as of December 30, 2006 and the condensed
      consolidated statements of operations for the three months ended March 31,
      2007
      and the three and six months ended June 30, 2006 have been prepared using the
      going concern basis of accounting on which the Company had previously reported
      its financial condition and its results of operations.





***Asset
      Sale***





On
      February 14, 2007, Familymeds Group, Inc. together with its wholly owned
      subsidiaries Familymeds, Inc. and Arrow Prescription Corp., entered into an
      Asset Purchase Agreement with Walgreen Co., an Illinois corporation, Walgreen
      Eastern Co., Inc., a New York corporation (together with Walgreen Co.,
“Walgreens”), pursuant to which the Company sold 54 of our locations and related
      assets to Walgreens (the “Asset Sale”). Of the 54 locations, 33 of the clinic
      and Worksite locations will remain open and continue to operate in place. In
      connection with the Asset Sale, which was consummated during the second quarter
      of 2007, the Company received proceeds of $58.5 million which included $14.9
      million for the value of inventories and reimbursement for certain occupancy
      costs related to those locations. The gain on the Asset Sale was approximately
      $40.0 million and is included as a component of gain on liquidation of pharmacy
      assets in the condensed consolidated statement of changes in net assets for
      the
      period from April 1, 2007 to June 30, 2007. $3.0 million of the purchase price
      was placed into escrow and is presented as restricted cash in the accompanying
      condensed consolidated statement of net assets as of June 30, 2007. The
      restrictions on this cash balance will be released at the earlier of one year
      from the date of closing or the final distribution of assets to the Company’s
      shareholders or dissolution of Familymeds.





In
      addition to the asset sale, during the first quarter of 2007 the Company sold
      11
      other locations for proceeds $3.5 million, resulting in a gain of $3.1 million
      which is included as a component of gain on sale of pharmacy assets in the
      condensed consolidated statement of operations for the three months ended March
      31, 2007.




7





***Overview
      of Business-*** On
      March
      19, 2004, Familymeds Group, Inc. (“FMG”) entered into an Agreement and Plan of
      Merger which was amended on July 1, 2004 and on October 11, 2004 (as amended,
      the “Merger Agreement”) with DrugMax, Inc. (“DrugMax”). Under the terms of the
      Merger Agreement, on November 12, 2004, FMG merged into DrugMax, and DrugMax
      became the surviving corporation in the merger (the “Merger”). The Merger was
      treated as a purchase of DrugMax by FMG for accounting purposes. Accordingly,
      for periods prior to the Merger, the information contained herein is the
      historical information of FMG. On July 10, 2006, DrugMax changed its name back
      to Familymeds Group, Inc,




The
      results of operations acquired in the merger have been included in the Company’s
      consolidated statements of operations (primarily in discontinued operations
      as
      described below).




During
      fiscal year ended December 31, 2005, the Company operated two drug distribution
      facilities: Valley Drug Company and Valley Drug Company South. During the third
      quarter of 2005, the Company determined that it would sell certain assets of
      the
      drug distribution business and eliminate operations conducted out of the New
      Castle, Pennsylvania facility and the St. Rose, Louisiana facility related
      to
      the distribution to independent pharmacies. Accordingly, since October 1, 2005,
      the Company considered substantially all of the wholesale distribution business
      as discontinued operations for financial statement presentation purposes.





There
      were no net revenues related to the discontinued operations for the three months
      ended June 30, 2007 and April 1, 2006, respectively.  The loss from
      discontinued operations was $0.0 million and $0.4 million for the three months
      ended March 31, 2007 and July 1, 2006, respectively.




**NOTE
      2 - PER SHARE INFORMATION**





The
      computations of basic and diluted net loss per common share are based upon
      the
      weighted average number of common shares outstanding and potentially dilutive
      securities. Potentially dilutive securities would include all-in-the money
      stock
      options and warrants.  All outstanding options and warrants to purchase
      shares of common stock were excluded from the March 31, 2007 computations of
      diluted net loss per common share because they were out of the money and
      inclusion of such shares would have been anti-dilutive had they have been in
      the
      money. Options and warrants to purchase 249,090 and 285,717 shares of common
      stock, respectively, were included in the July 1, 2006 computations of diluted
      net income per common share.




**NOTE
      3 - STOCK BASED COMPENSATION**




In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
      123(R), “Share-Based Payment (as amended).” SFAS No. 123(R) eliminates the
      alternative to use the intrinsic value method of accounting that was provided
      in
      SFAS No. 123, which generally resulted in no compensation expense recorded
      in
      the financial statements related to the issuance of equity awards to employees.
      SFAS No. 123(R) requires that the cost resulting from all share-based payment
      transactions be recognized in the financial statements. SFAS No. 123(R)
      establishes fair value as the measurement objective in accounting for
      share-based payment arrangements and requires all companies to apply a
      fair-value-based measurement method in accounting generally for all share-based
      payment transactions with employees and was adopted by the Company on January
      1,
      2006.




*Share
      Based Compensation Plans*




As
      of
      June 30, 2007, we have two share-based compensation plans, which are described
      below.




8





The
      DrugMax, Inc. 1999 Incentive and Non-Statutory Stock Option Plan permits the
      granting of stock options to purchase shares of common stock up to a total
      of
      600,000 shares. The exercise price per share of common stock covered by an
      option may not be less than the par value per share on the date of grant, and
      in
      the case of an incentive stock option, the exercise price may not be less than
      the market value per share on the date of grant. The terms of any option grants
      are established by the Board of Directors and / or compensation committee,
      subject to the requirements of the plan, but, generally, these options vest
      over
      a three year period at a rate of 33% each year. The Plan will expire on the
      earlier of the completion of the plan of liquidation or August 13, 2009. Options
      were issued to non-employee directors under this plan.




Each
      outside Director is issued an option to purchase 1,000 shares of common stock
      annually each year following his or her election to the Board of Directors.
      Each
      outside Director who serves as a member of a committee is issued an option
      to
      purchase 500 shares of the Company’s common stock annually. The chairperson of
      each committee, other than the Audit Committee, is issued an option to purchase
      an additional 500 shares of common stock annually. The chairperson of the Audit
      Committee and the Chairman of the Board shall receive an option to purchase
      1,000 shares of the Company’s common stock annually. The foregoing options are
      granted under the Company’s 1999 Incentive and Non-Statutory Stock Option Plan.
      The exercise price for the options is determined as of the annual shareholders
      meeting of each year.




The
      DrugMax, Inc. 2003 Restricted Stock Plan permits the granting of shares of
      restricted common stock up to a total of 350,000 shares. The Board of Directors
      determines the price, if any, on the date of grant. The Plan will expire on
      the
      earlier of the completion of the plan of liquidation or August 27, 2013.
      Restricted shares are issued to non-employee directors under this plan.




The
      Company uses the Black-Scholes option-pricing model to calculate the fair value
      of options. The key assumptions for this valuation method include the expected
      term of the option, stock price, volatility, risk-free interest rate, dividend
      yield and exercise price. Many of these assumptions are judgmental and highly
      sensitive in the determination of compensation expense. Under the assumptions
      indicated below, there were no option grants during the three months ended
      June
      30, 2007 and the weighted-average fair value for each option granted during
      the
      three months ended July 1, 2006 was $4.40. The table below indicates the key
      assumptions used in the option valuation calculations for options granted in
      the
      three months ended July 1, 2006 and a discussion of our methodology for
      developing each of the assumptions used in the valuation model:.




**Three Months**
              **Ended**
              **July
                1,**
              **2006**Risk-free
                interest rate
            
            
            4.94-4.97
            %Expected
                life
            
            
            3
                yearsVolatility
            
            
            80
            %Dividend
                yield
            
            
            -
            %




*Term* -
      This is the period of time over which the options granted are expected to remain
      outstanding. Options granted have a maximum term of ten years. An increase
      in
      the expected term will increase compensation expense.




*Volatility* -
      This is
      a measure of the amount by which a price has fluctuated or is expected to
      fluctuate. Volatilities are based on implied volatilities from traded options
      of
      the Company’s shares, historical volatility of the Company’s shares, and other
      factors, such as expected changes in volatility arising from planned changes
      in
      the Company’s business operations. An increase in the expected volatility will
      increase compensation expense.




9





*Risk-Free
      Interest Rate* -
      This is the U.S. Treasury rate on the date of the grant having a term equal
      to
      the expected term of the option. An increase in the risk-free interest rate
      will
      increase compensation expense.




*Dividend
      Yield* -
      We have never made any dividend payments and we have no plans to pay dividends
      in the foreseeable future. An increase in the dividend yield will decrease
      compensation expense.




The
      following table summarizes information about our stock option plan for the
      six
      months ended June 30, 2007.




**Number
                of**
              **Options**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Weighted**
              **Average**
              **Remaining**
              **Contractual**
              **life**
            
            **Weighted**
              **Average**
              **Fair****Value**Balance,
                December 30, 2006
            
            
            390,907
            
            $
            11.61
            
            
            8.1
                years
            
            $
            18.24Granted
            
            
            -
            
            
            -
            
            
            -
            
            
            -Exercised
            
            
            -
            
            
            -
            
            
            -
            
            
            -Forfeited
            
            
            7,180
            
            
            17.98
            
            
            
            
            
            6.71Options
                outstanding, June 30, 2007
            
            
            383,727
            
            $
            11.49
            
            
            7.6
                years
            
            $
            18.46Options
                exercisable, June 30, 2007
            
            
            304,205
            
            $
            11.79
            
            
            7.9
                years
            
            $
            21.93




As
      of
      June 30, 2007, there was $0.0 million of total unrecognized compensation cost
      related to stock options. There was no cash received from stock option exercises
      for the three months and six months ended June 30, 2007. There were no income
      tax benefits from share based arrangements.




Share
      based compensation expense was $0.6 million and $0.7 million for the three
      and
      six months ended June 30, 2007, respectively, and was $0.2 million and $0.4
      million for the three and six months ended July 1, 2006,
      respectively.





The
      following table summarizes information about restricted stock awards issued
      under the 2003 Restricted Stock Plan for the three months ended June 30,
      2007:




**Shares**
            
            **Weighted**
              **Average**
              **Grant-Date**
              **Fair
                Value**Non
                Vested Balance at December 30, 2006
            
            
            42,825
            
            $
            10.46Granted
            
            
            -
            
            
            -Vested
            
            
            9,667
            
            
            14.29Non
                Vested Balance at June 30, 2007
            
            
            33,158
            
            $
            9.34




As
      of
      June 30, 2007, there was $0.0 million of total unrecognized compensation costs
      related to restricted stock awards. At June 30, 2007, an aggregate of 382,192
      shares of common stock remained available for future grants under our stock
      plans, which cover restricted stock awards and stock options. We issue shares
      to
      satisfy stock option exercises and restricted stock awards.




10





**NOTE
      4 - INTANGIBLE ASSETS**




The
      carrying value of intangible assets is as follows (in thousands):




**June
                30,**
              **2007**
            
            **December
                30,**
              **2006****Gross**
              **Carrying**
              **Amount**
            
            **Accumulated**
              **Amortization**
            
            **Gross**
              **Carrying**
              **Amount**
            
            **Accumulated**
              **Amortization**Prescription
                files
            
            $
            4,318
            
            $
            (4,246
            )
            $
            21,946
            
            $
            (20,657
            )




The
      prescription files remaining as of June 30, 2007 are expected to be sold in
      connection with the plan of liquidation and the weighted average amortization
      period for these intangible assets is approximately 1 year. Amortization expense
      related to intangible assets was approximately $0.1 million and $0.5 million
      for
      the three months ended June 30, 2007 and July 1, 2006, respectively.
      Amortization expense related to intangible assets was approximately $0.3 million
      and $1.1 million for the six months ended June 30, 2007 and July 1, 2006,
      respectively.




**NOTE
      5 —DEBT**




Debt
      consists of the following (amounts in thousands):





**June
                30,**
              **2007**
            
            **December
                30,**
              **2006**Revolving
                credit facility
            
            $
            -
            
            $
            37,467Promissory
                notes payable
            
            
            121
            
            
            76Subordinated
                notes payable, net of discount of $2,247 at December 30,
                2006
            
            
            10,000
            
            
            6,753Total
            
            $
            10,121
            
            $
            44,296





***Credit
      Facility***





On
      October 12, 2005, the Company entered into a Loan and Security Agreement with
      Wells Fargo Retail Finance, LLC (“WFRF”), pursuant to which WFRF will provide
      the Company with a senior secured revolving credit facility up to $65.0 million
      (the “New Credit Facility”). On that same date the Company terminated its $65.0
      million Amended and Restated Credit Agreement with General Electric Capital
      Corporation (“GECC”) and in connection therewith repaid all outstanding amounts
      due under the credit facility to GECC along with a $0.5 million termination
      fee.
      The $65.0 million of maximum availability under the New Credit Facility is
      reduced by a $7.0 million reserve. Available credit is based on eligible
      receivables, inventory and prescription files, as defined in and determined
      pursuant to the agreement, and may be subject to reserves as determined by
      the
      lender from time to time. Interest on the revolving line of credit is calculated
      at the prime index rate plus an applicable prime margin (as defined in the
      agreement), unless the Company or the lender chooses to convert the loan to
      a
      LIBOR-based loan. In each case, interest is adjusted quarterly. The applicable
      prime index margin as of June 30, 2007 and December 30, 2006 was 8.25% and
      8.25%, respectively. As of June 30, 2007 and December 30, 2006,
      the interest rate, including applicable margin, used to calculate accrued
      interest was 8.5% and 8.5%, respectively. Interest is payable monthly.





The
      New
      Credit Facility included usual and customary events of default (subject to
      applicable grace periods) for facilities of this nature and provides that,
      upon
      the occurrence of an event of default, payment of all amounts payable under
      the
      New Credit Facility may be accelerated and/or the lenders’ commitments may be
      terminated. In addition, upon the occurrence of certain insolvency or bankruptcy
      related events of default, all amounts payable under the New Credit Facility
      shall automatically become immediately due and payable, and the lenders’
commitments shall automatically terminate. The New Credit Facility does not
      include any financial covenants.


11





The
      New
      Credit Facility includes an early termination fee of $0.7 million if paid in
      full before October 12, 2008. The New Credit Facility is secured by
      substantially all assets of the Company.





In
      connection with the Walgreens’ Asset Sale, Wells Fargo Retail Finance, LLC, as
      agent for the revolving credit lenders pursuant to the Loan and Security
      Agreement dated as of October 12, 2005 (as amended, modified, supplemented
      or
      restated and in effect from time to time, the “Loan Agreement”) among (i)
      Familymeds Group, Inc. (f/k/a Drugmax, Inc.), as Lead Borrower, (ii) the other
      Borrowers party thereto from time to time, (iii) the Revolving Credit Lenders
      party thereto from time to time, (iv) and Wells Fargo, has consented to the
      Asset Sale and the consummation of the sale, subject to various terms and
      conditions. Among those conditions, we agreed that all proceeds received by
      us
      from the sale shall be paid to Wells Fargo for application to the credit
      facility until all amounts due under the facility are paid in full and the
      Loan
      Agreement is terminated. Each such payment of proceeds applied to the credit
      facility shall permanently reduce the commitments in the amount of such payment.





On
      May
      11, 2007, in connection with the Asset Sale, the Company paid all amounts
      outstanding and terminated its $65 million Loan
      Agreement and
      in
      connection therewith repaid all outstanding amounts under the Loan Agreement
      along with a termination fee of $0.7 million. The termination fee is included
      as
      a component of interest expense in the accompanying condensed consolidated
      statement of changes in net assets.





***Note
      and Warrant Purchase Agreement***





On
      June
      29, 2006, the Company entered into a Note and Warrant Purchase Agreement and
      certain other agreements, each effective as of June 23, 2006, with Deerfield
      Special Situations Fund, L.P. (“Deerfield L.P.”) and Deerfield Special
      Situations Fund International, Limited (“Deerfield International”), pursuant to
      which Deerfield L.P. and Deerfield International (collectively, “Deerfield”)
      purchased two secured promissory notes in the aggregate principal amount of
      $10.0 million (one note in the principal amount of $3.3 million and the second
      note in the amount of $6.7 million collectively the “Notes”) and eight warrants
      to purchase an aggregate of 1.65 million shares of Familymeds Group, Inc. common
      stock (the “Warrants”), for an aggregate purchase price of $10.0 million.





The
      $10.0
      million purchase price for the Notes and Warrants was used entirely for an
      early
      repayment, settlement and termination of approximately $23.0 million in
      outstanding subordinated debt with Familymeds Group’s former supplier
      AmerisourceBergen Drug Corporation (“ABDC”). The subordinated debt with ABDC
      consisted of a subordinated convertible debenture in the original principal
      amount of $11.5 million and a subordinated promissory note in the original
      principal amount of $11.5 million. Both original debt instruments were 5-year
      agreements maturing in September 2010. In connection with the Deerfield
      transaction, Familymeds Group and ABDC entered into a payoff and mutual release
      agreement pursuant to which the parties agreed to settle and retire both
      existing debt instruments for a lump sum repayment of $10.0 million. Wells
      Fargo
      Retail Finance, LLC (“WFRF”), the Company’s senior lender, consented to
      Familymeds Group’s early repayment of the ABDC debt and waived any default under
      Familymeds Group’s credit facility with WFRF as a result of such repayment by
      entering into an amendment to such credit facility with Familymeds Group and
      its
      subsidiaries. . The Company extinguished the ABDC Notes on June 29, 2006 which
      resulted in a gain on the extinguishment of $13.1 million.





Principal
      on each of the Notes is due and payable in successive quarterly installments
      each in the amount of $0.17 million and $0.33 million, respectively, beginning
      on September 1, 2006 and on each December 1, March 1, June 1 and September
      1
      thereafter and continuing until June 23, 2011, on which date all outstanding
      principal and accrued and unpaid interest is due. The Notes bear interest at
      a
      rate equal to 2.5% for the first year, 5.0% for the second year, 10.0% for
      the
      third year, 15.0% for the fourth year and 17.5% for the fifth year. The Notes
      may be prepaid by the Company at anytime without penalty. Interest expense
      has
      been estimated over the five year period to be approximately $1.8
      million (excludes the effect of amortization of the debt discount of $2.5
      million discussed below) and due to the increasing interest rate on this
      debt, the Company records the average quarterly interest expense and record
      a
      corresponding asset or liability for the difference not currently payable each
      quarter. As of June 30, 2007, the Company has classified this liability as
      current as it expects to retire this obligation within 12 months of the balance
      sheet date.




12





In
      lieu
      of making any interest payments in cash during the first and second year of
      the
      Notes, the Company may issue and deliver to Deerfield shares of Company common
      stock.  Pursuant to an amendment in October 2006, such shares shall be
      issued annually and Deerfield shall not be able to transfer or sell such shares
      until such time as the quarterly interest payment represented by those shares
      shall become due.





On
      December 15, 2006, the Company and Deerfield agreed pursuant to an amendment
      to
      the Notes and an investor rights agreement, that in lieu of making the December
      1, 2006 principal payment in cash, the Company shall issue and deliver to
      Deerfield a number of shares of common stock, par value $0.001 per share, of
      Borrower equal to 269,059.





The
      Notes
      contain usual and customary events of default for notes of these dollar amounts
      and provide that, upon the occurrence of an event default, the entire
      outstanding principal balance and all interest accrued under each note shall
      immediately become due and payable without demand or notice to the Company.




The
      Notes
      are secured by subordinated security interests in substantially all of the
      assets of the Company and its subsidiaries, Familymeds, Inc. and Valley Drug
      Company South (“Valley South”). These subordinated security interests are
      evidenced by three security agreements: (i) a Security Agreement between the
      Company and Deerfield L.P., as agent for Deerfield (the “Agent”), (ii) a
      Security Agreement between Familymeds, Inc. and the Agent, and (iii) a Security
      Agreement between Valley South and the Agent (collectively, the “Security
      Agreements”). The Security Agreements are expressly subordinated to the prior
      lien rights of WFRF pursuant to the Company’s existing credit facility with
      WFRF. Both Familymeds and Valley South have entered into guaranty agreements
      pursuant to which they have guaranteed all of the obligations of the Company
      under the Notes.





In
      connection with the issuance of these Notes, 1.65 million of stock warrants
      were
      issued as follows: warrants for 0.30 million common shares were issued at an
      exercise price of $6.10 per share; warrants for 0.55 million common shares
      were
      issued at an exercise price of $7.50 per share; warrants for 0.55 million common
      shares were issued at an exercise price of $7.80 per share; and warrants for
      0.25 million common shares were issued at an exercise price of $9.20 per share.
      Proceeds from each warrant exercised by Deerfield will be used to equally repay
      the Notes and for the working capital needs of the Company. All of the Warrants
      are exercisable for a period of five years from the closing date.





On
      June
      29, 2006, in accordance with Accounting Principles Board (“APB”) Opinion No. 14
“Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,”
the Company allocated the proceeds received between the debt and the detachable
      warrants based upon the relative fair market values on the dates the proceeds
      were received. The net value allocated to the warrants was $2.5 million and
      was
      determined using the Black-Scholes option pricing formula. The $2.5 million
      has
      been recorded as debt discount and will be amortized over the life of the
      related debt using the effective interest method. The effective interest rate
      on
      the Notes, after giving effect to the amortization of the debt discount is
      approximately 17.0% annually.





**NOTE
      6 - INCOME TAXES**




The
      Company recorded income tax expense of $0.6 million for the period from April
      1,
      2007 to June 30, 2007. This was based on alternative minimum tax calculations
      that result in tax liability on the gain on the sale of the Company’s assets
      despite the net operating losses available to offset such income and is included
      as a component of the adjustment to convert to Liquidation Basis included in
      the
      accompanying condensed consolidated statement of changes in net assets. No
      income tax expense had been recorded during three months ended March 31, 2007
      and the three and six months ended July 1, 2006 due to the significant net
      operating losses available to the Company to offset such net income. The Company
      had established a valuation allowance on all of its deferred tax assets due
      to
      the uncertainty of their realization.




13





On
      December 31, 2006, the Company adopted the Financial Accounting Standards
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”)
      an interpretation of Financial Accounting Standards Statement No. 109,
“Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and
      measurement attribute for the financial statement recognition and measurement
      of
      a tax position taken or expected to be taken in a tax return. The interpretation
      requires that the Company recognize in the financial statements, the impact
      of a
      tax position, if that position is more likely than not of being sustained on
      audit, based on the technical merits of the position. FIN 48 also provides
      guidance on de-recognition, classification, interest and penalties, accounting
      in interim periods and disclosure. The adoption of FIN 48 had no material impact
      on its financial position or results of operations as a full valuation allowance
      has been established.





**NOTE
      7- CONTINGENCIES**




Prior
      to
      fiscal 2006, the Company’s drug distribution operations operated out of two
      locations, one in New Castle, Pennsylvania and one in St. Rose, Louisiana.
       The Pennsylvania operations were located at 209 Green Ridge Road, New
      Castle, Pennsylvania 16105, a facility consisting of approximately 45,000 square
      feet of office, warehouse, shipping and distribution space. Valley Drug Company
      (“Valley North”) leased this premises from Becan Development LLC (“Becan”), a
      company owned by a current director of the Company (Jugal Taneja) and certain
      former directors, officers and employees of the Company. The original lease
      (dated December 30, 2003) (the “Original Lease”) provided for a term of 15
      years, expiring December 30, 2018, and monthly lease payments of $17,000. 
When the Original Lease was executed, Becan and Valley North entered into a
      Consent, Subordination and Assumption Agreement (the “Guarantee”) with the
      Pennsylvania Industrial Development Authority (“PIDA”) and Regional Industrial
      Development Corporation of Southwest Pennsylvania (“RIDC”) dated December 30,
      2003, pursuant to which, among other things, Becan and Valley North, jointly
      and
      severally, assumed all obligations of RIDC to make payments and discharge all
      obligations expenses, costs and liabilities of RIDC in connection with the
      PIDA
      note (the “PIDA Note”). The PIDA Note is also secured by the Original Lease and
      the property.





In
      connection with the sale of the business operated out of the Pennsylvania
      facility to Rochester Drug Cooperative (“RDC”) (the “Asset Sale”), Becan and
      Valley North agreed to shorten the lease to five years ending, December 2010,
      and to sublease the premises to RDC. It was the intent of the parties at that
      time to assign the lease to RDC upon the consent to such assignment by PIDA.
      RDC
      held back $0.3 million of the purchase price related to the Asset Sale pending
      receipt of PIDA’s consent.  PIDA recently agreed to consent to
      the assignment of the lease to RDC subject to the preparation of final
      documents, including documents evidencing the parties agreement to shorten
      the
      maturity of the PIDA Note to five years ending December 2010; but, during
      October 2006, RDC notified PIDA that it was withdrawing its application to
      PIDA
      and that it was no longer willing to assume the lease. Contemporaneously with
      its notice to PIDA, RDC notified the Company that it refused to pay the $0.3
      million holdback to Valley because of the delays in obtaining the PIDA consent.
      RDC has signed a sublease for the property and remains legally responsible
      for
      the lease payments. In October 2006, the Company filed a demand for arbitration
      claiming RDC has acted in bad faith and demanding $0.3 million. Becan and its
      principals, including Mr. Taneja, indemnified Valley North and the
      Company against any claims or demands PIDA may bring against Valley or the
      Company in connection with the PIDA Note and will use their best efforts to
      have
      Valley released from all obligations under the PIDA Note.




As
      of
      June 30, 2007 and December 30, 2006, the Company had not recorded any
      liabilities related to the Guarantee. However, should the Company be required
      to
      perform under the terms of the Guarantee, the Company would be required to
      pay
      all amounts owed under the PIDA Note, which as of June 30, 2007 was
      approximately $0.8 million. The Company believes it will not be required to
      perform under the terms of the Guarantee. Further any requirement to perform
      under the Guarantee would be mitigated by the indemnification by Becan and
      its
      principals. Additionally, management believes, the fair value of the
      Pennsylvania facility that could be realized upon the sale of the
      facility exceeds the amounts outstanding on the PIDA Note and the other
      loans related to the premises.


14





**NOTE
      8 –
      DEPARTURES OF PRINCIPAL OFFICERS AND DIRECTORS**





In
      accordance with the plan of liquidation and dissolution, during the quarter
      several officers and directors either resigned or were involuntarily terminated.
      Severence payments in the amount of $2.0 million are included in the statement
      of changes in net assets as part of selling, general and administrative
      expenses.





**NOTE
      9 – SUBSEQUENT EVENTS**





**Sale
      of Pharmacy Assets**




On
      August
      27, 2007, the Company completed a sale of certain assets to Pharmacy Management
      Group LLC, a Mississippi Limited Liability Company (“PMG”). Under the terms of
      the sale transaction, the Company sold to PMG the pharmacy assets of five
      Mississippi pharmacies and one Alabama pharmacy operating under the brand name
      Familymeds for total consideration of approximately $2.6 million. Of the total
      approximate $2.6 million purchase price, the Company received approximately
      $2.1
      million in cash and approximately $0.5 million in a secured promissory note
      payable over 24 months with a balloon payment in the 24 th month.




**Payoff
      of Deerfield Notes**




As
      previously disclosed, the Company previously entered into a Note and Warrant
      Purchase Agreement and certain other agreements, each effective as of June
      23,
      2006, with Deerfield Special Situations Fund, L.P. (“ Deerfield
      L.P.”) and Deerfield
      Special Situations Fund International, Limited (“ Deerfield
      International”), pursuant to which Deerfield
      L.P. and Deerfield
      International (collectively, “ Deerfield”)
      purchased two secured promissory notes in the aggregate principal amount of
      $10.0 million (collectively the “Notes”) and eight warrants to purchase an
      aggregate of 1.65 million shares of common stock (the “Warrants”), for an
      aggregate purchase price of $10.0 million (the “Deerfield Investment”). Also as
      previously disclosed: (a) as of March 31, 2007, the Company classified the
      Notes
      as current as it expected to retire the Notes within 12 months of such date
      in
      connection with its plan of complete liquidation; (b) the
      Notes
      may be prepaid by the Company at anytime without penalty and (c) with
      Deerfield’s agreement, the Company did not make the March 1, 2007 or June 1,
      2007 principal payments on the Notes in anticipation of the early repayment
      of
      the Notes. In accordance with the forgoing, on July 24, 2007, the Company fully
      satisfied the Notes by paying to Deerfield $9.750 million in cash and delivered
      $250,000 into a secured, segregated cash collateral account, which funds will
      be
      released to Deerfield in 12 equal monthly amounts. Deerfield and the Company
      have terminated all agreements related to the Deerfield Investment and released
      each other from all obligations and claims related thereto.




**Payment
      of Liquidating Distribution**




Effective
      July 31, 2007, the Company filed a certificate of dissolution with the Nevada
      secretary of state. At that date the Company’s stock transfer books were closed,
      and shareholders of record on that date will be entitled to all liquidating
      distributions paid by the Company.




On
      August
      10, 2007, an initial liquidating distribution was made to shareholders of record
      in the amount of $0.70 per share for a total of $4.8 million.




15





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




The
      following Management’s Discussion and Analysis of Financial Condition and
      Results of Operations should be read in conjunction with our unaudited condensed
      consolidated financial statements and the related notes found elsewhere in
      this
      Form 10-Q. This discussion, as well as the notes to our unaudited condensed
      consolidated financial statements, contain forward-looking statements based
      upon
      our current expectations that involve risks and uncertainties, such as our
      plans, objectives, expectations and intentions, as set forth under “Cautionary
      Statement Regarding Forward-Looking Statements.” Our actual results and the
      timing of events could differ materially from those anticipated in these
      forward-looking statements as a result of many factors.





On
      February 7, 2007, our Board of Directors approved the sale of the majority
      of
      its pharmacy assets and a Plan of Complete Liquidation and Dissolution of the
      Company.  Its decision was based on a review of the Company’s past
      performance, projected future growth, ongoing liquidity constraints, vendor
      relations, industry outlook, and strategic alternatives.





On
      February 14, 2007, Familymeds Group, Inc. (“Familymeds”) together with its
      wholly owned subsidiaries Familymeds, Inc. and Arrow Prescription Corp., entered
      into an Asset Purchase Agreement with Walgreen Co., an Illinois corporation,
      Walgreen Eastern Co., Inc., a New York corporation (together with Walgreen
      Co.,
“Walgreens”), pursuant to which we will, subject to certain terms and
      conditions, sell up to 53 of the Company’s locations and related assets to
      Walgreens (the “Asset Sale”). The Company intends to sell the remaining assets
      to several other national and regional pharmacy operators.





On
      March
      30, 2007, Familymeds Group, Inc.’s shareholders voted to approve the Asset Sale.
      Shareholders also voted to approve and adopt a plan of complete liquidation
      and
      dissolution of the Company and the transactions contemplated thereby pursuant
      to
      which the Company will be dissolved and liquidated




***Cautionary
      Statement Concerning Forward-Looking Statements***




This
      Form
      10-Q contains forward-looking statements within the meaning of the Private
      Securities Litigation Reform Act of 1995. Familymeds bases these forward-looking
      statements on its expectations and projections about future events, which
      Familymeds has derived from the information currently available to it. In
      addition, from time to time, Familymeds or its representatives may make
      forward-looking statements orally or in writing. Furthermore, forward-looking
      statements may be included in Familymeds’ filings with the United States
      Securities and Exchange Commission or press releases or oral statements made
      by
      or with the approval of one of Familymeds’ executive officers. For each of these
      forward-looking statements, Familymeds claims the protection of the safe harbor
      for forward-looking statements contained in the Private Securities Litigation
      Reform Act of 1995. These forward-looking statements relate to future events
      or
      Familymeds’ future performance, including but not limited to:




·
            expected
                closing and timing of the closing of Familymeds’ anticipated asset sales
                and liquidation;




·
            expected
                cash to be received from the asset sales and cash to be disbursed
                to
                settle our obligations and liabilities, both known and
                unknown;




·
            expected
                cash distributions to shareholders amounts and the timing of these
                distributions;




·
            expected
                expenses in connection with the asset sales and the
                liquidation;




·
            possible
                or assumed future results of operations;
                and




·
            future
                revenue and earnings.




16





Forward-looking
      statements are those that are not historical in nature, particularly those
      that
      use terminology such as may, could, will, should, likely, expects, anticipates,
      contemplates, estimates, believes, plans, projected, predicts, potential or
      continue or the negative of these or similar terms. The statements contained
      in
      this Form 10-Q that are not purely historical are forward-looking statements
      within the meaning of Section 27A of the Securities Act of 1933, as
      amended, and Section 21E of the Securities Exchange Act of 1934, as
      amended, including statements regarding Familymeds’ expectations, beliefs,
      intentions or strategies regarding the future. Forward-looking statements are
      subject to certain known and unknown risks and uncertainties that could cause
      actual results to differ materially from those expressed in any forward-looking
      statements. These risks and uncertainties include, but are not limited to,
      the
      following important factors with respect to Familymeds:




·
            the
                satisfaction of conditions to complete the asset sales, regulatory
                approvals and third party consents;




·
            the
                amount of costs, fees and expenses related to the asset sales, interim
                operations, sales of the other remaining assets, and subsequent
                liquidation and dissolution of
                Familymeds;




·
            the
                uncertainty of general business and economic
                conditions;




·
            the
                amount to be recovered for inventories and other assets and the amount
                collected from accounts receivable and the amount paid to settle
                our
                obligations and liabilities;




·
            the
                loss of key personnel including
                pharmacists;




·
            the
                impact of competition, both expected and
                unexpected;




·
            adverse
                developments, outcomes and expenses in legal proceedings; and




·
            other
                risk factors as further described in this Form
                10-Q.





Forward-looking
      statements are only predictions as of the date they are made and are not
      guarantees of performance. All forward-looking statements included in this
      document are based on information available to Familymeds on the date of this
      Form 10-Q. Readers are cautioned not to place undue reliance on forward-looking
      statements. The forward-looking events discussed in this Form 10-Q and other
      statements made from time to time by Familymeds or its representatives may
      not
      occur, and actual events and results may differ materially and are subject
      to
      risks, uncertainties and assumptions about Familymeds including without
      limitation those discussed elsewhere in this Form 10-Q and the risks discussed
      in our United States Securities and Exchange Commission filings. Except for
      its
      ongoing obligations to disclose material information as required by the federal
      securities laws, Familymeds is not obligated to publicly update or revise any
      forward-looking statement, whether as a result of new information, future events
      or otherwise.





***Recent
      Developments - Plan of Liquidation***





On
      February 7, 2007, our Board of Directors approved the sale of a majority of
      our
      pharmacy assets (the “Asset Sale”) to Walgreen Co., an Illinois corporation, and
      Walgreen Eastern Co., Inc., a New York corporation (collectively, “Walgreens”)
      and a related plan of complete liquidation and dissolution of the Company (the
      “Plan of Complete Liquidation and Dissolution”) based upon a review of our past
      performance, projected future growth, ongoing liquidity constraints, vendor
      relations, industry outlook, and strategic alternatives. At a special meeting
      of
      shareholders held on March 30, 2007, our shareholders ratified the sale of
      a
      majority of our pharmacy assets and the Plan of Complete Liquidation and
      Dissolution.


17





Pursuant
      to the Plan of Complete Liquidation and Dissolution, as approved by our
      shareholders, our Board of Directors, without further action by our
      shareholders, may:




·
            dissolve
                the Company;




·
            liquidate
                our assets;




·
            pay,
                or provide for the payment of, any remaining, legally enforceable
                obligations of the Company; and




·
            distribute
                any remaining assets to our
                shareholders.





Since
      the
      approval of the Plan of Complete Liquidation and Dissolution by our shareholders
      on March 30, 2007, we have begun implementing the plan by attempting to sell
      our
      assets and satisfy our obligations. Among other things, on April 4, 2007, we
      began to the process of closing the Asset Sale to Walgreens. The Asset Sale
      to
      Walgreens will be completed on a staggered basis. The closing of the sale of
      all
      of the assets to Walgreens was completed by June 30, 2007. Through June 30,
      2007, Walgreens has paid approximately $57.2 million in cash proceeds of which
      $3.0 million will be kept in escrow to satisfy our post-closing indemnification
      obligations, if any. The final $1.3 million due from Walgreens was received
      on
      July 20, 2007.





Pursuant
      to our Asset Purchase Agreement with Walgreens, dated February 14, 2007, we
      sold
      54 of our locations and related assets to Walgreens. Of the 54 locations, 33
      of
      the clinic and Worksite locations will remain open and continue to operate
      in
      place. As consideration for this sale, Walgreens assumed only certain of our
      liabilities, including certain automobile and real estate leases, and paid
      us
      approximately $58.5 million which included $14.9 million for and the value
      of
      inventories and reimbursement for certain occupancy costs related to those
      locations.





In
      connection with the Asset Sale, Wells Fargo Retail Finance, LLC, as agent for
      the revolving credit lenders pursuant to the Loan and Security Agreement dated
      as of October 12, 2005 (as amended, modified, supplemented or restated and
      in
      effect from time to time, the “Loan Agreement”) among (i) Familymeds Group, Inc.
      (f/k/a Drugmax, Inc.), as Lead Borrower, (ii) the other Borrowers party thereto
      from time to time, (iii) the Revolving Credit Lenders party thereto from time
      to
      time, (iv) and Wells Fargo, has consented to the Asset Sale and the consummation
      of the sale, subject to various terms and conditions. Among those conditions,
      we
      agreed that all proceeds received by us from the sale shall be paid to Wells
      Fargo for application to the credit facility until all amounts due under the
      facility are paid in full and the Loan Agreement is terminated. Each such
      payment of proceeds applied to the credit facility shall permanently reduce
      the
      commitments in the amount of such payment.





Additionally,
      as a result of its announcement to sell the majority of its assets and to
      execute its Plan of Complete Liquidation and Dissolution, the Company has
      started to lose key employees and certain account receivable have delayed
      payments to the Company. Further, while the Company continues to expect the
      final Walgreens transaction to close by the end of the second quarter of 2007
      as
      previously disclosed, the Company has incurred delays in the staggered Walgreens
      closings.




These
      factors, coupled with delays in the sales of the Company’s remaining assets,
      currently are expected to result in (a) delays in implementing the Plan of
      Complete Liquidation and Dissolution, including delays in the initial
      distributions to shareholders, which initial distributions management previously
      estimated would take place by the end of the second quarter of 2007 but which
      actually took place on August 10, 2007 at a rate of $0.70 per share (b) lower
      than previously-estimated amounts being distributed to shareholders in
      connection with the Plan of Complete Liquidation and Dissolution, unless the
      Company is successful in selling its remaining assets at a greater value or
      recovering greater value through the reduction of its estimated liabilities,
      of
      which there can be no assurances.




18





Management
      currently does not believe it can quantify the aggregate impact of these factors
      on the amount of the distribution to shareholders.





Additionally,
      we have begun to satisfy certain of our obligations and we have begun to reduce
      our credit facility with Wells Fargo from the proceeds received from the Asset
      Sale. On May 11, 2007, the Company terminated its $65 million Loan
      Agreement and
      in
      connection therewith repaid all outstanding amounts under the Loan Agreement
      along with a termination fee of $650,000.





In
      connection with the Plan of Liquidation and Dissolution, once the Asset Sale
      is
      completed, we intend to file a certificate of dissolution with the State of
      Nevada, dissolving the Company. Pursuant to Nevada law, we will continue to
      exist for two years after the dissolution becomes effective or for such longer
      period as the Nevada courts shall direct, for the purpose of prosecuting and
      defending suits against us and enabling us gradually to close our business,
      to
      dispose of our property, to discharge our liabilities and to distribute to
      our
      shareholders any remaining assets. See “Risk Factors.”





Additionally,
      we intend to close our stock transfer books and discontinue recording transfers
      of our common stock at the close of business on the date we file the certificate
      of dissolution with the Nevada Secretary of State, which we refer to as the
      “final record date.” Thereafter, certificates representing our common stock will
      not be assignable or transferable on our books except by will, intestate
      succession or operation of law. The proportionate interests of all of our
      shareholders will be fixed on the basis of their respective stock holdings
      at
      the close of business on the final record date, and, after the final record
      date, any distributions made by us will be made solely to the shareholders
      of
      record at the close of business on the final record date, except as may be
      necessary to reflect subsequent transfers recorded on our books as a result
      of
      any assignments by will, intestate succession or operation of law. See “Risk
      Factors.”





***General
      Description of the Business***





Familymeds
      Group, Inc. (“Familymeds,” the “Company,” or “we” and other similar pronouns) is
      a pharmacy and drug distribution provider formed by the merger on November
      12,
      2004 of DrugMax, Inc. and Familymeds Group, Inc.  Familymeds Group, Inc.
      was formerly known as DrugMax, Inc. and on July 10, 2006, the Company amended
      its Articles of Incorporation to change its name from DrugMax, Inc. to
      Familymeds Group, Inc. We are incorporated in the state of Nevada and our
      corporate offices are located at 2 Bridgewater Road, Farmington, CT 06032,
      telephone (860) 676-1222. As of June 30, 2007, we operated 11 Company-owned
      locations including 9 pharmacies, one health and beauty location and one
      non-pharmacy mail order center.  The Company also franchises 7
      pharmacies.  During the first six months of 2007, we have sold 64 pharmacy
      locations and we expect to sell 6 additional locations by the end of the third
      quarter of 2007 pursuant to signed asset purchase agreements  Our
      pharmacies are located in 4 states and operate under the Familymeds Pharmacy
      and
      Arrow Pharmacy & Nutrition Center brand names.




As
      of
      June 30, 2007 the Company had Net Assets in Liquidation of $7.9 milliion, and
      at
      December 30, 2006, the Company had a net shareholders’ deficit of $14.3 million.
      On a going concern basis, the Company had net losses of $0.6 million, $7.2
      million, $54.9 million and $39.8 million for the three months ended March 31,
      2007 and for the years ended December 30, 2006, December 31, 2005, and January
      1, 2005, respectively.





On
      January 17, 2007, Familymeds received a letter from The NASDAQ Stock Market
      notifying Familymeds that NASDAQ had determined to delist Familymeds’ shares of
      common stock from the NASDAQ Capital Market effective as of the open of business
      on January 18, 2007 as a result of Familymeds failure to maintain compliance
      with 4310(c)(2)(B) (the requirement to maintain a minimum shareholders
      equity, market value of listed securities, or net income from continuing
      operations).




On
      January 18, 2007, Familymeds’ common stock began being quoted on the
      Over-the-Counter Bulletin Board, which we refer to as the “OTC Bulletin Board,”
under the symbol “FMRX.OB.” The OTC Bulletin Board is a regulated quotation
      service that displays real-time quotes, last-sale prices and volume information
      in over-the-counter equity securities. As a result of our common stock being
      delisted from the Nasdaq Capital Market, your ability to resell your shares
      of
      our common stock could be adversely affected.




19





General
      information, financial news releases and filings with the United States
      Securities and Exchange Commission, including annual and quarterly reports
      on
      Forms 10-K and 10-Q, current reports on Form 8-K, and all amendments to these
      reports are available free of charge on our website at www.Familymedsgroup.com or www.sec.gov .





***Pharmacy
      Operations*** ****





As
      of
      June 30, 2007, we operated 11 Company owned locations including 9 pharmacies,
      one home health center and one health and beauty location, in 4 states under
      the
      Familymeds Pharmacy and Arrow Pharmacy & Nutrition Center brand names. We
      have pharmacies which are located at the point of care between physicians and
      patients, oftentimes inside medical office buildings or on a medical campus.
      The
      balance of our locations are usually nearby medical facilities though more
      retail accessible.





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





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





***Worksite
      Pharmacy*** ***SM***





We
      operated Worksite Pharmacies SM (pharmacies
      that service a single, defined population) for large employers who are seeking
      to control overall employee prescription drug benefit expenditures while
      maintaining high employee satisfaction through improved accessibility. Our
      Worksite Pharmacies SM offer
      prescription services exclusively to the employer’s covered population. We can
      deliver these services at or near the employer’s work site by opening, staffing
      and managing a pharmacy. Our initial results have proven that this strategy
      reduces healthcare costs for the employer. Our research has shown that many
      employers, especially large Fortune 500 companies are seeking more aggressive
      methods to control healthcare expenditures, especially the pharmacy component
      of
      benefits. We have identified key large employers, those with over 2,000
      employees in a single location, to be target opportunities for this type of
      employer sponsored Worksite Pharmacy SM .
      We had
      a Worksite Pharmacy SM in
      the
      employee center of the Mohegan Sun Casino in Connecticut and Scotts Company
      LLC
      headquarters in Marysville, Ohio. Combined, these employers have more than
      14,000 employees and dependents as potential patients.


20




On
      January 2, 2007, our third Worksite Pharmacy opened to provide exclusive service
      to Toyota team members, participating on-site suppliers and their dependants.
      Under the contract with Toyota, Familymeds operates a full service pharmacy
      at
      the site of Toyota's newly constructed plant in San Antonio. The plant employs
      approximately 2,000 Toyota personnel.





All
      3 of
      our Worksite Pharmacies were sold as part of the Walgreens transaction in the
      second quarter of 2007.





***Medical
      Supply***





In
      February 2006, we reopened and began providing distribution services from our
      St. Rose, Louisiana facility which had previously been closed due to Hurricane
      Katrina. We reconfigured and replenished the warehouse to facilitate the direct
      distribution of pharmaceuticals to physicians, medical clinics and other health
      care providers. In October 2006, the operations known as Valley Medical Supply
      were relocated to the Company’s corporate location in Farmington, Connecticut
      and until recently did business as Familymeds Medical Supply.  This move
      reduced operating expenses.  Familymeds Medical Supply ceased doing
      business in the second quarter of 2007.





***Patient
      Compliance***





We
      have
      developed programs designed to improve patient compliance and to reduce costs.
      For example, we have a prescription compliance program called Reliable Refill,
      a
      discount plan called Senior Save15. Reliable Refill is a compliance program
      that
      identifies prescriptions that are due to be filled and schedules them for
      filling before the patient has run out of the previous prescriptions. Our Senior
      Save15 program, introduced prior to the Medicare Modernization Act, is our
      own
      discount program that gives senior customers access to all of our prescription
      and over-the-counter products at discounted prices. These and other programs
      are
      designed to improve medication therapy management among patients with chronic
      therapeutic needs especially the elderly population. Our data warehouse allows
      us to identify and target patients with special needs.





***Medicare
      Part D***





As
      of
      January 1, 2006, Medicare beneficiaries had the opportunity to receive
      subsidized prescription drug coverage through the Medicare Part D program.
      The
      new drug benefit is delivered by competing plans, and our pharmacies have
      contracted with each of the major providers to ensure our customers can continue
      purchasing their prescriptions from our pharmacies. While the new Medicare
      drug
      benefit is entirely voluntary, we believe a significant portion of the Medicare
      population will enjoy this new benefit. During the three months ended March
      31,
      2007 and July 1, 2006, net revenues from Medicare Part D prescriptions
      represented 20.8% and 19.8% of total prescription sales, respectively. The
      gross
      margin from this business is less than what the traditional prescription drug
      plans provide and the accounts receivable days outstanding is more than what
      the
      traditional prescription drug plans.




***Supply
      Chain Management***





Because
      of higher purchasing costs due to our inability to buy on a more credit worthy
      basis during fiscal year ended December 31, 2005, we began to experience a
      decrease in our ability to supply products to our customers and a decline in
      our
      gross margin.





McKesson
      Corporation and Familymeds Group, Inc. entered into a Supply Agreement effective
      as of December 28, 2006 and continuing for a term of 3 years. The Supply
      Agreement may be terminated prior to the 3 year term upon certain conditions
      including ninety (90) days written notice to the other party. Under the terms
      of
      the Supply Agreement, McKesson has agreed to continue as our primary supplier
      for prescription and non-prescription items. McKesson will continue to provide
      delivery to our locations up to 5 times per week and we will pay for such goods
      delivered 7 days from the date of invoice.


21





***Discontinued
      Operations***





During
      fiscal year ended December 31, 2005, we operated two drug distribution
      facilities: Valley Drug Company and Valley Drug Company South. During the third
      quarter of 2005, we determined that we would sell certain assets of the drug
      distribution business and eliminate operations conducted out of the New Castle,
      Pennsylvania facility and the St. Rose, Louisiana facility related to the
      distribution to independent pharmacies. Accordingly, as of October 1, 2005,
      we
      considered substantially all of the wholesale distribution business as
      discontinued operations for financial statement presentation purposes. In
      December 2005, Rochester Drug Cooperative (“RDC”) acquired certain assets from
      our wholly-owned subsidiary, Valley Drug Company, including a customer list,
      furniture, fixtures and equipment located at our New Castle, Pennsylvania
      facility (the “RDC Sale”). In connection with the sale, RDC assumed certain
      property leases, customer and other miscellaneous contracts. The total purchase
      price for these select assets was $0.7 million, of which $0.4 million was
      received upon closing and $0.3 million is required to be paid if and when the
      Pennsylvania Industrial Development Authority (“PIDA”) consents to a lease
      assignment of the New Castle facility to RDC. We leased this premises from
      Becan
      Development LLC (“Becan”), a company owned by a current director of the Company
      (Jugal Taneja) and certain former directors, officers and employees of the
      Company.





The
      original lease (dated December 30, 2003) (the “Original Lease”) provided for a
      term of 15 years, expiring December 30, 2018, and monthly lease payments of
      $0.017 million.  When the Original Lease was executed, Becan and Valley
      North entered into a Consent, Subordination and Assumption Agreement (the
“Guarantee”) with the Pennsylvania Industrial Development Authority (“PIDA”) and
      Regional Industrial Development Corporation of Southwest Pennsylvania (“RIDC”)
      dated December 30, 2003, pursuant to which, among other things, Becan and Valley
      Drug Company (Valley North”), jointly and severally, assumed all obligations of
      RIDC to make payments and discharge all obligations expenses, costs and
      liabilities of RIDC in connection with the PIDA note (the “PIDA Note”). 
The PIDA Note is also secured by the Original Lease and the property.




In
      connection with the RDC Sale, Becan and Valley North agreed to shorten the
      lease
      to five years ending, December 2010, and to sublease the premises to RDC. It
      was
      the intent of the parties at that time to assign the lease to RDC upon the
      consent to such assignment by PIDA.  RDC held back $0.3 million of the
      purchase price related to the RDC Sale pending receipt of PIDA’s consent. PIDA
      agreed to consent to the assignment of the lease to RDC subject to the
      preparation of final documents, including documents evidencing the parties
      agreement to shorten the maturity of the PIDA Note to five years ending December
      2010; but, during October 2006, RDC notified PIDA that it was withdrawing its
      application to PIDA and that it was no longer willing to assume the
      lease.   Contemporaneously with its notice to PIDA, RDC notified us
      that it refused to pay the $0.3 million holdback to Valley because of the delays
      in obtaining the PIDA consent.  RDC has signed a sublease for the property
      and remains legally responsible for the lease payments.  In October 2006,
      we filed a demand for arbitration claiming RDC has acted in bad faith and
      demanding $0.3 million. Becan and its principals, including Mr. Taneja,
      indemnified Valley North and us against any claims or demands PIDA may
      bring against Valley or us in connection with the PIDA Note and will use their
      best efforts to have Valley released from all obligations under the PIDA
      Note.




In
      connection with the sale of these assets, we transferred a portion of the New
      Castle, Pennsylvania pharmaceutical inventory to our retail pharmacies as well
      as a portion to its St. Rose, Louisiana facility for continued distribution
      to
      our retail pharmacies and for use in the Valley Medical Supply operations.
      In
      October 2006, these operations were relocated to our corporate location in
      Farmington, Connecticut and are now doing business under the name Familymeds
      Medical Supply.




During
      the six months ended June 30, 2007, there were no activities relating to our
      discontinued operations. This compares with no net revenues related to the
      discontinued operations and loss from discontinued operations of $0.4 million
      and $0.2 million for the three and six months ended July 1, 2006.




22





**Comparison
      of Operating Results for the three months ended March 31, 2007 and three and
      six
      months ended July 1, 2006.**





The
      Company’s shareholders approved the Plan of Complete Liquidation and Dissolution
      on March 30, 2007, the last business day of the fiscal quarter ended March
      31,
      2007. Accordingly, effective March 31, 2007, the Company adopted the liquidation
      basis of accounting. The condensed consolidated statement of net assets as
      of
      June 30, 2007 has been prepared on the liquidation basis of accounting while
      the
      condensed consolidated balance sheet as of December 30, 2006 and the condensed
      consolidated statements of operations and cash flows for the three months ended
      March 31, 2007 and six months ended July 1, 2006 have been prepared on the
      going
      concern basis of accounting. No condensed consolidated statement of changes
      in
      net assets has been presented for the one day ended March 31, 2007 because
      such
      activity was not material.





We
      refer
      to prescription products as Rx products and to the remaining products, such
      as
      over-the-counter medications, home medical equipment and home health appliances,
      as non-Rx products. While non-Rx reflects a smaller percentage of our overall
      revenues, the gross margin for non-Rx products is higher. The Rx portion of
      the
      pharmacy business is dependent upon a number of third party payors that pay
      a
      portion or all of the Rx cost on behalf of the customers, “Third Party
      Customers.” Prescriptions generated by Third Party Customers represented
      approximately 93% and 94%, respectively of Rx revenues for the three months
      ended March 31, 2007 and July 1, 2006, respectively.





For
      financial statement presentation purposes, the Company has
      reported substantially all of the full-line wholesale drug distribution as
      discontinued operations.




***Net
      Revenues***




Net
      revenue performance on a going-concern basis is detailed below:




**Three months**
                **Ended******
                **March 31, 2007******
              
              **Three
                  months**
                **Ended**
                **July
                  1, 2006**
              
              **Six
                  months**
                **Ended**
                **July
                  1, 2006**Net
                  Rx and non-Rx revenues (in millions) (1)
              
              $
              51.4
              
              $
              56.5
              
              $
              111.7Familymeds
                  Medical Supply
              
              
              1.0
              
              
              4.2
              
              
              5.1Total
                  net revenues (in millions)
              
              $
              52.4
              
              $
              60.7
              
              $
              116.8Rx
                  % of location net revenues
              
              
              93.3
              %
              
              93.7
              %
              
              93.8
              %Third
                  party % of Rx net revenues
              
              
              96.4
              %
              
              93.7
              %
              
              93.6
              %Number
                  of Company locations
              
              
              64
              
              
              79
              
              
              79Average
                  location net revenue per location (in millions)
              
              $
              0.8
              
              $
              0.7
              
              $
              1.4




*(1) 
                Net revenues are net of contractual
                allowances.*




23





Net
      revenue performance on a liquidation basis is detailed below:




**Three
                  months**
                **Ended******
                **June
                  30, 2007******Net
                  Rx and non-Rx revenues (in millions) (1)
              
              $
              19.9Familymeds
                  Medical Supply
              
              
              -Total
                  net revenues (in millions)
              
              $
              19.9Rx
                  % of location net revenues
              
              
              91.4
              %





***Gross
      Margin***





Gross
      margin was $2.7 million or 13.3% for the three months ended June 30, 2007.
      This
      compares to $11.8 million or 19.5% for the three months ended July 1, 2006.
      Gross margin was $12.4 million or 17.1% for the six months ended June 30, 2007.
      This compares to $22.8 million or 19.5% for the six months ended July 1,
      2006.





***Operating
      Expenses and Income***




Operating
      expenses include selling, general and administrative (“SG&A”) expenses,
      depreciation and amortization expense. Net operating expenses were $12.0 million
      or 60.2% of net revenues for the three months ended June 30, 2007. This compared
      to $15.3 million or 22.3% of net revenues for the three months ended July 1,
      2006. Net operating expenses were $24.5 million or 33.9% of net revenues for
      the
      six months ended June 30, 2007. This compared to $29.2 million or 25.0% of
      net
      revenues for the six months ended July 1, 2006.





***Interest
      Expense***




Interest
      expense was $2.6 million and $3.6 million for the three and six months ended
      June 30, 2007 versus $1.4 million and $2.8 million for the three and six months
      ended July 1, 2006. The increase was due to the write off of the Deerfield
      debt
      discount in the second quarter of 2007 partially offset by a decrease due to
      a
      lower outstanding debt balances.





***Income
      Taxes***




The
      Company recorded income tax expense of $0.6 million for the three months ended
      June 30, 2007. This was based on alternative minimum tax calculations that
      result in tax liability on the gain on the sale of the Company’s assets despite
      the net operating losses available to offset such income. The Company also
      recorded net income for the six months ended July 1, 2006. No income tax expense
      had been recorded during this period due to the significant net operating losses
      available to the Company to offset such net income. The Company has established
      a valuation allowance on all of its remaining deferred tax assets due to the
      uncertainty of their realization.




***Net
      Loss***




Net
      loss
      for the three and six months ended June 30, 2007 was $11.9 million and $12.5
      million versus net income of $7.8 million and $3.8 million for the three and
      six
      months ended July 1, 2006, respectively.  Factors impacting these results
      are discussed above.


24





***Gain
      on liquidation of pharmacy assets (liquidation basis)***




The
      following table shows the computation of the gain on liquidation:


**Three months**
                **Ended**
                **June 30, 2007**Total
                  cash received or receivable
              
              $
              58,451Inventory
                  purchased
              
              
              (14,112
              )Payment
                  for reimbursement of rent, utilities etc.
              
              
              (793
              )Net
                  book value of fixed and intangible assets sold
              
              
              (3,518
              )Net
                  gain on liquidation of pharmacy assets
              
              $
              40,028




***Adjustment
      to liquidation basis***





The
      adjustment to liquidation basis is made up of the following:




**Three months**
                **Ended**
                **June 30, 2007**Impairment
                  of fixed and intangible assets to net realizable value
              
              $
              2,455Settlement
                  of Deerfield warrants
              
              
              1,000Accrual
                  of legal settlements/wind-up costs
              
              
              1,315Income
                  tax provision
              
              
              581Total
                  adjustment to liquidation basis
              
              $
              5,351





***Inflation
      and Seasonality***




Management
      believes that inflation had no material effect on the operations or our
      financial condition for the three months ended June 30, 2007 and July 1, 2006.
      Historically, our third quarter business has been affected by seasonality and
      has been lower than our other three fiscal quarters’ business due to the effect
      of reduced patient visits and doctor referrals during typical summer vacation
      months.





**LIQUIDITY
      AND CAPITAL RESOURCES**




We
      have
      financed our operations and have met our capital requirements primarily through
      private issuances of equity securities, convertible notes, bank borrowings,
      trade creditors and cash generated from operations.  Our principal sources
      of liquidity as of June 30, 2007, consisted of cash and cash equivalents of
      approximately $23.1 million.





The
      Board
      of Directors approved the Asset Sale and the Plan of Complete Liquidation in
      part because we believe that our existing cash and amounts available under
      our
      senior credit facility and cash generated from operating activities may not
      be
      sufficient to meet our vendor terms and anticipated cash needs for the next
      12
      months.




25


**Credit
        Facility**
 
 On
        October 12, 2005, the Company entered into a Loan and Security Agreement
        with
        Wells Fargo Retail Finance, LLC (“WFRF”), pursuant to which WFRF will provide
        the Company with a senior secured revolving credit facility up to $65.0 million
        (the “New Credit Facility”). On that same date the Company terminated its $65.0
        million Amended and Restated Credit Agreement with General Electric Capital
        Corporation (“GECC”) and in connection therewith repaid all outstanding amounts
        due under the credit facility to GECC along with a $0.5 million termination
        fee.
        The $65.0 million of maximum availability under the New Credit Facility is
        reduced by a $7.0 million reserve. Available credit is based on eligible
        receivables, inventory and prescription files, as defined in and determined
        pursuant to the agreement, and may be subject to reserves as determined by
        the
        lender from time to time. Interest on the revolving line of credit is calculated
        at the prime index rate plus an applicable prime margin (as defined in the
        agreement), unless the Company or the lender chooses to convert the loan
        to a
        LIBOR-based loan. In each case, interest is adjusted quarterly. The applicable
        prime index margin as of June 30, 2007 and December 30, 2006 was 8.25% and
        8.25%, respectively. As of June 30, 2007 and December 30, 2006,
        the interest rate, including applicable margin, used to calculate accrued
        interest was 8.5% and 8.5%, respectively. Interest is payable monthly.




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




The
      New
      Credit Facility includes an early termination fee of $0.7 million if paid in
      full before October 12, 2008. The New Credit Facility is secured by
      substantially all assets of the Company.





In
      connection with the Asset Sale, Wells Fargo Retail Finance, LLC, as agent for
      the revolving credit lenders pursuant to the Loan and Security Agreement dated
      as of October 12, 2005 (as amended, modified, supplemented or restated and
      in
      effect from time to time, the “Loan Agreement”) among (i) Familymeds Group, Inc.
      (f/k/a Drugmax, Inc.), as Lead Borrower, (ii) the other Borrowers party thereto
      from time to time, (iii) the Revolving Credit Lenders party thereto from time
      to
      time, (iv) and Wells Fargo, has consented to the Asset Sale and the consummation
      of the sale, subject to various terms and conditions. Among those conditions,
      we
      agreed that all proceeds received by us from the sale shall be paid to Wells
      Fargo for application to the credit facility until all amounts due under the
      facility are paid in full and the Loan Agreement is terminated. Each such
      payment of proceeds applied to the credit facility shall permanently reduce
      the
      commitments in the amount of such payment.





On
      May
      11, 2007, the Company terminated its $65 million Loan
      Agreement and
      in
      connection therewith repaid all outstanding amounts under the Loan Agreement
      along with a termination fee of $650,000.




**Note
      and Warrant Purchase Agreement**





On
      June
      29, 2006, we entered into a Note and Warrant Purchase Agreement and certain
      other agreements, each effective as of June 23, 2006, with Deerfield Special
      Situations Fund, L.P. (“Deerfield L.P.”) and Deerfield Special Situations Fund
      International, Limited (“Deerfield International”), pursuant to which Deerfield
      L.P. and Deerfield International (collectively, “Deerfield”) purchased two
      secured promissory notes in the aggregate principal amount of $10.0 million
      (one
      note in the principal amount of $3.3 million and the second note in the amount
      of $6.7 million collectively the “Notes”) and eight warrants to purchase an
      aggregate of 1.65 million shares of Familymeds Group, Inc. common stock (the
      “Warrants”), for an aggregate purchase price of $10.0 million.





The
      $10.0
      million purchase price for the Notes and Warrants was used entirely for an
      early
      repayment, settlement and termination of approximately $23.0 million in
      outstanding subordinated debt with Familymeds Group’s former supplier
      AmerisourceBergen Drug Corporation (“ABDC”). The subordinated debt with ABDC
      consisted of a subordinated convertible debenture in the original principal
      amount of $11.5 million and a subordinated promissory note in the original
      principal amount of $11.5 million. Both original debt instruments were 5-year
      agreements maturing in September 2010. In connection with the Deerfield
      transaction, Familymeds Group and ABDC entered into a payoff and mutual release
      agreement pursuant to which the parties agreed to settle and retire both
      existing debt instruments for a lump sum repayment of $10.0 million. Wells
      Fargo
      Retail Finance, LLC (“WFRF”), the Company’s senior lender, consented to
      Familymeds Group’s early repayment of the ABDC debt and waived any default under
      Familymeds Group’s credit facility with WFRF as a result of such repayment by
      entering into an amendment to such credit facility with Familymeds Group and
      its
      subsidiaries. We extinguished the ABDC Notes on June 29, 2006 which resulted
      in
      a gain on the extinguishment of $13.1 million.




26





Principal
      on each of the Notes is due and payable in successive quarterly installments
      each in the amount of $0.2 million and $0.3 million, respectively, beginning
      on
      September 1, 2006 and on each December 1, March 1, June 1 and September 1
      thereafter and continuing until June 23, 2011, on which date all outstanding
      principal and accrued and unpaid interest is due. The Notes bear interest at
      a
      rate equal to 2.5% for the first year, 5.0% for the second year, 10.0% for
      the
      third year, 15.0% for the fourth year and 17.5% for the fifth year. The Notes
      may be prepaid by the Company at anytime without penalty. Interest expense
      has
      been estimated over the five year period to be approximately $1.8
      million (excludes the effect of amortization of the debt discount of $2.5
      million discussed below) and due to the increasing interest rate on this
      debt, the Company records the average quarterly interest expense and records
      a
      corresponding asset or liability for the difference not currently payable each
      quarter. As of June 30, 2007, the Company has classified this liability as
      current as it expects to retire this obligation within 12 months of the balance
      sheet date.





In
      lieu
      of making any quarterly interest payments in cash during the first and second
      year of the Notes, the Company may issue and deliver to Deerfield shares of
      common stock.  Pursuant to an amendment in October 2006, such shares shall
      be issued annually and Deerfield shall not be able to transfer or sell such
      shares until such time as the interest payment represented by those shares
      shall
      become due.





On
      December 15, 2006, the Company and Deerfield agreed pursuant to an amendment
      to
      the Notes and an investor rights agreement, that in lieu of making the December
      1, 2006 principal payment in cash, the Company shall issue and deliver to
      Deerfield a number of shares of common stock, par value $0.001 per share, of
      Borrower equal to 269,059.





The
      Notes
      contain usual and customary events of default for notes of these dollar amounts
      and provide that, upon the occurrence of an event default, the entire
      outstanding principal balance and all interest accrued under each note shall
      immediately become due and payable without demand or notice to the Company.




The
      Notes
      are secured by subordinated security interests in substantially all of the
      assets of the Company and its subsidiaries, Familymeds, Inc. and Valley Drug
      Company South (“Valley South”). These subordinated security interests are
      evidenced by three security agreements: (i) a Security Agreement between the
      Company and Deerfield L.P., as agent for Deerfield (the “Agent”), (ii) a
      Security Agreement between Familymeds, Inc. and the Agent, and (iii) a Security
      Agreement between Valley South and the Agent (collectively, the “Security
      Agreements”). The Security Agreements are expressly subordinated to the prior
      lien rights of WFRF pursuant to the Company’s existing credit facility with
      WFRF. Both Familymeds and Valley South have entered into guaranty agreements
      pursuant to which they have guaranteed all of the obligations of the Company
      under the Notes.





In
      connection with the issuance of these Notes, 1.65 million of stock warrants
      were
      issued as follows: warrants for 0.30 million common shares were issued at an
      exercise price of $6.10 per share; warrants for 0.55 million common shares
      were
      issued at an exercise price of $7.50 per share; warrants for 0.55 million common
      shares were issued at an exercise price of $7.80 per share; and warrants for
      0.25 million common shares were issued at an exercise price of $9.20 per share.
      Proceeds from each warrant exercised by Deerfield will be used to equally repay
      the Notes and for the working capital needs of the Company. All of the Warrants
      are exercisable for a period of five years from the closing date.


27





On
      June
      29, 2006, in accordance with Accounting Principles Board (“APB”) Opinion No. 14
“Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,”
the Company allocated the proceeds received between the debt and the detachable
      warrants based upon the relative fair market values on the dates the proceeds
      were received. The net value allocated to the warrants was $2.5 million and
      was
      determined using the Black-Scholes option pricing formula. The $2.5 million
      has
      been recorded as debt discount and will be amortized over the life of the
      related debt using the effective interest method. The effective interest rate
      on
      the Notes, after giving effect to the amortization of the debt discount is
      approximately 17.0% annually.





**Operating,
      Investing and Financing Activities**




***Cash
      Inflows and Outflows (going concern basis)***




As
      reported on our condensed consolidated statements of cash flows, our change
      in
      cash and cash equivalents during the three months ended March 31, 2007 and
      the
      six months ended July 1, 2006 is summarized as follows:




**Dollars
                  in thousands**
              
              **Three months**
                **Ended**
                **March 31, 2007**
              
              **Six months**
                **Ended**
                **July 1, 2006**Net
                  cash used in operating activities
              
              $
              (867
              )
              $
              (1,451
              )Net
                  cash provided by (used in) investing activities
              
              
              4,983
              
              
              (2,959
              )Net
                  cash provided by (used in) financing activities
              
              
              (4,107
              )
              
              767Change
                  in cash and cash equivalents
              
              $
              9
              
              $
              (3,643
              )




Details
      of our cash inflows and outflows are as follows during the three months ended
      March 31, 2007 and the six months ended July 1, 2006:




*Operating
      Activities:* During
      the three months ended March 31, 2007, we used $0.9 million in cash and cash
      equivalents in operating activities. This was comprised primarily of net loss
      of
      $0.6 million and a decrease in working capital of $1.8 million and is partially
      offset by non-cash charges totaling $2.1 million. For the six months ended
      July
      1, 2006, we used $1.5 million in cash and cash equivalents in operating
      activities. This was comprised primarily of net income of $3.8 million and
      a
      decrease in working capital of $4.8 million offset by non-cash items of $10.1
      million. Components of our significant non-cash adjustments for the three months
      ended March 31, 2007 and the six months ended July 1, 2006 are as follows:


28






**Non-cash
                  Adjustments**
              
              **Three**
                **months ended**
                **March
                  31**
                **2007**
                **(amounts in 
                  thousands)**
              
              **Six**
                **months ended**
                **July
                  1,**
                **2006**
                **(amounts in
                  thousands)**
              
              **Explanation
                  of Non-cash**
                **Activity**Depreciation
                  and amortization
              
              $
              524
              
              $
              1,727
              
              
              Consists
                  of depreciation of property and equipment as well as amortization
                  of
                  intangibles.Non
                  cash interest expense
              
              
              126
              
              
              848
              
              
              Interest
                  expense related to the Deerfield notes paid in common stock and
                  ABDC
                  principal payment shortfalls paid in common stock.Gain
                  on sale of pharmacy assets
              
              
              (3,100
              )
              
              -
              
              
              Gain
                  on the sale of pharmacy assets.Gain
                  on extinguishment of debt
              
              
              
              
              
              (13,086
              )
              
              We
                  retired the outstanding ABDC notes amounting to $23 million and
                  issued a
                  $10 million note due to DeerfieldOther
                  non-cash items, net
              
              
              409
              
              
              423
              
              
              Other
                  non-cash items include amortization of deferred financing fees,
                  adjustments to our allowance for doubtful accounts and non-cash
                  stock-based compensation.Total
                  non-cash adjustments to net income
              
              $
              (2,041
              )
              $
              (10,088
              )




*Investing
      Activities:* Cash
      provided by (used in) investing activities was $5.0 million for the three months
      ended March 31, 2007, and ($3.0) million for the six months ended July 1, 2006.
      Specific investing activity during those periods was as follows:





·
            During
                the three months ended March 31, 2007, we invested approximately
                $0.1
                million in fixed assets.





·
            During
                the first three months of 2007, we received cash of approximately
                $5.1
                million from the sale of our pharmacy
                locations.




*Financing
      Activities:* Net
      cash
      provided by (used in) financing activities was ($4.1) million during the three
      months ended March 31, 2007, and $0.8 million in the six months ended July
      1,
      2006. Specific financing activity during those periods was as follows:





·
            During
                the three months ended March 31, 2007, we repaid $4.1 million of
                our
                revolving credit facility. This compares to $2.0 million in net proceeds
                in the six month period of 2006.





·
            During
                the three months ended March 31, 2007, we did not make any scheduled
                debt
                repayments under our outstanding subordinated notes. This compares
                to $1.2
                million for scheduled debt repayments in the six month period of
                2006.




29




·
            During
                the first three months of 2007, we also did not receive any proceeds
                from
                the issuance of common stock under our employee stock plans. This
                compares
                to $0.009 million for proceeds related to employee stock option exercises
                in the six month period of 2006.




***Off-Balance
      Sheet Arrangements***





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





***Critical
      Accounting Policies and Estimates***




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





The
      liquidation basis of accounting adopted March 31, 2007 is dependent on many
      assumptions and estimates as to the ultimate liquidation of the Company’s assets
      and liabilities.





**Goodwill
      and Identifiable Intangible Assets**




Useful
      lives for identifiable intangibles are determined based on the expected future
      period of benefit of the asset, the assessment of which considers various
      characteristics of the asset, including historical cash flows. After goodwill
      is
      initially recorded, annual impairment tests are required, or more frequently
      if
      impairment indicators are present. The amount of goodwill cannot exceed the
      excess of the fair value of the related reportable unit (which is based, in
      part, on the Company’s stock price) over the fair value of reporting unit’s
      identifiable assets and liabilities. Continued downward movement in the
      Company’s common stock price could have a material effect on the fair value of
      goodwill in future measurement periods. As of December 30, 2006, all remaining
      goodwill was impaired and written off.




**Liquidation
      Basis of Accounting**





The
      Company’s shareholders approved the Plan of Complete Liquidation and Dissolution
      on March 30, 2007, the last business day of the fiscal quarter ended June 30,
      2007. Accordingly, effective March 31, 2007, the Company adopted the liquidation
      basis of accounting. The accompanying condensed consolidated statement of net
      assets as of June 30, 2007 has been prepared on the liquidation basis of
      accounting while the condensed consolidated balance sheet as of December 30,
      2006 and the condensed consolidated statements of operations and cash flows
      for
      the three months ended March 31, 2007 and July 1, 2006 have been prepared on
      the
      going concern basis of accounting. No condensed consolidated statement of
      changes in net assets has been presented for the one day ended March 31, 2007
      because such activity was not material.


30




**Impairment
      of Other Long-lived Assets**





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





Our
      impairment loss calculations contain uncertainty since we must use judgment
      to
      estimate future revenues, profitability and cash flows. When preparing these
      estimates, we consider historical results and current operating trends and
      our
      consolidated revenues, profitability and cash flow results and forecasts. These
      estimates can be affected by a number of factors including, but not limited
      to,
      general economic conditions, the cost of real estate, the continued efforts
      of
      third party customers to reduce their prescription drug costs, regulatory
      changes the continued efforts of competitors to gain market share and consumer
      spending patterns. If these projections change in the future, we may be required
      to write-down our long-lived assets. Long-lived assets evaluated for impairment
      include property and equipment as well as intangible assets, which as of June
      30, 2007 were approximately $0.4 million and $0.1 million, respectively and
      at
      December 30, 2006 were approximately $6.3 million and $1.3 million,
      respectively.




**Trade
      Receivables**





At
      June
      30, 2007 and December 30, 2006, trade receivables reflected approximately $7.7
      million and $19.7 million, respectively, of amounts due from various insurance
      companies, governmental agencies and individual customers. Of these amounts,
      there was approximately $3.7 million and $3.7 million reserved as of June 30,
      2007 and December 30, 2006, respectively, for a balance of net trade receivables
      of $4.0 million and $16.0 million, respectively. We use historical experience,
      market trends and other analytical data to estimate our allowance for doubtful
      accounts. Based upon these factors, the reserve at June 30, 2007 is considered
      adequate. Although we believe that the reserve estimate is reasonable, actual
      results could differ from our estimate, and such differences could be material.
      If the estimate is too low, we may incur higher bad debt expenses in the future
      resulting in lower net income or higher net losses. If the estimate is too
      high,
      we may experience lower bad debt expense in the future resulting in higher
      net
      income or lower net losses.





**Inventories**





Inventories
      consist of pharmaceuticals and other retail merchandise owned by us. Inventories
      are stated at the lower of cost (first-in, first-out method for pharmaceutical
      inventory and retail method for retail merchandise inventory) or market.
      Physical inventory counts are taken on a regular basis in each location to
      ensure that the amounts reflected in the unaudited condensed consolidated
      financial statements are properly stated. We use historical data to estimate
      our
      inventory loss reserves and we have not made any material changes in the
      accounting methodology used to establish our inventory loss reserves during
      the
      past three years. If the estimate of inventory losses is too low we may incur
      higher cost of sales in the future resulting in lower net income or higher
      net
      losses. If the estimate of inventory losses incurred is too high, we may
      experience lower cost of sales in the future resulting in higher net income
      or
      lower net losses. Inventories as of June 30, 2007 and December 30, 2006 were
      approximately $2.3 million and $25.0 million, respectively, net of approximately
      $0.4 million and $2.6 million of inventory loss reserves, respectively.


31




***Subsequent
      Events***





Effective
      July 31, 2007, the Company filed a certificate of dissolution with the Nevada
      secretary of state. At that date the Company’s stock transfer books were closed,
      and shareholders of record on that date will be entitled to all liquidating
      distributions paid by the Company.




On
      August
      10, 2007, an initial liquidating distribution was made to shareholders of record
      in the amount of $0.70 per share for a total of $4.8 million.




The
      Company continues to attempt to sell its remaining assets, including one retail
      pharmacy located in Connecticut, one long term care pharmacy located in
      Massachusetts, the internet business known as www.familymeds.com and two
      specialty retail nutrition/cosmetic stores, all of which the Company continues
      to operate. To date, the Company has been unable to secure a buyer for these
      remaining assets despite continuing efforts. The original forecasted value
      of
      these assets ranged from $1.5 million to $2.0 million in cash to the Company,
      plus the assumption by the buyers of those assets of certain lease liabilities
      relating thereto totaling approximately $1.3. Based on the difficulty it has
      encountered in selling these assets, the Company cannot predict when the assets
      will be sold and whether it will be able to sell those assets at the original
      estimated value or whether it will be able to secure a third party to assume
      such lease obligations. The Company intends to continue to market these assets
      to third parties but is also holding informal discussions with certain members
      of management that have indicated an interest in buying these assets and
      assuming such lease obligations.




The
      Company is also continuing to collect on its outstanding accounts receivable.
      The collection of these receivables has been slower than originally expected.
      Currently, based upon its difficulty in collecting on such receivables, the
      Company does not believe it will be able to collect all of such receivables.
      While it can make no assurances as to the exact amount of the total receivables
      the Company will need to write off, the Company currently estimates such write
      offs to approximate $500,000 greater than originally estimated, and has
      reflected this in the statement of net assets as of June 30, 2007.




Further,
      since announcing the Plan, certain vendors, landlords and outside parties have
      made claims against the Company for alleged liabilities totaling approximately
      $400,000, for which the Company had not previously reserved. The statement
      of
      net assets as of June 30, 2007 includes accruals for these claims.




All
      of
      the forgoing factors are expected to result in (a) delays in finalizing the
      Plan
      and (b) lower than previously-estimated amounts being distributed to
      shareholders in connection with the Plan, unless the Company is successful
      in
      selling its remaining assets at a greater value or recovering greater value
      through the reduction of its estimated liabilities, of which there can be no
      assurances. Management currently expects the total amount of the distributions
      to shareholders to be in the range of $1.75 to $1.85 per share.  As noted
      above, in August 2007 the Company made an initial distribution of $0.70 per
      share, leaving future distributions in the range of $1.05 to $1.15 per share.
      The Company expects to make another distribution to shareholders before the
      end
      of the fourth quarter of 2007, but the amount of such distribution has not
      yet
      been determined and depends significantly on the timing of the recovery of
      assets and the settlement and/or payment of liabilities.




The
      amount and timing of any distribution to shareholders in connection with the
      Plan is subject to various risks and uncertainties, including those contained
      in
      the Company’s Form 10-K, as amended, for the year ended December 30, 2006. This
      Form 8-K contains forward-looking statements within the meaning of the Private
      Securities Litigation Reform Act of 1995, including with regard to
      the:




·
            expected
                closing and timing of the closing of the Company’ anticipated asset sales
                and liquidation;·
            expected
                cash to be received from the asset sales and cash to be disbursed
                to
                settle its obligations and liabilities, both known and unknown;
                and·
            expected
                cash distributions to shareholders and the timing of those
                distributions.




32




Forward-looking
      statements are those that are not historical in nature, particularly those
      that
      use terminology such as may, could, will, should, likely, expects, anticipates,
      contemplates, estimates, believes, plans, projected, predicts, potential or
      continue or the negative of these or similar terms. The statements contained
      in
      this Form 8-K that are not purely historical are forward-looking statements
      within the meaning of Section 27A of the Securities Act of 1933, as
      amended, and Section 21E of the Securities Exchange Act of 1934, as
      amended. Forward-looking statements are subject to certain known and unknown
      risks and uncertainties that could cause actual results to differ materially
      from those expressed in any forward-looking statements. These risks and
      uncertainties include, but are not limited to, the following important factors
      with respect to the Company:




·
            the
                satisfaction of conditions to complete the asset sales, regulatory
                approvals and third party consents;·
            the
                amount of the costs, fees and expenses related to the asset sales,
                interim
                operations, and subsequent liquidation and dissolution of the
                Company;·
            the
                uncertainty of general business and economic
                conditions;·
            the
                amount to be recovered for inventories and other assets and the amount
                collected from accounts receivable and the amount paid to settle
                our
                obligations and liabilities;·
            the
                loss of key personnel; and·
            other
                risk factors as further described in the Company’s Form 10-K, as amended,
                for the year ended December 30,
                2006.




33


**Item
      3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**




As
      of
      June 30, 2007, $0.0 million and $9.0 million were outstanding on our revolving
      credit facility and Deerfield Notes, respectively. These borrowings are at
      a
      variable rate of interest. Assuming total debt of $9.0 million was outstanding
      for a full year, a 1% change in interest rates would change our interest expense
      by $0.1 million annually.





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





**Item
      4. CONTROLS AND PROCEDURES.**





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




**Conclusion
      Regarding the Effectiveness of Disclosure Controls and
      Procedures.** We
      carried out an evaluation, under the supervision and with the participation
      of
      our Chief Executive Officer and Chief Financial Officer, of the effectiveness
      of
      the design and operation of our disclosure controls and procedures as of the
      end
      of the period covered by this report pursuant to Exchange Act Rule 13a-15.
      Our
      disclosure controls and procedures include, without limitation, controls and
      procedures designed to ensure that information required to be disclosed by
      us in
      reports that we file or submit pursuant to the Securities Exchange Act of 1934,
      as amended, are accumulated and communicated to our management, including our
      Chief Executive Officer and Chief Financial Officer, as appropriate to allow
      timely decisions regarding required disclosure.  Based on this evaluation,
      our Chief Executive Officer and Chief Financial Officer concluded that our
      disclosure controls and procedures were effective as of the end of the period
      covered by this report.  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 in reaching a reasonable level
      of assurance, management necessarily was required to apply its judgment in
      evaluating the cost-benefit relationship of possible controls and procedures.





Our
      personnel reductions during the second quarter of 2007 have affected the overall
      control environment. However, management does not believe that these personnel
      reductions have had a significant impact on the effectiveness of the operation
      of the Company’s disclosure controls and procedures.





**Changes
      in Internal Control Over Financial Reporting.** There
      has been no change in our internal control over financial reporting during
      the
      second quarter of 2007 that has materially affected, or is reasonably likely
      to
      materially affect, our internal control over financial reporting.





**PART
      II - OTHER INFORMATION**




**Item
      1. LEGAL PROCEEDINGS.**




There
      has
      been no significant change in the status of the legal matters described in
      the
      Company’s fiscal 2006 Form 10-K, as amended.





**Item
      1A. RISK FACTORS.**





There
      have been no material changes to the Risk Factors described in the Company’s
      fiscal 2009 Form 10-K, as amended.


34




**Item
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**





None.





**Item
      3. DEFAULT UPON SENIOR SECURITIES.**




None.





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




The
      shareholders of the Company voted on 2 items at the special meeting of
      shareholders held on March 30, 2007:




The
      proposal to ratify and approve the Asset Purchase Agreement, including sale
      of a
      majority of the Company’s pharmacy assets to Walgreen Co. and Walgreen Eastern
      Co., Inc., received the following votes:




·
            4,120,613
            Votes for approval·
            189,203
            Votes against·
            7,329
            Abstentions




There
      were no broker non-votes for this item.




The
      proposal to approve and adopt the Plan of Complete Liquidation and Dissolution
      of the Company, including the liquidation and dissolution of Familymeds Group,
      Inc., received the following votes:




·
            4,122,003
            Votes for approval·
            187,813
            Votes against·
            7,329
            Abstentions




There
      were no broker non-votes for this item.




**Item
      5. OTHER INFORMATION.**




None.




35


**Item
      6. EXHIBITS**





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.


36


**SIGNATURES**




In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly authorized.





**Familymeds
                Group, Inc.**Date:
                December 18, 2007
            By:
            */s/
                Edgardo A. Mercadante*Edgardo
                A. Mercadante
              President,
                Chief Executive Officer and Chairman of the Board
              (Principal
                Executive Officer)Date: December
                18, 2007
            By:
            */s/
                James E. Searson*James
                E. Searson
              Senior
                Vice President, Chief Financial Officer and Treasurer
              (Principal
                Financial and Accounting Officer)




37