**SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
  
  **FORM
        10-Q**
  
  **x**
              **QUARTERLY
                  REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
                  OF 1934**
  **For
        the quarterly period ended October 1, 2005**
  **Commission
        File Number 1-15445**
  
  **DRUGMAX,
        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.)**
  **312
        Farmington Avenue, 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. x Yes  ̈ No
  Indicate
        by check mark whether the registrant is an accelerated filer (as defined
        in Rule
        12-b-2 of the Exchange Act.)  ̈ Yes x No.
  As
        of
        November 7, 2005 there were 65,545,415 shares of common stock, par value
        $0.001
        per share, outstanding.
  
  
 **DRUGMAX,
          INC. AND SUBSIDIARIES**
 **FORM
          10-Q**
 **FOR
          THE NINE MONTHS ENDED OCTOBER 1, 2005**
 **TABLE
          OF CONTENTS**
  **Page No.****PART
                    I- FINANCIAL INFORMATION**Item
                    1. Condensed Consolidated Financial Statements of DrugMax, Inc.
                    and
                    Subsidiaries (formerly Familymeds Group, Inc. and Subsidiaries)Condensed
                    Consolidated Balance Sheets as of October 1, 2005 and January
                    1, 2005
                    (unaudited)
                
                3Condensed
                    Consolidated Statements of Operations for the Three and Nine
                    Months Ended
                    October 1, 2005 and September 25, 2004 (unaudited)
                
                4Condensed
                    Consolidated Statements of Cash Flows for the Nine Months Ended
                    October 1,
                    2005 and September 25, 2004 (unaudited)
                
                5Notes
                    to Condensed Consolidated Financial Statements
                
                6Item
                    2. Management’s Discussion and Analysis of Financial Condition and Results
                    of Operations
                
                15Item
                    3. Quantitative and Qualitative Disclosures About Market Risk
                
                27Item
                    4. Controls and Procedures
                
                27**PART
                    II - OTHER INFORMATION**Item
                    1. Legal Proceedings
                
                28Item
                    2. Unregistered Sales of Equity Securities
                
                28Item
                    3. Default upon Senior Securities
                
                28Item
                    4. Submission of Matters to a Vote of Security Holders
                
                29Item
                    5. Other Information
                
                29Item
                    6. Exhibits and Reports on Form 8-K
                
                29**SIGNATURES**
                
                30
   2
   **PART
          I - FINANCIAL INFORMATION**
  **Item
          1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
  **DRUGMAX,
          INC. AND SUBSIDIARIES**
 **CONDENSED
          CONSOLIDATED BALANCE SHEETS**
 **(UNAUDITED)**
 
 **October
                    1, 2005**
                
                **January
                    1, 2005****ASSETS**CURRENT
                    ASSETS:Cash
                    and cash equivalents
                
                $
                1,361,610
                
                $
                2,331,552Trade
                    receivables, net of allowances of approximately $1,723,000 and
                    $3,897,000,
                    respectively
                
                
                10,023,615
                
                
                20,570,053Inventories
                
                
                23,232,286
                
                
                34,525,247Prepaid
                    expenses and other current assets
                
                
                761,640
                
                
                1,965,515Assets
                    held for sale
                
                
                13,669,098
                
                
                —Total
                    current assets
                
                
                49,048,249
                
                
                59,392,367PROPERTY
                    AND EQUIPMENT—Net of accumulated depreciation and amortization of
                    approximately $12,716,000 and $11,707,000, respectively
                
                
                4,227,497
                
                
                5,250,684GOODWILL
                
                
                20,776,603
                
                
                19,813,080OTHER
                    INTANGIBLE ASSETS—Net of accumulated amortization of approximately
                    $17,518,000 and $15,350,000, respectively
                
                
                8,169,022
                
                
                10,570,061OTHER
                    NONCURRENT ASSETS
                
                
                558,014
                
                
                571,874TOTAL
                
                $
                82,779,385
                
                $
                95,598,066**LIABILITIES
                    AND STOCKHOLDERS’ (DEFICIT) EQUITY**CURRENT
                    LIABILITIES:Revolving
                    credit facility
                
                $
                38,564,679
                
                $
                32,870,787Promissory
                    notes payable
                
                
                1,340,237
                
                
                2,284,212Current
                    portion of notes payable
                
                
                4,157,996
                
                
                —Current
                    portion of obligations under capital leases
                
                
                —
                
                
                30,092Accounts
                    payable
                
                
                25,223,317
                
                
                26,132,491Accrued
                    expenses
                
                
                9,822,714
                
                
                5,949,342Total
                    current liabilities
                
                
                79,108,943
                
                
                67,266,924LONG-TERM
                    ACCOUNTS PAYABLE
                
                
                —
                
                
                22,425,000NOTES
                    PAYABLE
                
                
                19,109,308
                
                
                —OTHER
                    LONG-TERM LIABILITIES
                
                
                167,993
                
                
                50,854COMMITMENTS
                    AND CONTINGENCIESSTOCKHOLDERS’
                    (DEFICIT) EQUITY:Common
                    stock, $0.001 par value, 45,000,000 shares authorized; 20,131,032
                    and
                    19,483,674 shares issued and outstanding, respectively
                
                
                20,131
                
                
                19,484Additional
                    paid in capital
                
                
                176,936,482
                
                
                175,499,012DrugMax
                    Series A Convertible Preferred Stock, $1,000 par value, 5,000,000
                    shares
                    authorized, 17,000 shares issued and outstanding; (involuntary
                    liquidation
                    value $17,000,000)
                
                
                14,935,092
                
                
                14,026,902Accumulated
                    deficit
                
                
                (206,390,171
                )
                
                (177,841,211
                )Unearned
                    compensation
                
                
                (1,108,393
                )
                
                (5,848,899
                )Total
                    stockholders’ (deficit) equity
                
                
                (15,606,859
                )
                
                5,855,288TOTAL
                
                $
                82,779,385
                
                $
                95,598,066
 
 See
          accompanying notes to condensed consolidated financial statements.
  3
  **DRUGMAX,
          INC. AND SUBSIDIARIES**
 **CONDENSED
          CONSOLIDATED STATEMENTS OF OPERATIONS**
 **(UNAUDITED)**
 
  **Three
                    Months Ended**
                
                **Nine
                    Months Ended****October
                    1, 2005**
                
                **September
                    25, 2004**
                
                **October
                    1, 2005**
                
                **September
                    25, 2004**NET
                    REVENUES
                
                $
                51,754,624
                
                $
                53,449,257
                
                $
                163,67l,751
                
                $
                165,475,849COST
                    OF SALES
                
                
                41,878,076
                
                
                42,556,234
                
                
                130,819,318
                
                
                131,195,033Gross
                    margin
                
                
                9,876,548
                
                
                10,893,023
                
                
                32,852,433
                
                
                34,280,816SELLING,
                    GENERAL AND ADMINISTRATIVE EXPENSES
                
                
                13,039,244
                
                
                10,824,939
                
                
                41,391,422
                
                
                33,009,565DEPRECIATION
                    AND AMORTIZATION
                
                
                1,107,240
                
                
                1,178,139
                
                
                3,419,607
                
                
                3,590,018(GAIN)
                    LOSS ON DISPOSAL OF FIXED AND INTANGIBLE ASSETS
                
                
                (2,334
                )
                
                (255,056
                )
                
                6,435
                
                
                (1,028,204
                )OPERATING
                    LOSS
                
                
                (4,267,602
                )
                
                (854,999
                )
                
                (11,965,031
                )
                
                (1,290,563
                )OTHER
                    (EXPENSE) INCOME:Interest,
                    net
                
                
                (1,753,661
                )
                
                (1,164,181
                )
                
                (3,921,230
                )
                
                (2,634,245
                )Other
                    income
                
                
                67,781
                
                
                215,877
                
                
                353,755
                
                
                372,838Total
                    other (expense) income
                
                
                (1,685,880
                )
                
                (948,304
                )
                
                (3,567,475
                )
                
                (2,261,407
                )LOSS
                    FROM CONTINUING OPERATIONS
                
                
                (5,953,482
                )
                
                (1,803,303
                )
                
                (15,532,506
                )
                
                (3,551,970
                )LOSS
                    FROM DISCONTINUED OPERATIONS
                
                
                (8,581,149
                )
                
                —
                
                
                (11,162,748
                )
                
                —NET
                    LOSS
                
                
                (14,534,631
                )
                
                (1,803,303
                )
                
                (26,695,254
                )
                
                (3,551,970
                )FMG
                    Redeemable Preferred Stock dividends
                
                
                —
                
                
                (1,289,420
                )
                
                —
                
                
                (3,882,749
                )DrugMax
                    Preferred Stock dividends
                
                
                400,847
                
                
                —
                
                
                (1,853,706
                )
                
                —NET
                    LOSS AVAILABLE TO COMMON SHAREHOLDERS
                
                $
                (14,133,784
                )
                $
                (3,092,723
                )
                $
                (28,548,960
                )
                $
                (7,434,719
                )BASIC
                    AND DILUTED LOSS PER SHARE:Loss
                    per share from continuing operations available to common shareholders
                
                $
                (0.28
                )
                $
                (2.40
                )
                $
                (0.88
                )
                $
                (5.77
                )Loss
                    per share from discontinued operations
                
                
                (0.43
                )
                
                —
                
                
                (0.56
                )
                
                —Net
                    loss available to common shareholders
                
                $
                (0.71
                )
                $
                (2.40
                )
                $
                (1.44
                )
                $
                (5.77
                )WEIGHTED
                    AVERAGE SHARES OUTSTANDING:Basic
                    and Diluted Shares
                
                
                20,047,418
                
                
                1,288,909
                
                
                19,840,980
                
                
                1,288,909
  See
          accompanying notes to condensed consolidated financial
          statements.
  4
  **DRUGMAX,
          INC. AND SUBSIDIARIES**
 **CONDENSED
          CONSOLIDATED STATEMENTS OF CASH FLOWS**
 **(UNAUDITED)**
 **Nine
                    Months Ended****October
                    1, 2005**
                
                **September
                    25, 2004**CASH
                    FLOWS FROM OPERATING ACTIVITIES:Loss
                    from continuing operations
                
                $
                (15,532,506
                )
                $
                (3,551,970
                )Loss
                    from discontinued operations
                
                
                (11,162,748
                )
                
                —Adjustments
                    to reconcile net loss to net cash (used in) provided by operating
                    activities:Depreciation
                    and amortization
                
                
                3,419,607
                
                
                3,590,018Stock
                    compensation expense
                
                
                5,074,006
                
                
                —Noncash
                    interest expense
                
                
                659,269
                
                
                352,686Amortization
                    of deferred financing costs
                
                
                186,953
                
                
                265,935Provision
                    for (benefit from) doubtful accounts
                
                
                120,020
                
                
                (336,948
                )Loss
                    (gain) on disposal of fixed assets and intangible assets
                
                
                6,435
                
                
                (1,028,204
                )Effect
                    of changes in operating assets and liabilities:Trade
                    receivables
                
                
                2,851,288
                
                
                (690
                )Inventories
                
                
                2,782,993
                
                
                113,078Prepaid
                    expenses and other current assets
                
                
                355,592
                
                
                (783,981
                )Accounts
                    payable
                
                
                (334,174
                )
                
                3,774,881Accrued
                    expenses
                
                
                1,138,378
                
                
                (546,566
                )Other
                
                
                130,999
                
                
                302,272Changes
                    in assets held for sale
                
                
                6,210,783
                
                
                —Net
                    cash (used in) provided by operating activities
                
                
                (4,093,105
                )
                
                2,150,511CASH
                    FLOWS FROM INVESTING ACTIVITIES:Purchases
                    of property and equipment
                
                
                (1,450,528
                )
                
                (416,730
                )Proceeds
                    from sale of property and equipment
                
                
                —
                
                
                351,387Proceeds
                    from sale of prescription files
                
                
                —
                
                
                752,100Net
                    cash (used in) provided by investing activities
                
                
                (1,450,528
                )
                
                686,757CASH
                    FLOWS FROM FINANCING ACTIVITIES:Proceeds
                    (repayments) on revolving credit facility, net
                
                
                5,693,892
                
                
                (3,020,540
                )Payment
                    of promissory notes payable
                
                
                (1,218,975
                )
                
                —Payment
                    of obligations under capital leases
                
                
                (30,092
                )
                
                (29,883
                )Payment
                    of deferred financing costs
                
                
                (434,741
                )
                
                (117,635
                )Proceeds
                    from exercise of stock options
                
                
                563,607
                
                
                —Net
                    cash provided by (used in) financing activities
                
                
                4,573,691
                
                
                (3,168,058
                )NET
                    DECREASE IN CASH AND CASH EQUIVALENTS
                
                
                (969,942
                )
                
                (330,790
                )CASH
                    AND CASH EQUIVALENTS—Beginning of period
                
                
                2,331,552
                
                
                1,307,094CASH
                    AND CASH EQUIVALENTS—End of period
                
                $
                1,361,610
                
                $
                976,304SUPPLEMENTAL
                    DISCLOSURES OF CASH FLOW INFORMATION:Cash
                    paid for interest
                
                $
                3,279,800
                
                $
                2,315,638Noncash
                    transactions—Payment
                    of DrugMax Series A preferred stock dividends in common
                    stock
                
                $
                294,194
                
                
                —Payment
                    of subordinated notes payable interest in common stock
                
                $
                520,694
                
                
                —Conversion
                    of accounts payable to subordinated notes payable
                
                $
                23,000,000
                
                
                —
   See
          accompanying notes to condensed consolidated financial statements.
  
 5
 **DRUGMAX,
          INC. AND SUBSIDIARIES**
 **Notes
          to Condensed Consolidated Financial Statements (unaudited)**
  **NOTE
          A - BASIS OF PRESENTATION**
  The
          accompanying condensed consolidated financial statements include the accounts
          of
          DrugMax, Inc. and its wholly-owned subsidiaries (collectively referred
          to as the
“Company”). All intercompany accounts and transactions have been eliminated.
  The
          accompanying unaudited condensed consolidated financial statements have
          been
          prepared in conformity with generally accepted accounting principles for
          interim
          financial information and with the instructions to Form 10-Q and Rule 10-01
          of
          Regulation S-X. Accordingly, they do not include all of the information
          and
          footnotes required by accounting principles generally accepted in the United
          States of America for complete financial statements. In the opinion of
          management, all adjustments (consisting of normal recurring items) considered
          necessary for a fair presentation have been included. Interim results are
          not
          necessarily indicative of the results that may be expected for a full year.
          These statements should be read in conjunction with the audited consolidated
          financial statements included in our Annual Report on Form 10-K for the
          fiscal
          year ended January 1, 2005 filed with the Securities and Exchange Commission.
  The
          Company’s fiscal year 2005 begins on January 2, 2005 and ends on December 31,
          2005. The Company’s fiscal quarters end on the Saturday closest to March 31,
          June 30 and September 30. Each fiscal quarter is 13 weeks in length. The
          Company’s third quarter for fiscal year 2005 ended on October 1,
          2005.
  **NOTE
          B - MERGER, BUSINESS, DISCONTINUED OPERATIONS AND GOING CONCERN**
  ***Merger*** —On
          March
          19, 2004, Familymeds Group, Inc. (“FMG”) entered into an Agreement and Plan of
          Merger which was amended on July 1, 2004 and also on October 11, 2004 (as
          amended, the “Merger Agreement”) with DrugMax, Inc. (“DrugMax”). Under the terms
          of the Merger Agreement, on November 12, 2004, FMG merged into DrugMax,
          and
          DrugMax became the surviving corporation in the Merger (the “Merger”). The
          Merger was treated as a purchase of DrugMax by FMG for accounting purposes.
          Accordingly, for periods prior to the Merger, the information herein is
          historical information of FMG.
  The
          results of operations of DrugMax have been included in the Company’s
          consolidated statements of operations since the date of acquisition. The
          excess
          of the purchase price over the estimated fair values of the underlying
          assets
          acquired and liabilities assumed was allocated to goodwill. The allocation
          of
          the purchase price was finalized during the nine months ended October 1,
          2005
          resulting in an increase of $963,523 in goodwill (see Note G - Goodwill
          and
          Other Intangible Assets).
  In
          connection with the Merger, the Company terminated certain DrugMax employees.
          Included in a restructuring liability as of the Merger date was total severance
          obligations of approximately $966,000, $451,000 of which had been paid
          as of
          October 1, 2005. Additionally, an accrued lease liability of $85,000 was
          recorded related to an office location that is no longer used.
  In
          the
          Merger, the shareholders of FMG (along with certain FMG warrant holders
          and note
          holders) received an aggregate of 10,470,507 shares of the Company’s common
          stock along with warrants to purchase an additional 3,500,090 shares of
          the
          Company’s common stock. The exercise price of the warrants is $2.61 per share.
          In addition, in connection with the Merger, the Company issued an aggregate
          of
          656,047 shares of restricted common stock, along with options to purchase
          an
          additional 1,574,369 shares of common stock, to certain employees and directors
          of FMG who agreed to continue providing services subsequent to the Merger.
          The
          exercise price of the stock options is $0.57 per share. The noncash compensation
          charge recorded during the three months and nine months ended October 1,
          2005
          relating to the restricted stock and stock options related to the Merger
          was
          $1,132,840 and $5,074,006, respectively, which was based on the provisions
          of
          the restricted stock and stock option agreements. During the nine months
          ended
          October 1, 2005, an additional 38,200 warrants were issued to former FMG
          shareholders. These additional warrants were valued at $45,426 which was
          reflected as an adjustment to goodwill during the nine months ended October
          1,
          2005.
 
 ***Business*** —As
          of
          October 1, 2005, the Company owned or franchised pharmacy locations in
          13
          states. As of October 1, 2005 and September 25, 2004 there were 77 and
          76 owned
          locations, respectively, including one home health center and one non-pharmacy
          mail order center. In addition there are 7 franchised pharmacy locations.
          The
          Company is not actively seeking to franchise additional pharmacy locations.
          Additionally, the Company has two drug distribution centers located in
          New
          Castle, Pennsylvania and St. Rose, Louisiana as discussed below.
 
 6
 
  ***Discontinued
              Operations*** —In
              August 2005, Hurricane Katrina resulted in the closure of the
              warehouse
              facility located in St. Rose, Louisiana. The Company has decided to
              permanently
              close the facility. The facility lease expires during October 2006
              and estimated
              remaining lease costs of $0.2 million were accrued as of October 1,
              2005. The
              Company maintains insurance coverage, which provides for reimbursement
              from
              losses resulting from property damage, loss of product and losses
              from
              business interruption. The Company estimates approximately $0.2 million
              of
              inventory was damaged during the hurricane and incurred approximately
              $0.8
              million of incremental costs related to closing the facility and relocating
              the
              inventory and operations to our New Castle facility. Additionally,
              provisions
              for bad debts of $0.5 million were recorded related to estimated losses
              resulting from customers whose businesses were affected by the hurricane
              and the
              related unamortized customer list asset of $0.5 million was also written
              off.
              These costs were expensed and included in loss from discontinued operations
              in
              the accompanying condensed consolidated statement of operations for
              the three
              months and nine months ended October 1, 2005. The Company is currently
              evaluating the extent of the loss from business interruption and is
              attempting
              to recover these costs through insurance claims. No amounts have been
              recorded
              related to amounts that may be received from insurance.
 
 Also,
              during the third quarter of 2005, the Company determined that it would
              sell
              certain assets of its wholesale drug distribution business and discontinue
              operations conducted out of the New Castle, Pennsylvania facility and
              the
              operations previously conducted out of the St. Rose, Louisiana facility
              related
              to distribution to independent pharmacies. The Company will continue
              with that
              portion of the wholesale distribution business related to the distribution
              of
              pharmaceuticals directly to physicians and medical clinics. Assets
              held for sale
              as of October 1, 2005 were $13.7 million which consisted of net accounts
              receivable of $4.6 million, net inventories of $8.4 million and other
              assets of
              $0.7 million. Net revenues related to discontinued operations were
              $22.7 million
              and $80.1 million for the three months and nine months ended October
              1, 2005,
              respectively. The total loss from discontinued operations for the three
              and nine
              months ended October 1, 2005 of $8.6 million and $11.2 million, respectively
              represents the loss from operations of the discontinued operations
              of $4.8
              million and $7.4 million and loss on disposal of the discontinued operations
              of
              $3.8 million for each of the periods presented. The loss on disposal
              of
              discontinued operations includes asset impairments and accrued lease
              liabilities
              related to the New Castle, Pennsylvania facility. There were no revenues
              recorded for the discontinued operations for 2004 periods as these
              operations
              were acquired in the Merger. The assets of the discontinued business
              have been
              put up for sale and the Company has engaged a nationally known advisor
              to
              conduct a sale of the assets.
 
 The
              Company expects to complete a sale of the assets before December 31,
              2005. All
              of the proceeds from the sale will be used to pay down the New Credit
              Facility
              and the amount available for borrowings will be reduced based on eligible
              receivables and inventory pledged as collateral.
 
 As
              a
              result of the decision to sell certain assets of the drug distribution
              business,
              the Company completed impairment analysis of the related long-lived
              assets. The
              Company believes the remaining intangible assets of $23.8 million as
              of October
              1, 2005 will be realizable through the distribution business related
              to the
              distribution of pharmaceuticals directly to physicians and medical
              clinics using
              the contracts acquired in the Merger.
 
 Revenues,
              operating expenses, and other non-operating costs for the discontinued
              operations have been excluded from our results from continuing operations
              and
              included in our condensed consolidated statements of operations, as
              loss from
              discontinued operations for the three months and nine months ended
              October 1,
              2005. The assets of the discontinued operations being sold are included
              in our
              condensed consolidated balance sheet as assets held for sale as of
              October 1,
              2005.
 ***Going
              Concern***— The
              accompanying condensed consolidated financial statements have been
              prepared
              assuming that the Company will continue as a going concern. The report
              of
              independent registered public accounting firm for the Company’s January 1, 2005
              consolidated financial statements was modified with respect to uncertainties
              regarding the Company’s ability to continue as a going concern since the Company
              has a history of operating losses and the Company was in default of
              covenants on
              its primary credit facility and lender could demand repayment. Since
              then
              the  Company has taken significant action to address
              these issues
              including the refinancing of our senior credit facility and the raising
              of
              additional equity capital which substantially improve liquidity and
              the ability
              to improve profitability through growth. Specifically, on October 12,
              2005, the
              Company entered into a new secured senior credit agreement (see Note
              C -
              Subsequent Events) with Wells Fargo Retail Finance, LLC (“WFRF”), which replaced
              the Senior Credit Facility (see Note H - Debt) for which the Company
              was in
              violation of certain financial and other covenants. Also on October
              3, 2005 the
              Company closed on the sale of 44,093,432 shares of the Company’s common stock
              and warrants to purchase an additional 22,046,715 shares of common
              stock, for
              net cash proceeds of $47.4 million, less expenses of $3.8 million (see
              Note C -
              Subsequent Events). Management believes that these transactions along
              with
              disposition of the discontinued operations and cost reduction initiatives
              implemented will enable the Company to continue as a going concern.
 
 7
 **NOTE
          C - SUBSEQUENT EVENTS**
  ***New
          Credit Facility***
 
 On
          October 12, 2005, the Company entered into a Loan and Security Agreement
          with
          WFRF, pursuant to which WFRF provided 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 under the old credit
          facility including a termination fee of $500,000. The $65.0 million of
          maximum
          availability under the New Credit Facility is reduced by a $7.0 million
          reserve
          as of October 31, 2005. While the New Credit Facility currently does not
          require
          compliance with financial covenants, the Company has the ability to reduce
          this
          reserve by $3.5 million by agreeing to implement one or more financial
          covenants. Available credit is based on eligible receivables, inventory
          and
          prescription files, as defined in and determined pursuant to the agreement.
          Interest on New Credit Facility 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 October
          31, 2005
          was 0.25%. As of October 31, 2005, the interest rate, including
          applicable margin, was 7.00%. 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.
 
 ***Sale
          of Securities***
 
 On
          September 23, 2005 and September 26, 2005, the Company entered
          into
          securities purchase agreements to sell to certain qualified institutional
          buyers
          and accredited investors an aggregate of 44,093,432 shares of the Company’s
          common stock and warrants to purchase an additional 22,046,715 shares of
          common
          stock, for an aggregate purchase price of $51,104,340. The sales of the
          securities were consummated on October 3, 2005 and, therefore, these
          transactions are not reflected in the accompanying balance sheet as of
          October
          1, 2005. The offering was executed in two traunches at the then current
          market
          price. A purchase agreement for the first traunch was executed on
          September 23, 2005, for an aggregate of $47,814,265. The unit price
          of the
          common stock and corresponding warrant to purchase one half share of common
          stock was $1.1525. These warrants are exercisable until October 2,
          2010 at
          an exercise price of $1.09 per share. A purchase agreement for the second
          traunch was executed on September 26, 2005, for an aggregate of
          $3,290,075.
          The unit price of the common stock and corresponding warrant to purchase
          one
          half share of common stock was $1.2625. These warrants are exercisable
          until
          October 3, 2010 at an exercise price of $1.20 per share.
  The
          expenses in connection with the private placement were approximately $3,750,000
          and were netted against the proceeds in stockholders’ (deficit)
          equity.
 
 Proceeds
          from the New Credit Facility and securities sale were used to repay in
          full the
          Company’s existing line of credit with GECC and redeem the Series A Preferred
          Stock as discussed below and are also expected to be used to provide financing
          for working capital, letters of credit, capital expenditures, potential
          acquisitions and other general corporate purposes.
 
 ***Redemption
          of Preferred A Stock***
 
 On
          September 26, 2005, the Company entered into agreements with its Series
          A
          Preferred Stock to have their shares of Series A Preferred Stock redeemed
          for
          cash upon the closing of the sale of the common stock and warrants described
          above. Accordingly, in connection with the closing of the private placement,
          on
          October 3, 2005 the Company redeemed the 17,000 shares of Series A Preferred
          Stock outstanding for 100% of the stated value or $17 million. In addition,
          the
          Company issued 488,070 shares of common stock, valued at $844,360, to certain
          of
          the holders of its Series A Preferred Stock in connection with the
          redemption.
 
 8
 In
          connection with the redemption, the exercise price of the 1,378,374 warrants
          previously issued to the purchasers of Series A Preferred Stock was reduced
          to
          $1.09 per share from $2.80 per share.
 
 ***Increase
          in Authorized Shares***
 
 On
          October 3, 2005, the Articles of Incorporation were amended to increase
          the
          number of shares of common stock authorized from 45,000,000 to 100,000,000.
          Additionally, on October 25, 2005, the Articles of Incorporation were further
          amended to increase the number of shares of common stock authorized from
          100,000,000 to 200,000,000.
 
 **NOTE
          D - NET LOSS PER SHARE**
  For
          periods prior to the Merger, the weighted average shares outstanding have
          been
          computed based on the number of shares that former FMG common shareholders
          would
          have received in the transaction, on an as-if converted basis (i.e., if
          the
          preferred shares were converted to common shares prior to the Merger) and
          had
          the Merger consideration not been distributed to the preferred shareholders
          based on liquidation values. Based on the exchange ratio, FMG common
          shareholders would have received 1,288,909 shares of common stock. Accordingly,
          for periods prior to the Merger, all per share information has been restated
          to
          reflect such exchange ratio. 3,253,901 and 672,393 options to purchase
          common
          stock for the nine months ended October 1, 2005 and September 25, 2004,
          respectively, have not been included in the calculation of net loss per
          share as
          their effect would have been anti-dilutive.
 
 **NOTE
          E - STOCK BASED COMPENSATION**
  The
          Company applies APB Opinion No. 25, *Accounting
          for Stock Issued to Employees* (“APB
          15”), and its related interpretations in accounting for employee stock
          compensation and Emerging Issues Task Force 96-18, *Accounting
          for Equity Instruments That Are Issued to Other Than Employees for Acquiring,
          or
          in Conjunction with Selling, Goods or Services* ,
          to
          account for options issued to non-employees. Had compensation cost for
          the
          Company’s stock-based compensation plans been determined based on the fair value
          of the awards at the grant dates, consistent with the method of Statement
          of
          Financial Accounting Standards (“SFAS”) No. 123, *Accounting
          for Stock-Based Compensation* (“SFAS
          123”), the change in the Company’s net loss would not have been significant for
          the periods presented.
  No
          stock
          options were granted during the nine months ended September 25, 2004. During
          the
          nine months ended October 1, 2005, the Company granted 90,000 shares of
          restricted stock and options to purchase 150,000 shares of common stock
          at $2.80
          per share.
 
  9
  **NOTE
          F - NEW ACCOUNTING PRONOUNCEMENTS**
  In
          December 2004, the Financial Accounting Standards Board (“FASB”) issued
          Statement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based
          Payment* (SFAS
          123R), which is a revision of Statement of Financial Accounting Standards
          No.
          123, *Accounting
          for Stock-Based Compensation* .
          SFAS
          123R supersedes APB 25, *Accounting
          for Stock Issued to Employees* ,
          and
          amends Statement of Financial Accounting Standards No. 95, *Statement
          of Cash Flows* (“SFAS
          95”). Generally, the approach in SFAS 123R is similar to the approach described
          in SFAS 123. However, SFAS 123R requires all share-based payments to employees,
          including grants of employee stock options, to be recognized in the statement
          of
          operations based on their fair values. Pro forma disclosure is no longer
          an
          alternative. SFAS 123R must be adopted no later than January 1, 2006. Early
          adoption will be permitted in periods in which financial statements have
          not yet
          been issued. The Company is required to adopt SFAS 123R on January 1, 2006.
  As
          permitted by SFAS 123, the Company currently accounts for share-based payments
          to employees using Opinion 25’s intrinsic value method and, as such, generally
          recognizes no compensation cost for employee stock options. Accordingly,
          the
          adoption of SFAS 123R’s fair value method may have a significant impact on our
          results of operations, although it will have no impact on our overall financial
          position. Determining the exact impact of adoption of SFAS 123R cannot
          be
          predicted at this time because it will depend on levels of share-based
          payments
          granted in the future and the assumptions for the variables which impact
          the
          computation. However, had the Company adopted SFAS 123R in prior periods,
          the
          impact of that standard would have approximated the impact of SFAS 123
          as
          described in the disclosure of pro forma net income and earnings per share
          above.
 
 In
          March
          2005, the SEC released Staff Accounting Bulletin (“SAB”) No. 107, *Share-Based
          Payment* (“SAB
          107”) *.* SAB 107
          provides the SEC staff position regarding the application of SFAS No. 123R.
          SAB
          107 contains interpretive guidance related to the interaction between SFAS
          123R
          and certain SEC rules and regulations, as well as provides the Staff’s views
          regarding the valuation of share-based payment arrangements for public
          companies. SAB 107 also highlights the importance of disclosures made related
          to
          the accounting for share-based payment transactions. The Company is currently
          reviewing the effect of SAB 107 on its condensed consolidated financial
          statements as it prepares to adopt SFAS 123R.
 
 **NOTE
          G - GOODWILL AND OTHER INTANGIBLE ASSETS**
  The
          carrying value of goodwill and other intangible assets is as follows:
  **October
                    1, 2005**
                
                **January
                    1, 2005****Gross**
                  **Carrying**
                  **Amount**
                
                **Accumulated**
                  **Amortization**
                
                **Gross**
                  **Carrying**
                  **Amount**
                
                **Accumulated**
                  **Amortization**Other
                    intangible assets
                
                $
                25,687,214
                
                $
                (17,518,192
                )
                $
                25,919,769
                
                $
                (15,349,708
                )Goodwill
                
                
                20,776,603
                
                
                —
                
                
                19,813,080
                
                
                —
  
 During
          the three months ended October 1, 2005, the Company revised the purchase
          price
          for additional Merger expenses and also adjusted to purchase price allocation
          to
          reflect the fair value of the underlying assets acquired and liabilities
          assumed. The table below reflects the changes to goodwill:
  Goodwill,
                      January 1, 2005
                  
                  $
                  19,813,080Adjustments
                      to goodwill:Additional
                      contract costs required by Merger
                  
                  
                  936,015Merger
                      expenses, including warrants issued to FMG shareholders related
                      to the
                      Merger
                  
                  
                  131,363Other
                  
                  
                  (103,855
                  )Total
                      adjustments to goodwill
                  
                  
                  963,523Goodwill,
                      October 1, 2005
                  
                  $
                  20,776,603
 
 10
 The
          Merger required the Company to enter into an agreement with a former officer
          and
          director which requires payments in excess of market value over a three
          year
          period. The incremental costs of approximately $936,000 over the term of
          the
          agreement were recorded as goodwill.
 
 The
          weighted average amortization period for intangible assets is approximately
          7.3
          years as of October 1, 2005 and January 1, 2005, respectively. Amortization
          expense related to intangible assets was approximately $686,000 and $630,000
          for
          the three months ended October 1, 2005 and September 25, 2004, respectively.
          Amortization expense related to other intangible assets was approximately
          $2,092,000 and $1,912,000 for the nine months ended October 1, 2005 and
          September 25, 2004, respectively.
  Estimated
          aggregate amortization expense is expected to be $590,000 for the remainder
          of
          fiscal year 2005, and $1,830,000, $768,000, $647,000 and $555,000 for the
          fiscal
          years 2006, 2007, 2008 and 2009, respectively.
  **NOTE
          H - DEBT**
  Debt
          at
          October 1, 2005 and January 1, 2005 consisted of the following:
  **October
                    1, 2005**
                
                **January 1, 2005**Revolving
                    credit facility
                
                $
                38,564,679
                
                $
                32,870,787Promissory
                    notes payable
                
                
                1,340,237
                
                
                2,284,212Subordinated
                    notes payable(1)
                
                
                23,267,304
                
                
                —Total
                
                $
                63,172,220
                
                $
                35,154,999Long-term
                    accounts payable, including current portion(1)
                
                $
                —
                
                $
                23,000,000
  
 *(1)*
                *Represents
                    $23.0 million of accounts payable converted to subordinated notes
                    payable
                    on March 21, 2005, and $267,304 as a “Deemed Payment” increase to
                    principal pursuant to the subordinated notes payable agreement.*
 
 ***Revolving
          Credit Facility***
  On
          December 9, 2004, the Company entered into the Second Amended and Restated
          Credit Agreement (the “Senior Credit Facility”) with GECC, which increased the
          credit facility from $31 million to $65 million. The $65 million of maximum
          availability was reduced by $7.5 million of permanent availability. The
          Senior
          Credit Facility had a maturity date of December 9, 2007. On August 31,
          2005, the
          Company received from GECC an executed letter agreement (the “Amendment”),
          pursuant to which GECC (a) waived its right to collect default interest
          for all
          periods prior to the date of the Amendment, but otherwise reserved all
          of its
          rights and remedies resulting from the Company’s default under the Senior Credit
          Facility, (b) increased the applicable interest margins under the Senior
          Credit
          Facility by an average of 1.0% per annum and (c) imposed an additional
          1% per
          annum “PIK” interest, which began to accrue as of August 2005. The Amendment
          further provided that PIK interest would be due and payable upon the termination
          of the Senior Credit Facility; however, the requirement would be waived
          if the
          Senior Credit Facility was terminated or repaid prior to October 31, 2005.
          On
          October 12, 2005, the Company entered into a new Loan and Security
          Agreement (See Note C-Subsequent Events) with WFRF and terminated the Senior
          Credit Facility with GECC. The PIK interest was waived upon the termination
          of
          the Senior Credit Facility.
  Interest
          on the Senior Credit Facility was calculated at either the index rate (as
          defined) plus an applicable index margin (as defined) or, at the option
          of the
          Company, at an adjusted monthly LIBOR index rate plus an applicable LIBOR
          margin
          (as defined). The applicable index margin as of October 1, 2005 and September
          25, 2004 was 3.75% and 3.25%, respectively. The interest rates, including
          applicable margin, that were used to calculate accrued interest were 8.25%
          and
          5.92% as of October 1, 2005, and September 25, 2004, respectively. Interest
          was
          payable monthly. The Senior Credit Facility prohibited the payment of dividends
          in cash. As of October 1, 2005, $38.6 million was outstanding under the
          Senior
          Credit Facility and $0.1 million was available for additional borrowings,
          based
          on eligible receivables and inventory.
 
 11
 The
          Senior Credit Facility required monthly compliance with certain restrictive
          covenants including, but not limited to, minimum EBITDA, maximum capital
          expenditures, maximum fixed charge coverage ratio, minimum net worth, minimum
          inventory turnover, maximum trade receivable days sales outstanding, maximum
          accounts payable days outstanding and maximum ratio of non-pharmaceutical
          inventory to total inventory. The Company violated certain of these covenants
          as
          of January 1, 2005 and each subsequent month thereafter through October
          1, 2005,
          including the EBITDA and net worth financial covenants, and other covenants,
          and
          as of such dates was in default on this obligation.
 
 ***Subordinated
          Notes Payable***
  On
          March
          22, 2005, the Company entered into the First Amendment to the Senior Credit
          Facility (the “March 2005 Amendment”). The March 2005 Amendment provided for an
          increase in the reduction of permanent availability from $5.5 million to
          $7.5
          million and allowed the Company to convert the $23.0 million of accounts
          payable
          after consideration of a $6.0 million payment in March 2005 to AmerisourceBergen
          Drug Corporation (“ABDC”) into a subordinated convertible debenture in the
          original principal amount of $11,500,000 (the “Subordinated Convertible
          Debenture”) and a subordinated promissory note in the original principal amount
          of $11,500,000 (the “Subordinated Note”).
  The
          Subordinated Note is due and payable in quarterly installments of $575,000
          beginning on December 1, 2005 through September 1, 2010, on which date
          all
          outstanding amounts are due. The Subordinated Note bears interest at the
          prime
          rate plus 2.0% per annum (8.75% as of October 1, 2005), provided that in
          no
          event will the interest rate in effect be less than 5.0% per annum or greater
          than 10.0% per annum. Interest accrued on the Subordinated Note is payable
          quarterly and interest payments commenced June 1, 2005. Interest expense
          of
          $246,771 and $507,278 was recorded during the three months and nine months
          ended
          October 1, 2005, respectively.
 
 The
          Subordinated Convertible Debenture is due and payable in quarterly installments
          of $605,263 commencing on March 1, 2006 through August 15, 2010, on which
          date
          all outstanding amounts are due. Quarterly principal payments are payable
          in
          cash or in shares of common stock in an amount equal to $605,263 divided
          by
          $3.4416 (the “Issue Price”), at the Company’s option. The Subordinated
          Convertible Debenture bears interest at 10.0%, if the quarterly interest
          payment
          is made in common stock or the prime rate plus 1% per annum (7.75% as of
          October
          1, 2005), if the quarterly interest payment is made in cash, provided that
          in no
          event will the interest rate in effect be less than 5.0% per annum or greater
          than 10.0% per annum. Quarterly interest payments are required to be paid
          in
          common stock through February 28, 2006. Commencing March 1, 2006, quarterly
          interest payments may be paid in cash or common stock in an amount equal
          to the
          interest then due and owing divided by the Issue Price, or a combination
          thereof. The first interest payment of $233,194 was made on June 1, 2005
          through
          the issuance of 67,757 shares of common stock. The second interest payment
          of
          $287,500 was made on September 1, 2005 through the issuance of 83,536 shares
          of
          common stock. Interest expense of $290,694 and $616,528 was recorded during
          the
          three months and nine months ended October 1, 2005, respectively.
  If
          common
          stock is used to make principal or interest payments on the Subordinated
          Convertible Debenture, and the proceeds ABDC receives upon any sale of
          the
          Company’s common stock (or the proceeds ABDC would have received upon a sale in
          the event no shares are sold by ABDC) are less than the principal and interest
          due, the Company is required to pay such difference to ABDC in cash on
          the date
          of maturity of the Subordinated Convertible Debenture. As of October 1,
          2005 the
          Company received notice from ABDC that a shortfall in the value received
          from
          the sale of securities received as payment of interest was $267,304. This
          amount
          is considered a “Deemed Payment” under the terms of the Subordinated Convertible
          Debenture and the amount is reflected as a liability in the condensed
          consolidated balance sheet as of October 1, 2005. Through December 31,
          2005,
          ABDC may not sell any shares of the Company’s common stock received that, in the
          aggregate, exceed 25% of the average trading volume of the Company’s common
          stock for the preceding 10 trading days.
 
 In
          connection with the Subordinated Convertible Debenture, DrugMax entered
          into a
          registration rights agreement dated March 21, 2005 with ABDC pursuant to
          which
          the Company agreed to file a registration statement with the SEC to register
          the
          resale of all common stock issuable to ABDC in connection with the Subordinated
          Debenture no later than May 30, 2005. Further on May 26, 2005, ABDC granted
          the
          Company a 45 day extension to file the registration statement. On July
          7, 2005,
          the company filed a registration statement on Form S-1. The SEC declared
          the
          Form S-1 effective on August 10, 2005. The Subordinated Debenture and
          Subordinated Note are guaranteed by DrugMax and certain of DrugMax’s
          subsidiaries, including Valley Drug Company, Valley Drug Company South,
          Familymeds, and Familymeds Holdings, Inc. (the “Debtors”) pursuant to Continuing
          Guaranty Agreements dated as of March 21, 2005. The Debtors also entered
          into a
          subordinated security agreement dated as of March 21, 2005, pursuant to
          which
          each of the Debtors agreed that upon the occurrence of certain defaults,
          each
          Debtor would be deemed at that point to have granted to ABDC a springing
          lien
          upon and a security interest in substantially all of its assets to secure
          the
          Subordinated Debenture and the Subordinated Note. However, pursuant to
          a
          subordination agreement dated March 21, 2005, the Subordinated Debenture,
          the
          Subordinated Note, the Guarantees and the Security Agreement are subordinated
          to
“Senior Debt.” Senior Debt consists of all senior indebtedness now or hereafter
          owing, including indebtedness under the Senior Credit Facility and any
          debt
          incurred by the Company to replace or refinance such debt.
  12
 **NOTE
          I - DRUGMAX SERIES A CONVERTIBLE PREFERRED STOCK**
  On
          December 2, 2004, for an aggregate purchase price of $17 million, the Company
          sold to certain qualified institutional buyers and accredited investors
          an
          aggregate of 17,000 shares of series A convertible redeemable preferred
          stock
          (the “Series A”). These shares were convertible into an aggregate of 4,594,591
          shares of the Company’s common stock, based upon an initial conversion price of
          $3.70 per share. However, in an amendment to the certificate of designation,
          on
          July 7, 2005, the conversion price was reduced from $3.70 per share to
          $2.80 per
          share and the Series A stock became convertible into an aggregate of 6,071,425
          shares of DrugMax common stock. In addition, the investors received warrants
          to
          purchase an aggregate of 1,378,374 shares of DrugMax common stock. The
          exercise
          price of the warrants was $4.25 per share upon issuance. The exercise price
          was
          reduced to $1.09 upon the redemption of the Series A. The warrants are
          exercisable into common stock and expire on the fifth anniversary of the
          closing. Midsummer Investment, Ltd. acted as the lead investor in the private
          placement. First Albany Capital served as the lead placement agent for
          the
          transaction and the Maxim Group, LLC served as co-agent.
 
 The
          Company filed a registration on Form S-3 to register the resale of the
          shares of
          common stock issuable upon the conversion of the Series A stock and the
          exercise
          of the warrants. The Company was required to maintain the registration
          effective
          until all of such shares have been sold or may be sold without volume
          restrictions pursuant to rule 144. The Form S-3 was declared effective
          by the
          SEC on January 19, 2005. The Company’s agreement with the preferred stockholders
          contained a provision to the effect that if the registration statement
          ceased
          for any reason to remain continuously effective or the holders were not
          permitted to utilize the prospectus therein to resell such registrable
          securities for 10 consecutive calendar days but no more than an aggregate
          of 15
          calendar days during any 12-month period (the “Event Date”), then in addition to
          any other rights the holders may have, the Company shall pay
          to
          each holder an amount in cash equal to 2% of the aggregate purchase price
          paid
          by such holder as partial liquidated damages. Such amounts were to be payable
          on
          the Event Date and on each monthly anniversary of the Event Date until
          such time
          as the registration statement became effective or until the holders are
          permitted to utilize the prospectus to resell securities.
 
 Effective
          April 20, 2005, the Company suspended sales under the previously filed
          registration statement to resell such securities. Under the terms of the
          Series
          A, the investors were entitled to liquidated damages until such time as
          the
          registration statement became effective. On July 7, 2005, the Company amended
          the certificate of designation to reduce the conversion price of the Series
          A
          from $3.70 to $2.80 per share. In exchange, investors representing 95%
          of the
          Series A shareholders agreed to waive liquidated damages under the registration
          rights agreement through the date of the amendment and to amend the registration
          rights agreement to require the filing of a registration statement covering
          the
          registrable securities by July 8, 2005 and to require the effectiveness
          of such
          registration statement to be no later than October 1, 2005. On July 7,
          2005, the
          Company filed a registration statement on Form S-1. The SEC declared the
          Form
          S-1 effective on August 10, 2005. The amount of the liquidated damages
          owed as
          of July 2, 2005, $1.0 million, substantially all of which was waived by
          the
          shareholders, was recorded as additional DrugMax preferred stock dividends
          for
          the three months ended July 2, 2005. A total of $1.1 million was accrued
          through
          July 7, 2005 related to liquidated damages and reversed during the three
          months
          ended October 1, 2005. The revised conversion price does not represent
          a
          beneficial conversion feature.
 
 The
          Series A contained an increasing-rate dividend as follows: 7% per annum
          until
          the fourth anniversary; 9% per annum from the fourth until the fifth
          anniversary; 11% per annum from the fifth until the sixth anniversary and
          14%
          per annum thereafter. In accordance with SEC Staff Accounting Bulletin
          Topic 5, *Miscellaneous
          Accounting* ,
          Section
          Q, the Company has recorded a discount of $4,166,000 that would have been
          amortized over years one through six (the pre-perpetual dividend period),
          so
          that the effective rate of the dividend would be consistent for the life
          of the
          preferred stock.
 
 On
          October 3, 2005, the Company redeemed the Series A for cash of $17.0 million
          and
          488,069 shares (see Note C - Subsequent Events).
 
 13
 **NOTE
          J - SEGMENT INFORMATION**
  The
          Company operated as one business segment for all periods presented. This
          segment
          includes two reporting units: specialty pharmacy operations and drug
          distribution operations.
  **NOTE
          L - INCOME TAXES**
  The
          Company incurred net losses for the three months and nine months ended
          October
          1, 2005, and September 25, 2004. No income tax benefit had been recorded
          in
          these periods due to uncertainty of realization of deferred tax assets
          and
          limitations on net operating losses due to changes in ownership which limit
          the
          amount of pre-change losses that can be used in a tax year.
  14
  **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 condensed
          consolidated financial statements and the related notes found elsewhere
          in this
          Form 10-Q. This discussion, as well as the notes to our 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.
  ***Cautionary
          Statement Concerning Forward-Looking Statements***
  Certain
          oral statements made by management from time to time and certain statements
          contained in press releases and periodic reports issued by DrugMax, Inc.,
          including those contained herein, that are not historical facts are
“forward-looking statements” within the meaning of the Private Securities
          Litigation Reform Act of 1995. Because such statements involve risks and
          uncertainties, actual results may differ materially from those expressed
          or
          implied by such forward-looking statements. Forward-looking statements,
          are
          statements regarding the intent, belief or current expectations, estimates
          or
          projections of DrugMax, its directors or its officers about DrugMax and
          the
          industry in which it operates, and include among other items, statements
          regarding (a) DrugMax’s strategies regarding growth and business expansion,
          including its strategy of building an integrated specialty pharmacy platform
          with multiple sales channels, (b) DrugMax’s plans to dispose of certain
          operations, (c) its merger with Familymeds Group, Inc., (d) its financing
          plans,
          (e) trends affecting its financial condition or results of operations;
          and (f)
          its ability to continue to control costs and to meet its liquidity and
          other
          financing needs. Although DrugMax believes that its expectations are based
          on
          reasonable assumptions, it can give no assurance that the anticipated results
          will occur. When used in this report, the words
“expects,”“anticipates,”“intends,”“plans,”“believes,”“seeks,”“estimates,” and
          similar expressions are generally intended to identify forward-looking
          statements.
  Important
          factors that could cause the actual results to differ materially from those
          in
          the forward-looking statements include, among other items, (i) management’s
          ability to sell certain assets of the drug distribution business, (ii)
          changes
          in the regulatory and general economic environment related to the health
          care
          and pharmaceutical industries, including possible changes in reimbursement
          for
          healthcare products and in manufacturers’ pricing or distribution policies;
          (iii) the potential effect on pharmacy sales and gross margin rates attributable
          to the introduction in 2006 of a new Medicare prescription drug benefit
          and the
          continued efforts by state Medicaid entities to reduce pharmacy reimbursement
          rates; (iv) conditions in the capital markets, including the interest rate
          environment and the availability of capital; (v) changes in the competitive
          marketplace that could affect DrugMax’s revenue and/or cost bases, such as
          increased competition, lack of qualified marketing, management or other
          personnel, and increased labor and inventory costs; (vi) management’s ability to
          increase sales to target physician groups; and (vii) changes regarding
          the
          availability and pricing of the products which DrugMax distributes, as
          well as
          the loss of one or more key suppliers for which alternative sources may
          not be
          available.
 
 Further
          information relating to factors that could cause actual results to differ
          from
          those anticipated is included under the heading “Risk Factors” contained in
          DrugMax’s Annual Report on Form 10-K for the year ended January 1, 2005. The
          Company disclaims any intention or obligation to update or revise
          forward-looking statements, whether as a result of new information, future
          events or otherwise.
  ***Overview
          and Pro Forma Information***
  DrugMax,
          Inc. (“DrugMax,” the “Company,” or “we” and other similar pronouns) is a
          specialty pharmacy and drug distribution provider formed by the merger
          on
          November 12, 2004 of DrugMax, Inc. and Familymeds Group, Inc. (“FMG”). We work
          closely with doctors, patients, managed care providers, medical centers
          and
          employers to improve patient outcomes while delivering low cost and effective
          healthcare solutions. As of October 1, 2005, we operated one drug distribution
          facility, under the Valley Drug Company name, and 77 specialty pharmacies,
          including one home health center and one non-pharmacy mail order center,
          in 13
          states under the Arrow Pharmacy & Nutrition Center and Familymeds Pharmacy
          brand names. Our other distribution facility was closed in September as
          a result
          of Hurricane Katrina as discussed below.
 
 15
 During
          the third quarter, we determined that we will sell certain assets of the
          drug
          distribution business and eliminated operations conducted out of the New
          Castle,
          Pennsylvania facility and the operations previously conducted out of the
          St.
          Rose, Louisiana facility related to distribution to independent pharmacies.
          We
          will continue with that portion of the wholesale drug distribution business
          related to the distribution of pharmaceuticals directly to physicians and
          medical clinics. Therefore as of October 1, 2005, we consider substantially
          all
          of the wholesale distribution business as discontinued operations for financial
          statement presentation purposes. See our discussion on discontinued operations
          elsewhere under “ *Discontinued
          Operations* ”
          in
          Management’s Discussion and Analysis of Financial Condition and Results of
          Operations.
  Subsequent
          to October 1, 2005, we completed a private placement of our common stock,
          redeemed the Series A and refinanced our senior credit facility
          as
          described in more detail below. The
          following table provides selected pro forma information as of  October
          1, 2005 ,
          reflecting (i) the $47.4 million net proceeds from the sale of securities,
          (ii)
          the redemption of the Series A for cash of  $17.0 million, (iii)
          the
          issuance of 488,069 shares of common stock valued at the $0.8 million in
          connection with the Series A redemption, (iv) the $2.1 million difference
          in the
          carrying value of the Series A and the aggregate redemption of $17.8 million,
          (v) the prepayment penalty and other costs associated with the repayment
          of the
          old credit facility of $1.1 million and (vi) $20.0 million of cash
          used
          to reduce the amount outstanding on the New Credit Facility.
 
 **As
                    of October 1, 2005****As
                    Reported**
                
                ******Pro
                    Forma**Cash
                    and Cash Equivalents
                
                $
                1,361,610
                
                $
                11,710,425Revolving
                    Credit Facility
                
                
                38,564,679
                
                
                19,232,246Stockholders’
                    (Deficit) Equity*(1)*
                
                
                (15,606,859
                )
                
                13,661,311
 
 *(1)
          As reported amount includes Drugmax Series A Convertible Preferred
          Stock of
          $14,935,092 as of October 1, 2005.*
 
 The
          selected pro forma information presented above should be read in conjunction
          with, and is qualified in its entirety by, the interim condensed consolidated
          financial statements, including the notes thereto, of DrugMax, Inc. included
          herein. The pro forma financial information, while helpful in illustrating
          the
          financial characteristics of the transactions described in Note C - Subsequent
          Events, does not reflect the financial condition of the Company that would
          have
          resulted had the financial transactions described above and Note C - Subsequent
          Events had been consummated on October 1, 2005.
  ***Strategy***
  ***General*** ****
  Our
          primary strategy is to build an integrated specialty drug pharmacy platform
          with
          multiple sales channels including: clinic and apothecary pharmacies, Worksite
          pharmacies, institutional “closed door” type pharmacies, central fill mail order
          based pharmacy and a pharmaceutical distribution center focused on physician
          sales. We believe this can be accomplished through the present base of
          operations, through additional organic opening of new pharmacies and by
          acquiring pharmacies. We believe the integration of these types of locations
          will uniquely enable us to supply specialty drugs to patients, physicians
          and
          other healthcare providers.
  Our
          strategy is to locate specialty clinic and apothecary pharmacy operations
          near
          or in medical facilities. The strategy is driven by the location concept
          whereby
          situating a clinical or specialty type pharmacy near the point of acute
          or
          chronic care provides us with a “first capture” opportunity to service patients
          when they visit their physicians. This also enables us to collaborate with
          the
          physician in the therapeutic regimen and may provide opportunities for
          lower
          cost generic or alternative pharmaceutical therapy. We have recently placed
          significant emphasis on the higher cost injectable and orally administered
          specialty pharmaceuticals. Our focus for the future is increasing pharmacy
          revenues through these “Specialty Pharmaceuticals.” Many of these patients or
          special patient groups require central fill and or mail order follow-up
          care
          that can be provided through our “closed door” pharmacy or mail order center
          located in Connecticut. We also supply online web based access to all or
          most of
          our services and products through our nationally known website
          www.familymeds.com.
 
 We
          offer
          a comprehensive selection of branded and generic prescription and
          non-prescription pharmaceuticals, specialty injectables, generic biologics,
          compounded medicines, healthcare-related products and diagnostic products.
          These
          products are used for the treatment of acute or chronic medical conditions
          and
          may be purchased through our platforms.
 
 The
          company strategy also includes selling specialty pharmaceuticals and healthcare
          products to physicians, home care providers and related healthcare providers
          including respiratory therapists and nurse practitioners that often
          re-administer these products to their patient immediately. We are growing
          this
          strategy by combining selling access through our existing physician
          relationships and medically based pharmacies with a central telephonic
          inside
          sales force who actively pursues these practitioners as well as new potential
          practitioner customers. Our unique selling proposition to these practitioners
          is
          ease of obtaining product through same day delivery through our onsite
          pharmacies as well as our ability to supply the pharmaceutical to the physician
          already prepared “ready to use” and then we would bill their patients
          payor/insurance carrier or Medicare under part B depending on the type
          of
          coverage each patient has. This strategy for distribution of pharmaceuticals
          will be ongoing and utilizes the combined platforms of our wholesale authorized
          distribution agreements to obtain the drugs through the proper channel
          pricing
          and together with central and decentralized distribution to the practitioner
          customer depending on the customer needs.
  16
 ***Specialty
          Pharmacy Operations*** ****
  As
          of
          October 1, 2005, we operated 77 corporate pharmacies, one central fill
          home
          healthcare product center and franchised seven pharmacies in 13 states.
          44 of
          our pharmacies are located at the point of care between physicians and
          patients,
          oftentimes inside medical office buildings or on a medical campus the balance
          of
          our locations are usually nearby to medical facilities though more retail
          accessible. The majority of our revenues from specialty pharmacy operations
          come
          from the sale of prescription pharmaceuticals which represented approximately
          94% of our net revenues for the nine months ended October 1, 2005 and fiscal
          year ended January 1, 2005. Our corporate pharmacies provide services to
          over
          400,000 acute or chronically ill patients each year, many with complex
          specialty
          and medical product needs.
  We
          operate our pharmacies under the trade names Familymeds Pharmacy (“Familymeds”)
          and Arrow Pharmacy and Nutrition Centers (“Arrow”). Familymeds is primarily used
          for pharmacies outside of New England. The Familymeds locations were primarily
          originated by acquiring the base pharmacy business from HMO’s, hospitals and
          regional independent operators. The locations are primarily clinic size
          with a
          small footprint, usually less than 1,500 sq. ft. The Arrow trade name is
          used in
          New England where most of the pharmacies were opened as a start-up or
          re-acquired from former Arrow franchise operators who opened these legacy
          pharmacy operations as start-ups. These locations are primarily apothecary
          size,
          approximately 2,000 sq. ft. and may be more visible as retail type locations,
          though primarily nearby hospitals or medical campus locations. Our locations
          in
          Michigan and certain locations elsewhere throughout our trading area may
          have a
          larger footprint to accommodate a comprehensive inventory of nutritional
          and
          home medical supplies.
 
 By
          our
          estimates there are more than 5,000 locations at or near the point of care
          available to open additional pharmacies nationwide. Because of our experience
          with operating pharmacies in these locations, we believe we are uniquely
          positioned to target these sites and increase our core pharmacy market
          presence.
          We also believe that we can grow our specialty pharmacy operations through
          selective acquisitions. The company is actively pursuing an acquisition
          strategy
          since our recently announced new financing. By increasing our store count,
          through acquisitions or the opening of new pharmacies at or near the point
          of
          medical care, we believe we can increase our customer base, expand our
          geographic reach and improve profitability by leveraging our existing
          infrastructure.
 
 Our
          strategy also includes 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 online including a
          comprehensive selection of prescription medications, vitamins and nutritional
          supplements, home medical equipment, and health and beauty aids directly
          from
          our specialty pharmacies, by mail order, and via the Internet. Familymeds.com
          is
          the foundation of our Internet offering. This website is one of the few
          sites
          certified as a Verified Internet Pharmacy Provider Site (VIPPS) by the
          National
          Association of Boards of Pharmacy (NABP). The VIPPS program is a voluntary
          certification program designed to approve and identify online pharmacies
          that
          are appropriately licensed and prepared to practice internet pharmacy.
          Familymeds.com is the non-prescription Internet commerce partner for select
          prescription benefit managers (PBMs) including Medco Health. We will continue
          to
          pursue opportunities to partner with managed care and others providers
          to
          increase our sales through our internet sales channel.
 
 We
          operate and locate Worksite Pharmacies SM (pharmacies
          that service a single, defined population) for large employers who are
          seeking
          to control overall employee prescription drug benefit expenditures while
          maintaining high employee satisfaction through improved accessibility.
          Our
          Worksite Pharmacies SM offer
          prescription services exclusively to the employer’s covered population. We can
          deliver these services at or near the employer’s work site by opening, staffing
          and managing a pharmacy. Our initial results have proven that this strategy
          reduces healthcare costs for the employer. Our research has shown that
          many
          employers, especially large Fortune 500 companies are seeking more aggressive
          methods to control healthcare expenditures, especially the pharmacy component
          of
          benefits. We have identified key large employers, those with over 2,000
          employees in a single location, to be target opportunities for this type
          of
          Employer Sponsored Worksite Pharmacy SM. In
          late
          2004, we opened a Worksite Pharmacy SM in
          the
          employee center of the Mohegan Sun Casino in Connecticut with more than
          10,000
          employees and dependents as potential patients. Through October 1, 2005,
          our
          performance at this location has exceeded our expectations.
 
 17
 We
          have
          developed special clinical compliance and generic therapeutic programs
          to
          attract patients and reduce pharmacy expenditures. We also have active
          programs
          designed to improve patient compliance and to reduce costs. We have three
          major
          programs, a prescription compliance program called Reliable Refill, a discount
          plan called Senior Save15 and an automated telephony system designed to
          notify
          patients of recalls, provide refill reminders and notify our customers
          of other
          important information. Reliable Refill is a compliance program that identifies
          prescriptions that are due to be filled and schedules them for filling
          before
          the patient has run out of the previous prescriptions. Our Senior Save15
          program, introduced prior to the Medicare Modernization Act, is our own
          discount
          program that gives senior customers access to all of our prescription and
          over-the-counter products at discounted prices. Our programs are designed
          to
          improve medication therapy management among patients with chronic therapeutic
          needs especially the elderly population. Our data warehouse identifies
          these
          patients and allows us to target these patients with special needs. We
          believe
          our data warehouse and our medication therapy management programs uniquely
          position our company as a specialty pharmacy provider.
 
 Although
          we do not offer franchises for sale at this time, in the case of renewing
          franchisees, we are subject to the disclosure requirements of the Federal
          Trade
          Commission and may be subject to pre-sale disclosure requirements and
          registration requirements of various state laws regulating the offer and
          sale of
          franchises. In addition, with respect to our existing franchisees, we also
          are
          subject to certain state laws regulating the franchisor-franchisee relationship.
          Failure to comply with these regulations could result in substantial financial
          penalties. As of October 1, 2005, we held franchise agreements for seven
          stores
          and are not materially dependent on these agreements. We believe the number
          of
          our franchised pharmacy locations will decrease over the next few years.
  ***Medicare
            Part D***
  Pharmacy
            sales trends are expected to continue to grow due, in part, to the Medicare
            Part
            D prescription drug benefit which rolls out in calendar 2006. As
            of
            January 1, 2006, Medicare beneficiaries will have the opportunity to
            receive
            subsidized prescription drug coverage through the Medicare Part D program.
            The
            new drug benefit will be 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 stores. While,
            the new Medicare drug benefit is entirely voluntary, we believe a significant
            portion of the Medicare population will enjoy this new benefit. While
            it
            is difficult to fully predict the impact on our business, we believe
            we are well
            positioned to capture additional prescription sales. However,
            we expect the gross margin from this business to be less than what the
            traditional prescription drug plans provide.
  ***Discontinued
            Operations***
  In
            August
            2005, Hurricane Katrina resulted in the closure of the warehouse
            facility
            located in St. Rose, Louisiana. The Company has decided to permanently
            close the
            facility. The facility lease expires during October 2006 and estimated
            remaining
            lease costs of $0.2 million were accrued as of October 1, 2005. The Company
            maintains insurance coverage, which provides for reimbursement from losses
            resulting from property damage, loss of product and losses from
            business
            interruption. The Company estimates approximately $0.2 million of inventory
            was
            damaged during the hurricane and incurred approximately $0.8 million
            of
            incremental costs related to closing the facility and relocating the
            inventory
            and operations to our New Castle facility. Additionally, provisions for
            bad
            debts of $0.5 million were recorded related to estimated losses resulting
            from
            customers whose businesses were affected by the hurricane and the related
            unamortized customer list asset of $0.5 million was also written off.
            These
            costs were expensed and included in loss from discontinued operations
            in the
            accompanying condensed consolidated statement of operations for the three
            months
            and nine months ended October 1, 2005. The Company is currently evaluating
            the
            extent of the loss from business interruption and is attempting to recover
            these
            costs through insurance claims. No amounts have been recorded related
            to amounts
            that may be received from insurance.
 
 Also,
            during the third quarter of 2005, the Company determined that it would
            sell
            certain assets of its wholesale drug distribution business and discontinue
            operations conducted out of the New Castle, Pennsylvania facility and
            the
            operations previously conducted out of the St. Rose, Louisiana facility
            related
            to distribution to independent pharmacies. The Company will continue
            with that
            portion of the wholesale distribution business related to the distribution
            of
            pharmaceuticals directly to physicians and medical clinics. Assets held
            for sale
            as of October 1, 2005 were $13.7 million which consisted of net accounts
            receivable of $4.6 million, net inventories of $8.4 million and other
            assets of
            $0.7 million. Net revenues related to discontinued operations were $22.7
            million
            and $80.1 million for the three months and nine months ended October
            1, 2005,
            respectively. The total loss from discontinued operations for the three
            and nine
            months ended October 1, 2005 of $8.6 million and $11.2 million, respectively
            represents the loss from operations of the discontinued operations of
            $4.8 million
            and $7.4 million and loss on disposal of the discontinued operations
            of $3.8
            million for each of the periods presented. The loss on disposal of discontinued
            operations includes asset impairments and accrued lease liabilities related
            to
            the New Castle, Pennsylvania facility. There were no revenues recorded
            for the
            discontinued operations for 2004 periods as these operations were acquired
            in
            the Merger. The assets of the discontinued business have been put up
            for sale
            and the Company has engaged a nationally known advisor to conduct a sale
            of the
            assets.
 
 The
            Company expects to complete a sale of the assets before December 31,
            2005. All
            of the proceeds from the sale will be used to pay down the New Credit
            Facility
            and the amount available for borrowings will be reduced based on eligible
            receivables and inventory pledged as collateral.
 
 As
            a
            result of the decision to sell certain assets of the drug distribution
            business,
            the Company completed impairment analysis of the related long-lived assets.
            The
            Company believes the remaining intangible assets of $23.8 million as
            of October
            1, 2005 will be realizable through the distribution business related
            to the
            distribution of pharmaceuticals directly to physicians and medical clinics
            using
            the contracts acquired in the Merger.
 18
 Revenues,
          operating expenses, and other non-operating
          costs for the discontinued operations have been excluded from our results
          from
          continuing operations and included in our condensed consolidated statements
          of
          operations, as loss from discontinued operations for the three months and
          nine
          months ended October 1, 2005. The assets of the discontinued operations
          being
          sold are included in our condensed consolidated balance sheet as assets
          held for
          sale as of October 1, 2005.
  **Comparison
          of Operating Results for the Three Months and Nine Months ended October
          1, 2005
          and September 25, 2004.**
  We
          refer
          to prescription products as Rx products and to the remaining products,
          such as
          over-the-counter medications, home medical equipment and home health appliances,
          as non-Rx products. While non-Rx reflects a smaller percentage of our overall
          revenues, the gross margin for non-Rx products is higher than the gross
          margin
          for Rx products. The Rx portion of the specialty pharmacy business is dependent
          upon a number of third party customers that pay a portion or all of the
          Rx cost
          on behalf of the customers, (“Third Party Customers”).
 
 Prescriptions
          generated by Third Party Customers represented approximately 94% of specialty
          pharmacy’s Rx sales in the three months ended October 1, 2005 and for the three
          months ended September 25, 2004. Prescriptions generated by Third Party
          Customers represented approximately 94% of specialty pharmacy’s Rx sales for the
          nine months ended October 1, 2005 and September 25, 2004. Revenues from
          our drug
          distribution operations (which are included in loss from discontinued
          operations, net of tax) were $23.4 million and $82.2 million for the three
          months and nine months ended October 1, 2005, respectively.
 
 ***Net
          Revenues***
  Net
          revenue performance is detailed below:
 **For the Three Months Ended**
                    
                    **For the Nine Months Ended**SPECIALTY
                          PHARMACY OPERATIONS
                    
                    **October
                        1,**
                      **2005**
                    
                    ******S****eptember
                        25,**
                      **2004**
                    
                    **October
                        1,**
                      **2005**
                    
                    **September
                        25,**
                      **2004**Net
                        revenues (in millions) (1)
                    
                    $
                    51.1
                    
                    $
                    53.4
                    
                    $
                    161.6
                    
                    $
                    165.5Rx
                        % of store net revenues
                    
                    
                    94.2
                    %
                    
                    94.8
                    %
                    
                    94.1
                    %
                    
                    94.0
                    %Third
                        party % of Rx net revenues
                    
                    
                    93.8
                    %
                    
                    93.7
                    %
                    
                    94.0
                    %
                    
                    93.8
                    %Number
                        of corporate stores
                    
                    
                    77
                    
                    
                    76
                    
                    
                    77
                    
                    
                    76Average
                        same store net revenue per store (in millions)
                    
                    $
                    0.7
                    
                    $
                    0.7
                    
                    $
                    2.1
                    
                    $
                    2.2DIRECT
                        DISTRIBUTION TO PHYSICIANSNet
                        revenues (in millions)
                    
                    $
                    0.6
                    
                    $
                    —
                    
                    $
                    2.1
                    
                    $
                    —
 
 *(1)*
                *Store
                    net revenues are net of contractual allowances.*
 
  **Three Months****Ended**
                      **October
                        1, 2005**
                      **versus**
                      **September
                        25,****2004**
                  
                  **Nine Months Ended**
                      **October
                        1, 2005**
                      **versus**
                      **September
                        25, 2004**Net
                      revenue decreases are as follows (in millions):Specialty
                      Pharmacy Operations:Net
                      effect of store openings/closings(1)
                  
                  $
                  (2.3
                  )
                  $
                  (0.8
                  )Prescription
                      sales(2)
                  
                  
                  —
                  
                  
                  (1.9
                  )Non-Rx
                      sales (3)
                  
                  
                  —
                  
                  
                  (1.2
                  )Net
                      decrease
                  
                  $
                  (2.3
                  )
                  $
                  (3.9
                  )
  19
 *(1)*
                *The
                    net effect of store openings/closings represents the difference
                    in
                    revenues by eliminating stores that were not open during the
                    full periods
                    compared.*
 
 *(2)*
                *Represents
                    the impact of increased lower priced generic prescription product
                    being
                    sold during the periods instead of higher priced brand prescription
                    products partially offset by the effect of price
                    increases.*
 
 *(3)*
                *The
                    nine months ended September 25, 2004 included an additional $1.4
                    million
                    of net revenues from specialty diabetic sales, which contributed
                    to no
                    decrease in Non-Rx sales for the three months ended September
                    25, 2004.
                    These sales were nonrecurring post May 2004.*
 
 ***Gross
          Margin***
  Gross
          margin was $9.9 million or 19.1% for the three months ended October 1,
          2005
          compared to $10.9 million or 20.4% for the three months ended September
          25,
          2004. Gross margin was $32.9 million or 20.1% for the nine months ended
          October
          1, 2005 compared to $34.3 million or 20.7% for the nine months ended September
          25, 2004. The decrease in the gross margin percentage is primarily the
          result of
          higher costs of pharmaceuticals during the three months and nine months
          ended
          October 1, 2005. Information that helps explain our gross margin trend
          is
          detailed below:
 **Three Months****Ended**
                    **October
                      1, 2005**
                    **versus**
                    **September
                      25,****2004**
                  
                  **Nine Months Ended**
                    **October
                      1, 2005**
                    **versus**
                    **September
                      25, 2004**Gross
                      margin decreases are as follows (in millions):Net
                      effect of store openings/closings(1)
                  
                  $
                  (0.5
                  )
                  $
                  (0.1
                  )Prescription
                      gross margin
                  
                  
                  (0.6
                  )
                  
                  (1.1
                  )Non-Rx
                      gross margin
                  
                  
                  —
                  
                  
                  (0.4
                  )Net
                      decrease
                  
                  $
                  (1.1
                  )
                  $
                  (1.6
                  )
 
 *(1)*
                *The
                    net effect of store openings/closings represents the difference
                    in gross
                    margin by eliminating stores that were not open during the full
                    periods
                    compared.*
 
 ***Total
          Operating Expenses***
  Operating
          expenses include selling, general and administrative (“SG&A”) expenses,
          depreciation and amortization expense and the gain (loss) on disposal of
          fixed
          assets and intangible assets. Intangible assets include the amounts allocated
          to
          prescription files for prescriptions acquired in previous purchase business
          combinations. A prescription file refers to the actual prescription maintained
          by a pharmacy for each prescription filled. Each prescription file has
          monetary
          value to a pharmacy because when pharmacies and/or prescription files are
          sold,
          the customers are more likely to leave their accounts with the purchaser
          than to
          transfer their business to a third-party pharmacy,
          as such the prescription base is thought of as a repeatable source of revenue.
          Accordingly, when pharmacies are sold, the number of prescription files
          is taken
          into consideration when determining the purchase price of the pharmacy.
          Intangible assets also include goodwill and authorized distributor licenses
          which were recorded in connection with the Merger. The authorized distributor
          licenses permit us to purchase pharmaceutical products directly from the
          manufacturers. Total operating expenses were $14.1 million or 27.3% of
          net
          revenues for the three months ended October 1, 2005. This compares to $11.7
          million, or 22.0% of net revenues for the three months ended September
          25, 2004.
          Total operating expenses were $44.8 million or 27.4% of net revenues for
          the
          nine months ended October 1, 2005. This compares to $35.6 million, or 21.5%
          of
          net revenues for the nine months ended September 25, 2004. Information
          that
          helps explain our operating expense trend is detailed below:
  20
 **Three Months****Ended**
                    **October
                      1, 2005****versus**
                    **September
                      25,****2004**
                  
                  
                  
                  **Nine Months Ended**
                    **October
                      1, 2005**
                    **versus**
                    **September
                      25, 2004**Operating
                      expenses increases (decreases) are as follows (in
                      millions):Selling,
                      general and administrative expenses
                  
                  $
                  2.2
                  (1)
                  
                  
                  
                  $
                  8.4
                  (2)Gain
                      on disposal of fixed assets and intangible assets (3)
                  
                  
                  0.2
                  
                  
                  
                  
                  
                  1.0Depreciation
                      and amortization
                  
                  
                  —
                  
                  
                  
                  
                  
                  (0.2
                  )Net
                      increase
                  
                  $
                  2.4
                  
                  
                  
                  
                  $
                  9.2
 
 *(1)*
                *The
                    increase is mainly due to corporate support expense of $1.1 million,
                    which
                    include costs associated with compliance in being a publicly
                    traded
                    company and $1.1 million of noncash compensation charges associated
                    with
                    restricted stock and options granted.*
 
 *(2)*
                *The
                    increase is mainly due to corporate support expense of $3.3 million,
                    which
                    include costs associated with being a publicly traded company
                    and $5.1
                    million of noncash compensation charges associated with restricted
                    stock
                    and options granted.*
 
 *(3)*
                *Gain
                    on disposal of fixed assets and intangible assets related to
                    the sale of
                    seven stores during the nine months ended September 25,
                    2004.*
  ***Interest
          Expense, Net***
  Interest
          expense, net was $1.8 million and $1.2 million for the three months ended
          October 1, 2005 and September 25, 2004, respectively. Interest expense,
          net was
          $3.9 million and $2.7 million for the nine months ended October 1, 2005
          and
          September 25, 2004, respectively. The increase in interest expense primarily
          relates to increased borrowings under the senior credit facility and interest
          payments due on the ABDC subordinated notes effective March 21, 2005.
  ***Income
          Taxes***
  No
          income
          tax benefit has been recorded in any period presented due to the uncertainty
          of
          realization of any related deferred tax assets.
 
 ***Loss
          from Continuing Operations***
  We
          incurred a loss from continuing operations of $6.0 million for the three
          months
          ended October 1, 2005 versus $1.8 million for the three months ended September
          25, 2004. We incurred a loss from continuing operations of $15.5 million
          for the
          nine months ended October 1, 2005 versus $3.6 million for the nine months
          ended
          September 25, 2004. Factors impacting these losses are discussed above.
          See Note
          B - Merger, Business, Discontinued Operations and Going Concern.
 
 ***Loss
          from Discontinued Operations***
  We
          incurred a loss from discontinued operations of $8.6 million and $11.2
          million
          for the three months and nine months ended October 1, 2005, respectively.
          We did
          not incur any losses from discontinued operations for the three months
          and nine
          months ended September 25, 2004 as the drug distribution business was acquired
          through the Merger post September 25, 2004.
  **Net
          Loss Available to Common Stockholders Per Share**
  Net
          loss
          available to common stockholders per basic and diluted share for the three
          months ended October 1, 2005 was $0.71 compared to $2.40 for the three
          months
          ended September 25, 2004. Net loss available to common stockholders per
          basic
          and diluted share for the nine months ended October 1, 2005 was $1.44 compared
          $5.77 for the nine months ended September 25, 2004.
 
 Loss
          from
          continuing operations available to common shareholders per basic and diluted
          share for the three months and nine months ended October 1, 2005 was $0.28
          and
          $0.88, respectively, compared to losses from continuing operations available
          to
          common shareholders per basic and diluted share for the three months and
          nine
          months ended September 25, 2004 of $2.40 and $5.77, respectively. The loss
          from
          discontinued operations per basic and diluted share for the three months
          and
          nine months ended October 1, 2005 was $0.43 and $0.56, respectively.
 
 21
 Weighted
          average shares used in the calculation of net loss per share for the 2004
          period
          have been restated to give effect to the Merger of DrugMax and FMG. The
          transaction was accounted for as a reverse merger, with FMG deemed the
          accounting acquirer. Accordingly, for periods prior to the Merger, the
          shares
          outstanding represent the number of shares that former FMG common shareholders
          would have received in the transaction, on an as-if converted basis, had
          the
          Merger consideration not been distributed to the preferred shareholders
          based on
          liquidation value, or approximately 1.3 million shares. For all other periods
          shares outstanding represent actual shares outstanding.
  ***Inflation
          and Seasonality***
  Management
          believes that inflation had no material effect on the operations or our
          financial condition for the three months and nine months ended October
          1, 2005
          and September 25, 2004. Management does not believe that our business is
          materially impacted by seasonality.
  **LIQUIDITY
          AND CAPITAL RESOURCES**
  **New
          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
          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. While the credit facility currently
          does not
          require compliance with financial covenants, the Company has the ability
          to
          reduce this reserve by $3.5 million by agreeing to implement one or more
          financial covenants. Available credit is based on eligible receivables,
          inventory and prescription files, as defined in and determined pursuant
          to the
          agreement, and may be subject to reserves as determined by the lender from
          time
          to time. Interest on the revolving line of credit is calculated at the
          Prime
          index rate plus an applicable Prime margin (as defined in the agreement),
          unless
          the Company or the lender chooses to convert the loan to a LIBOR-based
          loan. In
          each case, interest is adjusted quarterly. The applicable Prime index margin
          as
          of October 31, 2005 was 0.25%. As of October 31, 2005, the interest
          rate, including applicable margin, used to calculate accrued interest was
          7.00%.
          Interest is payable monthly.
 
 The
          New
          Credit Facility includes usual and customary events of default (subject
          to
          applicable grace periods) for facilities of this nature and provides that,
          upon
          the occurrence of an event of default, payment of all amounts payable under
          the
          New Credit Facility may be accelerated and/or the lenders’ commitments may be
          terminated. In addition, upon the occurrence of certain insolvency or bankruptcy
          related events of default, all amounts payable under the New Credit Facility
          shall automatically become immediately due and payable, and the lenders’
          commitments shall automatically terminate.
 
 The
          New
          Credit Facility includes an early termination fee of $650,000 if paid in
          full
          before October 12, 2008. The New Credit Facility is secured by substantially
          all
          assets of the Company. As of October 31, 2005, $24.3 million was outstanding
          on
          the line and $20.1 million was available for additional borrowings, based
          on
          eligible receivables and inventory.
 
 The
          proceeds of the New Credit Facility were used to repay in full the Company’s
          existing line of credit with General Electric Capital Corporation (“GECC”) (the
“Senior Credit Facility”) and is also expected to be used to provide financing
          for working capital, letters of credit, capital expenditures, future
          acquisitions and/or other general corporate purposes.
  **Sale
          of Securities**
 
 On
          September 23, 2005 and September 26, 2005, we entered into securities purchase
          agreements to sell to selling shareholders an aggregate of 44,093,432 shares
          of
          our common stock and warrants to purchase 22,046,715 shares of our common
          stock
          for an aggregate of $51.1 million. The offering was executed in two traunches
          at
          market price as determined by the closing bid price on each day. A purchase
          agreement for the first traunch was executed on September 23, 2005, for
          an
          aggregate of $47.8 million. The unit price of the common stock and corresponding
          warrant was $1.1525. The warrants are exercisable for a period of five
          years
          from the closing date at an exercise price of $1.09 per share. A purchase
          agreement for the second traunch executed on September 26, 2005, for an
          aggregate of $3.3 million. The unit price of the common stock and corresponding
          warrant was $1.2625. The warrants are exercisable for a period of five
          years
          from the closing date at an exercise price of $1.20 per share. The Company
          used
          a Black Scholes pricing model to determine the fair value of each warrant
          which
          was determined to be $0.0625.
 
 22
 The
          proceeds from the sale of our common stock and warrants were used to redeem
          $17.0 million of the Series A convertible redeemable preferred stock, to
          repay
          $20.0 million of our New Credit Facility, and the remainder is expected
          to be
          used for future growth and acquisitions.
 
 **Preferred
          Stock Sale**
 
 On
          December 2, 2004, for an aggregate purchase price of $17 million, we sold
          to
          certain qualified institutional buyers and accredited investors an aggregate
          of
          17,000 shares of Series A convertible redeemable preferred stock in separate
          transactions. In addition, the investors received warrants to purchase
          an
          aggregate of 1,378,374 shares of our common stock. The exercise price of
          each
          warrant is $4.25 per share; the warrants are exercisable into common stock
          and
          expire on the fifth anniversary of the closing. Holders of the Series A
          stock
          were entitled to receive cumulative dividends, before any dividends are
          paid to
          the common stockholders, at the rate per share of 7% per annum until the
          fourth
          anniversary, 9% per annum from the fourth anniversary of the closing until
          the
          fifth anniversary, 11% per annum from the fifth anniversary of the closing
          until
          the sixth anniversary and 14% per annum thereafter. The payment of dividends
          can
          be made by delivery of shares of common stock under certain circumstances.
          Except as provided in the certificate of designation, the shares of Series
          A
          stock did not have any voting rights. The holders of the Series A stock
          may at
          their option, from time to time, convert their shares into shares of common
          stock.
 
 Effective
          April 20, 2005, the Company suspended sales under the previously filed
          registration statement to resell such securities. Under the terms of the
          registration agreement, the investors were entitled to liquidated damages
          until
          such time as the registration statement was declared effective. On July
          7, 2005,
          we amended the certificate of designation to reduce the conversion price
          from
          $3.70 to $2.80. In exchange, investors representing 95% of the preferred
          shareholders agreed to waive liquidated damages under the registration
          rights
          agreement through the date of the amendment and to amend the registration
          rights
          agreement to require the filing of a registration statement covering the
          registrable securities by July 8, 2005 and to require the effectiveness
          of such
          registration statement to be no later than October 1, 2005.
 
 On
          September 26, 2005, the Company entered into agreements with its Series
          A
          Preferred Stock to have their shares of Series A Preferred Stock redeemed
          for
          cash upon the closing of the sale of the common stock and warrants described
          above. Accordingly, in connection with the closing of the private placement,
          on
          October 3, 2005 the Company redeemed the 17,000 shares of Series A Preferred
          Stock outstanding for 100% of the stated value or $17 million. In addition,
          the
          Company issued 488,070 shares of common stock, valued at $844,360, to certain
          of
          the holders of its Series A Preferred Stock in connection with the
          redemption.
 
 In
          connection with the redemption, the exercise price of the 1,378,374 warrants
          previously issued to the purchasers of Series A Preferred Stock was reduced
          to
          $1.09 per share from $2.80 per share.
 
 **Subordinated
          Note and Convertible Debenture**
  On
          March
          22, 2005, we converted $23.0 million in accounts payable owed to
          AmerisourceBergen Drug Corporation (“ABDC”) (after having repaid $6,000,000 on
          March 23, 2005 in connection with the closing of the new vendor supply
          agreement) into (a) a subordinated convertible debenture in the original
          principal amount of $11.5 million (the “Subordinated Convertible Debenture”) and
          (b) a subordinated promissory note in the original principal amount of
          $11.5
          million (the “Subordinated Note”). (See Note H to Condensed Consolidated
          Financial Statements - Debt.)
  The
          Subordinated Convertible Debenture and Subordinated Note are guaranteed
          by
          DrugMax and certain of DrugMax’s subsidiaries, including Valley Drug Company,
          Valley Drug Company South, Familymeds, Inc. and Familymeds Holdings, Inc.
          pursuant to Continuing Guaranty Agreements dated as of March 21, 2005.
          We also
          entered into a subordinated security agreement dated as of March 21, 2005,
          pursuant to which we agreed that upon the occurrence of certain defaults
          and the
          passage of applicable cure periods we shall be deemed at that point to
          have
          granted to ABDC a springing lien upon and a security interest in substantially
          all of our assets to secure the Subordinated Convertible Debenture and
          the
          Subordinated Note. Should this occur, we shall be deemed in default of
          our
          Senior Credit Facility. However, pursuant to a subordination agreement
          dated
          March 21, 2005, ABDC has agreed to subordinate the Subordinated Convertible
          Debenture, the Subordinated Note, the Guarantees and the Security Agreement
          to
          all “Senior Debt.” Senior Debt consists of all senior indebtedness now or
          hereafter owing, including indebtedness under the Senior Credit Facility
          and any
          debt incurred by us to replace or refinance such debt. On October 12, 2005,
          in
          connection with the New Credit Facility, ABDC executed an Assignment and
          Subordination Agreement with Wells Fargo Retail Finance, LLC. (“WFRF”) whereby
          the Subordination Agreement was assigned to WFRF and ABDC acknowledged
          the
          assignment.
 
 23
 Pursuant
          to the Subordinated Note, principal is due and payable in 20 successive
          quarterly installments each in the amount of $0.6 million beginning on
          December
          1, 2005 and continuing until September 1, 2010, on which date all outstanding
          amounts are required to be paid. The Subordinated Note bears interest at
          a
          variable rate equal to the prime rate plus 2.0% per annum. The interest
          rate
          adjusts on each quarterly payment date based upon the prime rate in effect
          on
          each such quarterly payment date; provided that in no event shall the interest
          rate in effect be less than 5.0% per annum or greater than 10% per annum.
          Interest accrued on the unpaid principal balance of the Subordinated Note
          is due
          and payable on each quarterly payment date and interest payments commenced
          on
          June 1, 2005. Interest of $0.3 million and $0.6 million was expensed during
          the
          three and nine months ended October 1, 2005, respectively. As of October
          1, 2005
          the Company received notice from ABDC that a shortfall in the value received
          from the sale of securities received as payment of interest was $267,304.
          This
          amount is considered a “Deemed Payment” under the terms of the Subordinated
          Convertible Debenture. Through December 31, 2005, ABDC may not sell any
          shares
          of the Company’s common stock received that, in the aggregate, exceed 25% of the
          average trading volume of the Company’s common stock for the preceding 10
          trading days.
 
 Pursuant
          to the Subordinated Convertible Debenture, principal is due and payable
          in 19
          successive quarterly installments each in the amount of $0.6 million commencing
          on March 1, 2006 and continuing until August 15, 2010, on which date all
          outstanding amounts are required to be paid. Quarterly principal payments
          are
          payable in cash or in shares of common stock in an amount equal to $0.6
          million
          divided by $3.4416 (the “Issue Price”). The Subordinated Convertible Debenture
          bears interest at a rate which adjust on each quarterly payment date and
          which
          is equal to (a) 10%, if the quarterly interest payment is made in common
          stock
          or (b) the prime rate on the date the quarterly interest payment is due
          plus 1%
          per annum, if the quarterly interest payment is made in cash; provided
          that in
          no event shall the interest rate in effect be less than 5.0% per annum
          or
          greater than 10% per annum. Quarterly interest payments to be paid in common
          stock through February 28, 2006. Commencing March 1, 2006, quarterly interest
          payments may be paid in cash or common stock in an amount equal to the
          interest
          then due and owing divided by the Issue Price, or a combination thereof.
          The
          first interest payment of $0.2 million was made on June 1, 2005 by issuing
          67,757 shares of common stock. The second interest payment of $0.3 million
          was
          made on September 1, 2005 by issuing 83,536 shares of common stock. Interest
          of
          $0.3 million and $0.5 million was expensed during the three months and
          nine
          months ended October 1, 2005, respectively.
 
 If
          common
          stock is used to make principal and interest payments on the Subordinated
          Convertible Debenture, and the proceeds ABDC receives upon any sale of
          our
          common stock (or the proceeds ABDC would have received upon a sale in the
          event
          no shares are sold by ABDC) are less than the principal and interest due,
          we are
          required to pay such difference to ABDC in cash on the date of maturity
          of the
          Subordinated Convertible Debenture. Through December 31, 2005, ABDC may
          not sell
          any shares of the Company’s common stock received that, in the aggregate, exceed
          25% of the average trading volume of our common stock for the preceding
          10
          trading days.
 
 In
          connection with the Subordinated Convertible Debenture, DrugMax entered
          into a
          registration rights agreement dated March 21, 2005 with ABDC pursuant to
          which
          we agreed to file a registration statement with the SEC to register the
          resale
          of all common stock issuable to ABDC in connection with the Subordinated
          Convertible Debenture no later than May 30, 2005. Further on May 26, 2005,
          ABDC
          granted us a 45 day extension to file the registration statement. On July
          7,
          2005, the Company filed a registration statement on Form S-1. The SEC declared
          the Form S-1 effective on August 10, 2005.
  24
  **Operating,
          Investing and Financing Activities**
  Following
          are the components of our operating, investing and financing activities
          for the
          three months and nine months ended October 1, 2005, using the direct cash
          flow
          method (in millions):
  **For the Nine**
                    **Months****Ended****October
                      1, 2005 (1)**
                  
                  
                  **For the Nine**
                    **Months****Ended****September
                      25, 2004**Cash
                      receipts
                  
                  $
                  166.5
                  
                  $
                  165.5Cash
                      paid to suppliers and employees
                  
                  
                  (167.3
                  )
                  
                  (161.1
                  )Interest
                      expense paid
                  
                  
                  (3.3
                  )
                  
                  (2.3
                  )Net
                      cash (used in) provided by operating activities
                  
                  
                  (4.1
                  )
                  
                  2.1Cash
                      paid to acquire property and equipment, net
                  
                  
                  (1.4
                  )
                  
                  (0.1
                  )Proceed
                      from sale of prescription files, net
                  
                  
                  —
                  
                  
                  0.8Net
                      cash (used in) provided by investing activities
                  
                  
                  (1.4
                  )
                  
                  0.7Proceeds
                      (payments) on revolving credit facility, net
                  
                  
                  5.7
                  
                  
                  (3.0
                  )Proceeds
                      from the exercise of stock options
                  
                  
                  0.5
                  
                  
                  —Deferred
                      financing costs
                  
                  
                  (0.4
                  )
                  
                  (0.1
                  )Repayment
                      of promissory notes payable and capital lease obligations,
                      net
                  
                  
                  (1.2
                  )
                  
                  —Net
                      cash provided by (used in) financing activities
                  
                  
                  4.6
                  
                  
                  (3.1
                  )Net
                      decrease in cash and cash equivalents
                  
                  
                  (0.9
                  )
                  
                  (0.3
                  )Cash
                      and cash equivalents, beginning of period
                  
                  
                  2.3
                  
                  
                  1.3Cash
                      and cash equivalents, end of period
                  
                  $
                  1.4
                  
                  $
                  1.0
  *(1)
          Includes activities for both continuing operations and discontinued
          operations.*
 
 **Operating
          Cash Flows**
  Net
          cash
          (used in) provided by operating activities was ($4.1) million and $2.1
          million
          for the nine months ended October 1, 2005 and September 25, 2004, respectively.
          The increase in the use of cash is due principally to increased inventory
          balances and accounts receivables and payments of accounts and accrued
          expenses.
  **Investing
          Cash Flows**
  Net
          cash
          (used in) provided by investing activities was ($1.4) million, and $0.7
          million
          for the nine months ended October 1, 2005 and September 25, 2004, respectively.
          Investing activities during the nine months ended October 1, 2005 included
          capital expenditures of $1.4 million. $0.7 million of cash provided from
          investing activities for the nine months ended September 25, 2004 relates
          primarily to the sale of seven specialty pharmacy locations.
 
 25
 **Financing
          Cash Flows**
  Net
          cash
          provided by (used in) financing activities was $4.6 million and ($3.1)
          million
          for the nine months ended October 1, 2005 and September 25, 2004, respectively.
          The increase in financing activities relates to increased borrowings on
          the
          Company’s Senior Credit Facility during the nine months ended October 1, 2005,
          while we had significantly decreased borrowings under the Senior Credit
          Facility
          for the nine months ended September 25, 2004.
  ***Off-Balance
          Sheet Arrangements***
  We
          do not
          make use of any off-balance sheet arrangements that currently have or that
          we
          expect are reasonably likely to have a material effect on our financial
          condition, results of operations or cash flows. We utilize operating leases
          for
          many of our store locations. We do not use special-purpose entities in
          any of
          our leasing arrangements.
  ***Critical
          Accounting Policies and Estimates***
  Management’s
          Discussion and Analysis of Financial Condition and Results of Operations
          (“MD&A”) contains a discussion of the Company’s consolidated financial
          statements, which have been prepared in accordance with accounting principles
          generally accepted in the United States. The preparation of these financial
          statements requires us to make estimates and assumptions that affect the
          reported amounts of assets and liabilities and the disclosure of contingent
          assets and liabilities at the date of the financial statements and the
          reported
          amounts of revenues and expenses during the reporting periods. On an on-going
          basis, we evaluate estimates and judgments, including the most significant
          judgments and 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 goodwill for impairment, assessing long-lived assets
          for
          impairment, evaluating the adequacy of the allowance for doubtful accounts,
          determining amounts to be realized for vendor rebates, allowances and
          chargebacks and estimating for inventory loss reserves.
  ***New
          Accounting Pronouncements***
  In
          December 2004, the Financial Accounting Standards Board (“FASB”) issued
          Statement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based
          Payment* (SFAS
          123R), which is a revision of Statement of Financial Accounting Standards
          No.
          123, *Accounting
          for Stock-Based Compensation* .
          SFAS
          123R supersedes APB 25, *Accounting
          for Stock Issued to Employees* ,
          and
          amends Statement of Financial Accounting Standards No. 95, *Statement
          of Cash Flows* (“SFAS
          95”). Generally, the approach in SFAS 123R is similar to the approach described
          in SFAS 123. However, SFAS 123R requires all share-based payments to employees,
          including grants of employee stock options, to be recognized in the statement
          of
          operations based on their fair values. Pro forma disclosure is no longer
          an
          alternative. SFAS 123R must be adopted no later than January 1, 2006. Early
          adoption will be permitted in periods in which financial statements have
          not yet
          been issued. The Company expects to adopt SFAS 123R on January 1, 2006.
 
 As
          permitted by SFAS 123, the Company currently accounts for share-based payments
          to employees using Opinion 25’s intrinsic value method and, as such, generally
          recognizes no compensation cost for employee stock options. Accordingly,
          the
          adoption of SFAS 123R’s fair value method may have a significant impact on our
          results of operations, although it will have no impact on our overall financial
          position. Determining the exact impact of adoption of SFAS 123R cannot
          be
          predicted at this time because it will depend on levels of share-based
          payments
          granted in the future and the assumptions for the variables which impact
          the
          computation. However, had the Company adopted SFAS 123R in prior periods,
          the
          impact of that standard would have approximated the impact of SFAS
          123
          as described in the disclosure of pro forma net income and earnings per
          share
          above.
 
 In
          March
          2005, the SEC released Staff Accounting Bulletin (“SAB”) No. 107, *Share-Based
          Payment* (“SAB
          107”) *.* SAB 107
          provides the SEC staff position regarding the application of SFAS No. 123R.
          SAB
          107 contains interpretive guidance related to the interaction between SFAS
          123R
          and certain SEC rules and regulations, as well as provides the Staff’s views
          regarding the valuation of share-based payment arrangements for public
          companies. SAB 107 also highlights the importance of disclosures made related
          to
          the accounting for share-based payment transactions. The Company is currently
          reviewing the effect of SAB 107 on its condensed consolidated financial
          statements as it prepares to adopt SFAS 123R.
 
 26
 
 **Item
          3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**
  As
          of
          October 1, 2005, $38.6 million was outstanding on our revolving credit
          facility.
          Borrowings on the revolving credit facility are at a variable rate of interest.
          Assuming $38.6 million was outstanding on the line for a full year, a 1%
          change
          in interest rates would change our interest expense by $0.4 million per
          annum
          based on the amount outstanding as of October 1, 2005.
  We
          do not
          currently utilize derivative financial instruments to address market risk.
  **Item
          4. CONTROLS AND PROCEDURES.**
  We
          maintain disclosure controls and procedures designed to ensure that information
          required to be disclosed in its Exchange Act reports is recorded, processed,
          summarized and reported within the time periods specified in the SEC’s rules and
          forms, and that such information is accumulated and communicated to the
          Company’s management, including its Chief Executive Officer and its Chief
          Financial Officer/Principal Accounting Officer, as appropriate, to allow
          timely
          decisions regarding required disclosure.
  As
          reported in our annual report on Form 10-K for the year ended January 1,
          2005
          and in our quarterly report on Form 10-Q for the quarter ended July 2,
          2005, we
          disclosed the following material weaknesses with regard to the Company’s drug
          distribution operations: inadequate staffing and supervision leading to
          the
          untimely identification and resolution of certain accounting matters; failure
          to
          perform timely cutoff and reviews; and inadequate preparation and insufficient
          review and analysis of certain financial statement account reconciliations.
  As
          a
          result of those weaknesses identified previously, we have taken specific
          steps
          to improve our disclosure controls and procedures at the drug distribution
          operations including:
  •
                
                In
                    March 2005, we hired a new controller to oversee our drug distribution
                    operations in New Castle, Pennsylvania.
  •
                
                Closing
                    procedures have been strengthened, including the timely preparation
                    and
                    review of account reconciliations and the performance of cutoff
                    tests.
  •
                
                As
                    a result of difficulties encountered during an information system
                    conversion on December 10, 2004 at our drug distribution operations
                    in New
                    Castle, PA, the company engaged an outside consultant with expertise
                    in
                    the newly installed accounting software to assist in the finalization
                    of
                    the conversion process.
  As
          of
          October 1, 2005, we carried out a re-evaluation, under the supervision
          and with
          the participation of our management, including our Chief Executive Officer
          and
          Chief Financial Officer, of the effectiveness of the design and operation
          of our
          disclosure controls and procedures and have determined that other than
          the
          matters discussed above, there were no changes in our internal control
          over
          financial reporting or in other factors that materially affected, or are
          reasonably likely to materially affect, our internal controls over financial
          reporting as of the date of this report.
  27
  **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 Annual Report filed with Form 10-K other than as stated
          below:
  On
          May
          14, 2003, prior to the Merger with FMG, Discount Rx, Inc., a Nevada corporation
          and one of our wholly-owned subsidiaries (“Discount”), acquired substantially
          all of Avery Pharmaceutical, Inc.’s (“Avery”) assets (“Avery Assets”) in
          exchange for assuming certain limited liabilities (the “Assumed Liabilities”) of
          Avery and issuing a promissory note to Mr. Al Sankary (“Sankary”) in the
          original principal amount of $318,000 (the “Sankary Note”). The Sankary Note and
          Avery specifically contemplated that Discount might have to pay certain
          unknown
          liabilities in connection with the acquisition in excess of the amount
          of
          Assumed Liabilities. Accordingly, the Sankary Note and the Avery Assets
          permit
          Discount to “set off” payments due under the Sankary Note against payments made
          in excess of the Assumed Liabilities. Discount believes the Avery obligations
          are well in excess of the Assumed Liabilities. On March 26, 2004, Sankary
          filed
          a lawsuit against Discount, in the 342 nd Judicial
          District Court of Tarrant County, Texas (“Sankary Suit”). The complaint in the
          Sankary Suit alleges that Discount defaulted under the Sankary Note as
          a result
          of Discount’s failure to make payments when due to Sankary. In June 2005, the
          parties settled this matter and the Sankary Suit was dismissed. Under the
          terms
          of the settlement agreement, Discount agreed to pay Sankary $275,000 in
          five (5)
          monthly installments commencing June 6, 2005 and ending October 6, 2005.
          The
          final installment was made on October 6, 2005 as stipulated by the settlement
          agreement.
  On
          February 23, 2005, a former employee of DrugMax, James Hostetler, filed
          suit in
          the United States District Court for the Northern District of Illinois
          Eastern
          Division claiming DrugMax breached a compensation agreement. Specifically,
          Mr.
          Hostetler claims he is owed a commission of an unspecified amount as a
          result of
          the sale of securities consummated on December 2, 2004. For an aggregate
          purchase price of $17 million, we sold to certain qualified institutional
          buyers
          and accredited investors an aggregate of 17,000 shares of our Series A
          convertible redeemable preferred stock. We have filed our response and
          intend to
          defend ourselves vigorously. Management does not believe Mr. Hostetler
          is
          entitled to any such commissions as he played no role in the sale of these
          securities. As a result of the early stage of this proceeding, we cannot
          currently estimate its outcome and have made no provision in the accompanying
          condensed consolidated financial statements for the resolution of the matter.
  On
          June
          8, 2005, a complaint to recover preferential payments previously paid to
          Valley
          Drug Company South was filed against Valley Drug Company South by Safescript
          Pharmacies, Inc. et al in the United States Bankruptcy Court for the Eastern
          District of Texas, Tyler Division. The complaint seeks judgment against
          Valley
          Drug Company South in the amount of approximately $870,000. On October
          24, 2005,
          the plaintiff filed a motion requesting the court to dismiss this matter.
          We
          expect the court to file its order of dismissal in due course.
  From
          time
          to time, we may become involved in additional litigation arising in the
          ordinary
          course of our business. In the opinion of management, after consultation
          with
          counsel, the disposition of these matters arising in the normal course
          of
          business is not likely to have a material adverse effect, individually
          or in the
          aggregate, on our financial position or results of operations.
  **Item
          2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**
  None.
  **Item
          3. DEFAULT UPON SENIOR SECURITIES.**
  On
          December 9, 2004, the Company entered into the Second Amended and Restated
          Credit Agreement (the “Senior Credit Facility”) with General Electric Capital
          Corporation (“GECC”). The Senior Credit Facility required monthly compliance
          with certain restrictive covenants including, but not limited to, minimum
          EBITDA, maximum capital expenditures, maximum fixed charge coverage ratio,
          minimum net worth, minimum inventory turnover, maximum trade receivable
          days
          sales outstanding, maximum accounts payable days outstanding and maximum
          ratio
          of non-pharmaceutical inventory to total inventory. The Company violated
          certain
          of these covenants as of January 1, 2005 and each subsequent month thereafter
          through October 1, 2005, including the EBITDA and net worth financial covenants,
          and other covenants, and as of such dates was in default on this obligation.
 
 On
          October 12, 2005, the Company entered into a Loan and Security Agreement
          (See Note C to the Condensed Consolidated Financial Statements -Subsequent
          Events) with Wells Fargo Retail Finance, LLC (“WFRF”), pursuant to which WFRF
          provided the Company with a senior secured revolving credit facility consisting
          of up to $65 million (the “New Credit Facility”). Accordingly, on
          October 12, 2005, the Company terminated its $65 million Amended
          and
          Restated Credit Agreement with GECC and in connection therewith repaid
          all
          outstanding amounts under the old credit facility to GECC along with a
          termination fee of $500,000.
 
 28
 **Item
          4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**
  None.
  **Item
          5. OTHER INFORMATION.**
  None.
  **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.
  
 29
 
 **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.
  **DrugMax,
                    Inc.**Date:
                    November 15, 2005
                
                By:
                
                */s/
                    Edgardo A. Mercadante*Edgardo
                    A. MercadanteChief
                    Executive Officer, President and Co-Chairman of the
                    BoardDate:
                    November 15, 2005
                
                By:
                
                */s/
                    James E. Searson*James
                    E. SearsonSenior
                    Vice President, Chief Financial Officer andPrincipal
                    Accounting Officer
  
 30