**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-Q**





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




FOR
      THE
      QUARTERLY PERIOD ENDED MARCH
      31,
      2007




OR





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




FOR
      THE
      TRANSITION PERIOD FROM _______________ TO
      _______________




**Commission
      File Number 1-15445**





**FAMILYMEDS
      GROUP, INC.**


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







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




**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.    Yes x No o




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




Large
      accelerated filer o   Accelerated
      filer o Non-accelerated
      filer  x




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




As
      of May
      15, 2007 there were 6,959,017 shares of common stock, par value $0.001 per
      share, outstanding.









**FAMILYMEDS
      GROUP, INC. AND SUBSIDIARIES**


**FORM
      10-Q**


**FOR
      THE THREE MONTHS ENDED MARCH 31, 2007**


**TABLE
      OF CONTENTS**




**Page No.****PART
                I -****FINANCIAL
                INFORMATION**Item
                1. Condensed Consolidated Financial Statements of Familymeds Group,
                Inc.
                and Subsidiaries
            
            1Condensed
                Consolidated Balance Sheets as of March 31, 2007 and December
                30, 2006 (unaudited)
            
            1Condensed
                Consolidated Statements of Operations for three months ended March
                31,
                2007 and April 1, 2006 (unaudited)
            
            2Condensed
                Consolidated Statements of Cash Flows three months ended March 31,
                2007
                and April 1, 2006 (unaudited)
            
            3Notes
                to Condensed Consolidated Financial Statements (unaudited)
            
            4Item
                2. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations
            
            14Item
                3. Quantitative and Qualitative Disclosures About Market Risk
            
            30Item
                4. Controls and Procedures
            
            30**PART
                II -****OTHER
                INFORMATION**Item
                1. Legal Proceedings
            
            31Item
                1A. Risk Factors
            
            31Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            
            31Item
                3. Default upon Senior Securities
            
            31Item
                4. Submission of Matters to a Vote of Security Holders
            
            31Item
                5. Other Information
            
            32Item
                6. Exhibits
            
            32**SIGNATURES**
            
            33




i




**PART
      I - FINANCIAL INFORMATION**




**Item
      1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**FAMILYMEDS
                  GROUP, INC. AND SUBSIDIARIES****CONDENSED
                    CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2007 AND DECEMBER
                    30, 2006****(in
                  thousands, except share data)****(unaudited)****March
                  31, 2007**
              
              **December
                  30, 2006****ASSETS**CURRENT
                  ASSETS:Cash
                  and cash equivalents
              
              $
              854
              
              $
              845Trade
                  receivables, net of allowance for doubtful accounts of
                  approximately$4,006
                  and $3,720 in 2007 and 2006, respectively
              
              
              13,504
              
              
              16,038Inventories
              
              
              18,419
              
              
              22,417Prepaid
                  expenses and other current assets
              
              
              1,499
              
              
              1,553Total
                  current assets
              
              
              34,276
              
              
              40,853PROPERTY
                  AND EQUIPMENT—Net of accumulated depreciation and
                  amortizationof
                  approximately $14,328 and $14,502 in 2007 and 2006,
                  respectively
              
              
              5,732
              
              
              6,269INTANGIBLE
                  ASSETS—Net of accumulated amortization ofapproximately
                  $18,910 and $20,657 in 2007 and 2006, respectively
              
              
              1,118
              
              
              1,289OTHER
                  NONCURRENT ASSETS
              
              
              750
              
              
              750TOTAL
                  ASSETS
              
              $
              41,876
              
              $
              49,161**LIABILITIES
                  AND STOCKHOLDERS’ DEFICIT**CURRENT
                  LIABILITIES:Notes
                  payable, net of discount of $2,122 and $2,247 in 2007 and
                  2006
              
              $
              6,879
              
              $
              6,753Promissory
                  notes payable
              
              
              76
              
              
              76Revolving
                  credit facility
              
              
              33,360
              
              
              37,467Accounts
                  payable
              
              
              12,911
              
              
              14,843Accrued
                  expenses
              
              
              3,502
              
              
              4,269Other
                  current liabilities
              
              
              55
              
              
              59Total
                  current liabilities
              
              
              56,783
              
              
              63,467COMMITMENTS
                  AND CONTINGENCIESSTOCKHOLDERS’
                  DEFICIT:Series
                  A convertible preferred stock, $1,000 par value, 500,000 authorized
                  and
                  none outstanding
              
              
              -
              
              
              -Common
                  stock, $.001 par value, 200,000,000 shares authorized; 6,962,821
                  shares
                  issued and outstanding for 2007 and 2006, respectively.
              
              
              67
              
              
              67Additional
                  paid in capital
              
              
              230,996
              
              
              230,949Accumulated
                  deficit
              
              
              (245,970
              )
              
              (245,322
              )Total
                  stockholders’ deficit
              
              
              (14,907
              )
              
              (14,306
              )TOTAL
                  LIABILITIES AND STOCKHOLDERS' DEFICIT
              
              $
              41,876
              
              $
              49,161


See
        notes
        to condensed consolidated financial statements.


1


**FAMILYMEDS
                GROUP, INC. AND SUBSIDIARIES****CONDENSED
                CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED
                MARCH 31,
                2007 AND APRIL 1, 2006 (Going Concern Basis)****(in
                thousands, except per share data)****(Unaudited)****Three
                Months Ended****March
                31, 2007**
            
            **April
                1, 2006**NET
                REVENUES
            
            $
            52,396
            
            $
            56,040COST
                OF SALES
            
            
            42,626
            
            
            45,125Gross
                margin
            
            
            9,770
            
            
            10,915SELLING,
                GENERAL AND ADMINISTRATIVE EXPENSES
            
            
            11,963
            
            
            12,987GAIN
                ON SALE OF PHARMACY ASSETS
            
            
            (3,100
            )
            
            -DEPRECIATION
                AND AMORTIZATION EXPENSE
            
            
            524
            
            
            838OPERATING
                INCOME (LOSS)
            
            
            383
            
            
            (2,910
            )OTHER
                INCOME (EXPENSE):Interest
                expense
            
            
            (1,031
            )
            
            (1,396
            )Interest
                income
            
            
            -
            
            
            10Other
                income
            
            
            -
            
            
            59Total
                other expense, net
            
            
            (1,031
            )
            
            (1,327
            )Loss
                from continuing operations
            
            
            (648
            )
            
            (4,237
            )Income
                from discontinued operations
            
            
            -
            
            
            181NET
                LOSS
            
            $
            (648
            )
            $
            (4,056
            )BASIC
                AND DILUTED INCOME (LOSS) PER COMMON SHARE:Loss
                from continuing operations
            
            
            (0.09
            )
            
            (0.64
            )Income
                from discontinued operations
            
            
            -
            
            
            0.03Net
                loss
            
            $
            (0.09
            )
            $
            (0.61
            )WEIGHTED
                AVERAGE SHARES OUTSTANDING:Basic
                and Diluted Shares
            
            
            6,963
            
            
            6,587




See
        notes
        to condensed consolidated financial statements.


2




**FAMILYMEDS
                  GROUP, INC. AND SUBSIDIARIES****CONDENSED
                  CONSOLIDATED STATEMENTS OF CASH FLOWS****FOR
                  THE THREE MONTHS ENDED MARCH 31, 2007 AND APRIL 1, 2006 (Going
                  Concern
                  Basis)****(in
                  thousands)****(Unaudited)****Three
                  Months Ended****March
                  31, 2007**
              
              **April
                  1, 2006**CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  loss
              
              $
              (648
              )
              $
              (4,056
              )Adjustments
                  to reconcile net loss to net cash provided by (used in) operating
                  activities:Depreciation
                  and amortization
              
              
              524
              
              
              838Stock
                  compensation expense
              
              
              47
              
              
              125Noncash
                  interest expense
              
              
              126
              
              
              314Amortization
                  of deferred financing fees
              
              
              76
              
              
              75Provision
                  for doubtful accounts
              
              
              286
              
              
              27Gain
                  on sale of pharmacy assets
              
              
              (3,100
              )
              
              -Effect
                  of changes in operating assets and liabilities:Trade
                  receivables
              
              
              2,248
              
              
              1,541Inventories
              
              
              2,223
              
              
              1,069Prepaid
                  expenses and other current assets
              
              
              54
              
              
              306Accounts
                  payable
              
              
              (1,932
              )
              
              716Accrued
                  expenses
              
              
              (767
              )
              
              229Other
              
              
              (4
              )
              
              (156
              )Net
                  cash provided by (used in) operating activities
              
              
              (867
              )
              
              1,028CASH
                  FLOWS FROM INVESTING ACTIVITIES:Purchases
                  of property and equipment
              
              
              (147
              )
              
              (845
              )Purchases
                  of pharmacy assets
              
              
              -
              
              
              (244
              )Proceeds
                  from sale of pharmacy assets
              
              
              5,130
              
              
              -Net
                  cash provided by (used in) investing activities
              
              
              4,983
              
              
              (1,089
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:(Repayment
                  of) proceeds from revolving credit facility, net
              
              
              (4,107
              )
              
              192Repayment
                  of promissory notes payable
              
              
              -
              
              
              (358
              )Proceeds
                  from exercise of stock options
              
              
              -
              
              
              3Net
                  cash used in financing activities
              
              
              (4,107
              )
              
              (163
              )NET
                  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
              
              
              9
              
              
              (224
              )CASH
                  AND CASH EQUIVALENTS—Beginning of period
              
              
              845
              
              
              6,681CASH
                  AND CASH EQUIVALENTS—End of period
              
              $
              854
              
              $
              6,457SUPPLEMENTAL
                  DISCLOSURES OF CASH FLOW INFORMATION:Cash
                  paid for interest
              
              $
              797
              
              $
              1,008Noncash
                  transactions—Subordinated
                  Convertible Debenture interest payments made in common
                  stock
              
              $
              -
              
              $
              900




See
        notes
        to condensed consolidated financial statements.




3




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


**Notes
      to Condensed Consolidated Financial Statements**


**(Unaudited)**




**NOTE
      1 - BUSINESS**




***Asset
        Sale, Plan Of Complete Liquidation And Dissolution, Business, Discontinued
        Operations And Going Concern***




Familymeds
      Group, Inc. (“Familymeds,” the “Company,” or “we” and other similar pronouns) is
      a pharmacy and drug distribution provider formed by the merger on November
      12,
      2004 of DrugMax, Inc. and Familymeds Group, Inc.  Familymeds Group, Inc.
      was formerly known as DrugMax, Inc. and on July 10, 2006, the Company amended
      its Articles of Incorporation to change its name from DrugMax, Inc. to
      Familymeds Group, Inc. As of March 31, 2007, we operated 67 Company-owned
      locations including 64 pharmacies, one health and beauty location, one
      non-pharmacy mail order center, and a drug distribution business primarily
      focused on the direct distribution of specialty pharmaceuticals to physicians,
      medical clinics and other health care providers known as Familymeds Medical
      Supply.  The Company also franchises 7 pharmacies.   The
      Company’s pharmacies are located in 12 states and operate under the Familymeds
      Pharmacy, Arrow Pharmacy & Nutrition Center, and Worksite Pharmacy SM brand
      names. The Company reports on a 52-53 week fiscal year.





As
      of
      March 31, 2007 and December 30, 2006, the Company had a net shareholders’
deficit of $14.9 million and $14.3 million and had incurred net losses of $0.6
      million, $7.2 million, $54.9 million and $39.8 million for the three months
      ended March 31, 2007 and for the years ended December 30, 2006, December 31,
      2005, and January 1, 2005, respectively.





During
      the past two years, the Company has taken significant steps to improve its
      operating results, reduce costs and improve its financial performance. These
      include the sale of common stock for net proceeds of $47.4 million, the
      redemption of all of its outstanding Series A Preferred Stock, the refinancing
      of the senior credit facility with a new $65.0 million facility, which allowed
      for additional borrowing availability, and the sale and discontinuation of
      a
      majority of the Company’s full-line wholesale drug distribution operations,
      which had incurred significant losses.




Further,
      during the second quarter of 2006, the Company entered into a Note and Warrant
      Purchase Agreement and certain other agreements described below, each effective
      as of June 23, 2006, with Deerfield Special Situations Fund, L.P. and Deerfield
      Special Situations Fund International, Limited (collectively, “Deerfield”),
      pursuant to which Deerfield purchased two secured promissory notes in the
      aggregate principal amount of $10.0 million (one note in the principal amount
      of
      $3.3 million and the second note in the amount of $6.7 million, collectively
      the
“Notes”) and eight warrants to purchase an aggregate of 1.65 million shares of
      Company common stock (the “Warrants”), for an aggregate purchase price of $10.0
      million.  The $10.0 million purchase price for the Notes and Warrants was
      used entirely for an early repayment, settlement and termination of
      approximately $23.0 million in outstanding subordinated debt and accrued unpaid
      interest with the Company’s former supplier AmerisourceBergen Drug
      Corporation.




Also
      during the third and fourth quarters of 2006, the Company closed or sold
      underperforming stores and continued to evaluate its ongoing operations to
      improve results.  During the 2nd half of 2006, the Company implemented
      selling and general administrative expense reduction measures, including a
      workforce reduction of 33 employees at the Company headquarters in Farmington,
      Connecticut in July 2006, directed at reducing costs and improving overall
      liquidity.  Despite
      these efforts, the Company continued to experience a reduction in gross margins
      due to the increased number of participants enrolled in Medicare Part D plans
      and the increased pressure by other third parties to reduce prescription
      reimbursement rates.




4




These
      negative pressures on gross margin coupled with the increasing demand for
      pharmacists, rising salary requirements, increasing health care costs and
      professional liability insurance costs, will continue to negatively impact
      the
      Company’s ability to become profitable.





The
      continued gross margin pressure on prescription drug sales, among other factors,
      has created a more urgent need for a larger scaled enterprise for its clinic
      and
      Worksite Pharmacy business model. To this end, the Company exhaustively sought
      new capital; however, such financing opportunities were highly
      dilutive.




As
      a
      result, and, in light of the factors noted above, the current competitive
      environment and the Company’s highly leveraged capital structure, the Board of
      Directors concluded that the Company lacked the capital resources necessary
      in
      the long-term to compete effectively in its industry and in an effort to
      maximize the value of the shareholders’ investment in the Company, the Board of
      Directors decided to examine certain financial and strategic alternatives to
      the
      Company remaining independent.




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




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




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





***Asset
      Sale***





On
      February 14, 2007, Familymeds Group, Inc. together with its wholly owned
      subsidiaries Familymeds, Inc. and Arrow Prescription Corp., entered into an
      Asset Purchase Agreement with Walgreen Co., an Illinois corporation, Walgreen
      Eastern Co., Inc., a New York corporation (together with Walgreen Co.,
“Walgreens”), pursuant to which the Company will, subject to certain terms and
      conditions, sell up to 53 of our locations and related assets to Walgreens
      (the
“Asset Sale”). Of the 53 locations, 33 of the clinic and Worksite locations will
      remain open and continue to operate in place. As consideration for this sale,
      Walgreens will assume only certain of our liabilities, including certain
      automobile and certain real estate leases, and will pay us approximately $43.0
      million in addition to amounts to be paid for customer accounts receivable
      and
      inventories related to those locations. $3.0 million of the purchase price
      shall
      be placed into escrow until the earlier of one year from the closing date or
      the
      final distribution of assets to the Company’s shareholders or dissolution of
      Familymeds.





The
      Company intends to sell its remaining assets to several other national and
      regional pharmacy operators for cash and assumption of certain real estate
      leases, subject to closing physical inventory counts.





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




5


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





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





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




·
            dissolve
                Familymeds;




·
            liquidate
                the Company’s assets;




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




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





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




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




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





There
      were no net revenues related to the discontinued operations for the three months
      ended March 31, 2007 and April 1, 2006, respectively.  The income from
      discontinued operations was $0.0 million and $0.2 million for the three months
      ended March 31, 2007 and April 1, 2006, respectively.





**NOTE
      2 - BASIS OF PRESENTATION**





***Basis
      of Presentation (Liquidation and Going Concern Basis of
      Accounting)***




The
        Company’s shareholders approved the Plan of Complete Liquidation and Dissolution
        on March 30, 2007, the last business day of the fiscal quarter ended March
        31,
        2007. Accordingly, effective April 1, 2007, the Company adopted the liquidation
        basis of accounting. The accompanying condensed consolidated financial
        statements have been prepared on the going concern basis of
        accountin g.




6




As
      of
      March 31, 2007 and December 30, 2006, the Company had a net shareholders’
deficit of $14.9 million and $14.3 million and had incurred net losses of $0.6
      million, $7.2 million, $54.9 million and $39.8 million for the three months
      ended March 31, 2007 and for the years ended December 30, 2006, December 31,
      2005, and January 1, 2005, respectively.  In addition to the Plan of
      Complete Liquidation and Dissolution, these matters raise substantial doubt
      about the Company's ability to continue as a going concern.





**NOTE
      3 - PER SHARE INFORMATION**





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





**NOTE
      4 - STOCK BASED COMPENSATION**




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





*Share
      Based Compensation Plans*




As
      of
      March 31, 2007, we have two share-based compensation plans, which are described
      below.




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




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




7




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





Upon
      election to the Board of Directors, each outside Director, receives an award
      of
      restricted stock in the amount of $50,000. Such shares vest 1/3 upon the date
      of
      grant and 1/3 on the first and second anniversary thereafter. Further, on each
      year following his or her election to the Board, each outside Director receives
      an award of restricted stock in the amount of $25,000. The foregoing shares
      are
      granted under the Company’s 2003 Restricted Stock Plan.




There
      were no option grants during the three months ended March 31, 2007. The Company
      uses the Black-Scholes option-pricing model to calculate the fair value of
      options. The key assumptions for this valuation method include the expected
      term
      of the option, stock price, volatility, risk-free interest rate, dividend yield
      and exercise price. Many of these assumptions are judgmental and highly
      sensitive in the determination of compensation expense. Under the assumptions
      indicated below, the weighted-average fair value for each option granted during
      the three months ended April 1, 2006 was $8.38. The table below indicates the
      key assumptions used in the option valuation calculations for options granted
      in
      the three months ended March 31, 2007 and April 1, 2006 and a discussion of
      our
      methodology for developing each of the assumptions used in the valuation
      model:





**Three Months**
              **Ended**
              **April
                1,**
              **2006**Risk-free
                interest rate
            
            
            4.62
            %Expected
                life
            
            
            3
                yearsVolatility
            
            
            77
            %Dividend
                yield
            
            
            -
            %




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




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




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




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




8


The
      following table summarizes information about our stock option plan for the
      three
      months ended March 31, 2007.




**Number
                of**
              **Options**
            
            **Weighted**
              **Average**
              **Exercise
                Price**
            
            **Weighted**
              **Average**
              **Remaining**
              **Contractual
                life**
            
            **Weighted**
              **Average**
              **Fair
                Value**Balance,
                December 30, 2006
            
            
            390,907
            
            $
            11.61
            
            
            8.1
                years
            
            $
            18.24Granted
            
            
            -
            
            
            -
            
            
            -
            
            
            -Exercised
            
            
            -
            
            
            -
            
            
            -
            
            
            -Forfeited
            
            
            425
            
            
            14.82
            
            
            
            
            
            6.72Options
                outstanding, March 31, 2007
            
            
            390,482
            
            $
            11.61
            
            
            7.8
                years
            
            $
            18.26Options
                exercisable, March 31, 2007
            
            
            287,463
            
            $
            12.14
            
            
            7.6
                years
            
            $
            23.07




As
      of
      March 31, 2007, there was $0.2 million of total unrecognized compensation cost
      related to stock options. These costs are expected to be recognized over a
      weighted average period of 1.0 year. There was no cash received from stock
      option exercises for the three months ended March 31, 2007. There were no income
      tax benefits from share based arrangements.




Share
      based compensation expense was $0.05 million and $0.1 million for the three
      months ended March 31, 2007 and April 1, 2006, respectively.





The
      following table summarizes information about restricted stock awards issued
      under the 2003 Restricted Stock Plan for the three months ended March 31,
      2007:




**Shares**
              
              **Weighted**
                **Average**
                **Grant-Date**
                **Fair
                  Value**Non
                  Vested Balance at December 30, 2006
              
              
              42,825
              
              $
              10.46Granted
              
              
              -
              
              
              -Vested
              
              
              -
              
              
              -Non
                  Vested Balance at March 31, 2007
              
              
              42,825
              
              $
              10.46




As
      of
      March 31, 2007, there was $0.4 million of total unrecognized compensation costs
      related to restricted stock awards. These costs are expected to be recognized
      over a weighted average period of 1.0 year. At March 31, 2007, an aggregate
      of
      375,437 shares of common stock remained available for future grants under our
      stock plans, which cover restricted stock awards and stock options. We issue
      shares to satisfy stock option exercises and restricted stock awards.




9


**NOTE
      5 - INTANGIBLE ASSETS**




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




**March
                31,**
              **2007**
            
            **December
                30,**
              **2006****Gross**
              **Carrying**
              **Amount**
            
            **Accumulated**
              **Amortization**
            
            **Gross**
              **Carrying**
              **Amount**
            
            **Accumulated**
              **Amortization**Intangible
                assets
            
            $
            20,028
            
            $
            (18,910
            )
            $
            21,946
            
            $
            (20,657
            )




The
      remaining weighted average amortization period for intangible assets is
      approximately 1 year assuming the Company completes its Plan of Liquidation
      and
      Dissolution. Amortization expense related to intangible assets was approximately
      $0.2 million and $0.5 million for the three months ended March 31, 2007 and
      April 1, 2006, respectively. These intangible assets are expected to be fully
      amortized during fiscal 2007.




**NOTE
      6 —DEBT**




Debt
      consists of the following (amounts in thousands):




**March
                  31,**
                **2007**
              
              **December
                  30,**
                **2006**Revolving
                  credit facility (1)
              
              $
              33,360
              
              $
              37,467Promissory
                  notes payable
              
              
              76
              
              
              76Subordinated
                  notes payable, net of discount of $2,122 and $2,247,
                  respectively
              
              
              6,879
              
              
              6,753Total
              
              $
              40,315
              
              $
              44,296




*(1)*
                *On
                    May 11, 2007, the Company terminated its $65 million**revolving
                    credit facility**and
                    in connection therewith repaid all outstanding amounts under
                    the revolving
                    credit facility along with a termination fee of $0.7 million.*





***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 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
      due under the credit facility to GECC along with a $0.5 million termination
      fee.
      The $65.0 million of maximum availability under the New Credit Facility is
      reduced by a $7.0 million reserve. Available credit is based on eligible
      receivables, inventory and prescription files, as defined in and determined
      pursuant to the agreement, and may be subject to reserves as determined by
      the
      lender from time to time. Interest on the revolving line of credit is calculated
      at the prime index rate plus an applicable prime margin (as defined in the
      agreement), unless the Company or the lender chooses to convert the loan to
      a
      LIBOR-based loan. In each case, interest is adjusted quarterly. The applicable
      prime index margin as of March 31, 2007 and December 30, 2006 was 8.25% and
      8.25%, respectively. As of March 31, 2007 and December 30, 2006,
      the interest rate, including applicable margin, used to calculate accrued
      interest was 8.5% and 8.5%, respectively. Interest is payable monthly.





The
      New
      Credit Facility included an early termination fee of $0.7 million if paid in
      full before October 12, 2008. The New Credit Facility was secured by
      substantially all assets of the Company. As of March 31, 2007, $33.4 million
      was
      outstanding on the revolving line of credit and $1.8 million was estimated
      as
      available for additional borrowings, based on eligible receivables, inventory
      and prescription files.




10





In
      connection with the Walgreens’ Asset Sale, Wells Fargo Retail Finance, LLC, as
      agent for the revolving credit lenders consented to the Asset Sale and the
      consummation of the sale, subject to various terms and conditions. Among those
      conditions, we agreed that all proceeds received by us from the sale shall
      be
      paid to Wells Fargo for application to the credit facility until all amounts
      due
      under the facility are paid in full and the Loan Agreement is terminated.
      Accordingly, on May 11, 2007, the Company terminated its $65 million Loan
      Agreement and
      in
      connection therewith repaid all outstanding amounts under the Loan Agreement
      along with a termination fee of $0.7 million.





***Note
      and Warrant Purchase Agreement***





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





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





Principal
      on each of the Notes is due and payable in successive quarterly installments
      each in the amount of $0.17 million and $0.33 million, respectively, beginning
      on September 1, 2006 and on each December 1, March 1, June 1 and September
      1
      thereafter and continuing until June 23, 2011, on which date all outstanding
      principal and accrued and unpaid interest is due. The Company intends to payoff
      these notes prior to the end of the second quarter of 2007 and therefore did
      not
      make the March 1, 2007 and does not intend to make the June 1, 2007 principal
      payments. Deerfield has accepted this arrangement. The Notes bear interest
      at a
      rate equal to 2.5% for the first year, 5.0% for the second year, 10.0% for
      the
      third year, 15.0% for the fourth year and 17.5% for the fifth year. The Notes
      may be prepaid by the Company at anytime without penalty. Interest expense
      has
      been estimated over the five year period to be approximately $1.8
      million (excludes the effect of amortization of the debt discount of $2.5
      million discussed below) and due to the increasing interest rate on this
      debt, the Company records the average quarterly interest expense and record
      a
      corresponding asset or liability for the difference not currently payable each
      quarter. As of March 31, 2007, the Company has classified this liability as
      current as it expects to retire this obligation within 12 months of the balance
      sheet date.




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





11




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





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




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





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





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




**NOTE
      7 - INCOME TAXES**




The
      Company incurred a net loss for the three months ended March 31, 2007 and April
      1, 2006. No income tax expense had been recorded during these periods due to
      the
      significant net operating losses available to the Company to offset such net
      income. The Company has established a valuation allowance on all of its deferred
      tax assets due to the uncertainty of their realization.




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




12


**NOTE
      8- CONTINGENCIES**




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





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




As
      of
      March 31, 2007 and December 30, 2006, the Company has not recorded any
      liabilities related to the Guarantee. However, should the Company be required
      to
      perform under the terms of the Guarantee, the Company would be required to
      pay
      all amounts owed under the PIDA Note, which as of March 31, 2007 was
      approximately $0.8 million. The Company believes it will not be required to
      perform under the terms of the Guarantee. Further any requirement to perform
      under the Guarantee would be mitigated by the indemnification by Becan and
      its
      principals. Additionally, management believes, the fair value of the
      Pennsylvania facility that could be realized upon the sale of the
      facility exceeds the amounts outstanding on the PIDA Note and the other
      loans related to the premises.





**NOTE
      9- SUBSEQUENT EVENTS**





On
      May
      11, 2007, the Company terminated its $65 million New
      Credit Facility and
      in
      connection therewith repaid all outstanding amounts under the credit facility
      along with a termination fee of $0.7 million.





On
      April
      4, 2007, the Company received a portion of the purchase price and began the
      process of selling its pharmacy assets to Walgreens. The closing of the sale
      of
      all of the assets to Walgreens is expected to be completed by the end the second
      quarter of 2007. Through May 11, 2007, Walgreens has paid approximately $43.4
      million in cash proceeds of which $3.0 million will be kept in escrow to satisfy
      our post-closing indemnification obligations, if any.





13




On
      April
      2, 2007, Rakesh K. Sharma resigned as a director to the Company.




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




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





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





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





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


14




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




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




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




·
            expected
                cash to be received from the asset sales, including but not limited
                to,
                inventories, accounts receivable, fixed assets, prescription files
                and
                other assets, and cash to be disbursed to settle our obligations
                and
                liabilities, both known and
                unknown;




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




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




·
            possible
                or assumed future results of operations;
                and




·
            future
                revenue and earnings.




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




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




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




·
            the
                uncertainty of general business and economic
                conditions;




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




·
            the
                loss of key personnel including
                pharmacists;




15




·
            the
                impact of competition, both expected and
                unexpected;




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




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




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





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





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





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




·
            dissolve
                the Company;




·
            liquidate
                our assets;




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




·
            distribute
                any remaining assets to our
                shareholders.




Since
      the
      approval of the Plan of Complete Liquidation and Dissolution by our shareholders
      on March 30, 2007, we have begun implementing the plan by attempting to sell
      our
      assets and satisfy our obligations. Among other things, on April 4, 2007, we
      began to the process of closing the Asset Sale to Walgreens. The Asset Sale
      to
      Walgreens will be completed on a staggered basis. The closing of the sale of
      all
      of the assets to Walgreens is expected to be completed by the end the second
      quarter of 2007. Through May 11, 2007, Walgreens has paid approximately $43.4
      million in cash proceeds of which $3.0 million will be kept in escrow to satisfy
      our post-closing indemnification obligations, if any.





Pursuant
      to our Asset Purchase Agreement with Walgreens, dated February 14, 2007, we
      will, subject to certain terms and conditions, sell up to 53 of our locations
      and related assets to Walgreens. Of the 53 locations, 33 of the clinic and
      Worksite locations will remain open and continue to operate in place. As
      consideration for this sale, Walgreens will assume only certain of our
      liabilities, including certain automobile and real estate leases, and will
      pay
      us approximately $43.0 million for pharmacy assets, in addition to amounts
      for
      customer accounts receivable and inventories related to those locations, subject
      to certain adjustments.





In
      connection with the Asset Sale, Wells Fargo Retail Finance, LLC, as agent for
      the revolving credit lenders pursuant to the Loan and Security Agreement dated
      as of October 12, 2005 (as amended, modified, supplemented or restated and
      in
      effect from time to time, the “Loan Agreement”) among (i) Familymeds Group, Inc.
      (f/k/a Drugmax, Inc.), as Lead Borrower, (ii) the other Borrowers party thereto
      from time to time, (iii) the Revolving Credit Lenders party thereto from time
      to
      time, (iv) and Wells Fargo, has consented to the Asset Sale and the consummation
      of the sale, subject to various terms and conditions. Among those conditions,
      we
      agreed that all proceeds received by us from the sale shall be paid to Wells
      Fargo for application to the credit facility until all amounts due under the
      facility are paid in full and the Loan Agreement is terminated. Accordingly,
      on
      May 11, 2007, the Company terminated its $65 million Loan
      Agreement and
      in
      connection therewith repaid all outstanding amounts under the Loan Agreement
      along with a termination fee of $0.7 million.





16





We
      intend
      to sell our remaining assets to several other national and regional pharmacy
      operators. We also have begun this process. During the first quarter of 2007,
      we
      sold 10 pharmacy locations and we expect to sell 60 additional locations to
      Walgreens and others by the end of the second quarter of 2007.





The
      Company previously reported it had executed asset purchase agreements and
      letters of intent for the sale of the majority of its assets. To date, the
      Company has sold and closed pharmacies together with related pharmacy assets
      to
      multiple buyers, including Walgreens. One non-Walgreens original potential
      purchaser of pharmacy assets who had previously executed a letter of intent
      has
      decided not to pursue the transaction. As a result, the Company has continued
      to
      market those assets to other potential buyers and has subsequently signed a
      new
      letter of intent for a portion of those assets. However, the new potential
      purchaser has proposed a transaction which would exclude certain assets and
      changes the valuation on the assets included.





The
      Company will continue to market all remaining assets and continue to seek better
      valuations, however potential valuation differences may result in a reduced
      overall recovery estimated to be $2.0-$5.0 million less than originally
      estimated.




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





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





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




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





17




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





***General
      Description of the Business***





Familymeds
      Group, Inc. (“Familymeds,” the “Company,” or “we” and other similar pronouns) is
      a pharmacy and drug distribution provider formed by the merger on November
      12,
      2004 of DrugMax, Inc. and Familymeds Group, Inc.  Familymeds Group, Inc.
      was formerly known as DrugMax, Inc. and on July 10, 2006, the Company amended
      its Articles of Incorporation to change its name from DrugMax, Inc. to
      Familymeds Group, Inc. We are incorporated in the state of Nevada and our
      corporate offices are located at 312 Farmington Avenue, Farmington, CT 06032,
      telephone (860) 676-1222. As of March 31, 2007, we operated 67 Company-owned
      locations including 64 pharmacies, one health and beauty location, one
      non-pharmacy mail order center, and a drug distribution business primarily
      focused on the direct distribution of specialty pharmaceuticals to physicians,
      medical clinics and other health care providers known as Familymeds Medical
      Supply.  The Company also franchises 7 pharmacies.  During the first
      quarter of 2007, we have sold 10 pharmacy locations and we expect to sell 60
      additional locations by the end of the second quarter of 2007 pursuant to signed
      asset purchase agreements  Our pharmacies are located in 12 states and
      operate under the Familymeds Pharmacy, Arrow Pharmacy & Nutrition Center,
      and Worksite Pharmacy SM brand
      names.




As
      of
      March 31, 2007 and December 30, 2006, the Company had a net shareholders’
deficit of $14.9 million and $14.3 million and had incurred net losses of $0.6
      million, $7.2 million, $54.9 million and $39.8 million for the three months
      ended March 31, 2007 and for the years ended December 30, 2006, December 31,
      2005, and January 1, 2005, respectively.




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




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




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





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





As
      of
      March 31, 2007, we operated 67 Company owned locations including 64 pharmacies,
      one home health center, one health and beauty location and one non-pharmacy
      mail
      order center, in 12 states under the Familymeds Pharmacy, Arrow Pharmacy &
Nutrition Center, and Worksite Pharmacy SM brand
      names. We have pharmacies which are located at the point of care between
      physicians and patients, oftentimes inside medical office buildings or on a
      medical campus. The balance of our locations are usually nearby medical
      facilities though more retail accessible.




18




We
      operate our pharmacies under the trade names Familymeds Pharmacy (“Familymeds”),
      Arrow Pharmacy and Nutrition Centers (“Arrow”) and Worksite Pharmacy SM .
      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.





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





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





We
      operate 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 .
      Currently, we have a Worksite Pharmacy SM in
      the
      employee center of the Mohegan Sun Casino in Connecticut and Scotts Company
      LLC
      headquarters in Marysville, Ohio. Combined, these employers have more than
      14,000 employees and dependents as potential patients.




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





***Medical
      Supply***





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




19




Revenues
      from this operation for the three months ended March 31, 2007 and April 1,
      2006
      were $1.0 million and $0.9 million, respectively. The Company expects revenues
      from this operation to decline as we have announced our Plan of Complete
      Liquidation and Dissolution.




***Patient
      Compliance***





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





***Medicare
      Part D***





As
      of
      January 1, 2006, Medicare beneficiaries had the opportunity to receive
      subsidized prescription drug coverage through the Medicare Part D program.
      The
      new drug benefit is delivered by competing plans, and our pharmacies have
      contracted with each of the major providers to ensure our customers can continue
      purchasing their prescriptions from our pharmacies. While the new Medicare
      drug
      benefit is entirely voluntary, we believe a significant portion of the Medicare
      population will enjoy this new benefit. During the three months ended March
      31,
      2007 and April 1, 2006, net revenues from Medicare Part D prescriptions
      represented 20.8% and 14.0% of total prescription sales, respectively. The
      gross
      margin from this business is less than what the traditional prescription drug
      plans provide and the accounts receivable days outstanding is more than what
      the
      traditional prescription drug plans.




***Supply
      Chain Management***





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





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





***Discontinued
      Operations***





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





20





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




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




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




During
      the three months ended March 31, 2007, there were no activities relating to
      our
      discontinued operations. This compares with no net revenues related to the
      discontinued operations and income from discontinued operations of $0.2 million
      for the three months ended April 1, 2006.





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


The
        Company’s shareholders approved the Plan of Complete Liquidation and Dissolution
        on March 30, 2007, the last business day of the fiscal quarter ended March
        31,
        2007. Accordingly, effective April 1, 2007, the Company adopted the liquidation
        basis of accounting. The condensed consolidated balance sheets as of March
        31,
        2007 and December 30, 2006 and the condensed consolidated statements of
        operations and cash flows for the three months ended March 31, 2007 and April
        1,
        2006  have been prepared on the going concern basis of
        accounting.


We
      refer
      to prescription products as Rx products and to the remaining products, such
      as
      over-the-counter medications, home medical equipment and home health appliances,
      as non-Rx products. While non-Rx reflects a smaller percentage of our overall
      revenues, the gross margin for non-Rx products is higher. The Rx portion of
      the
      pharmacy business is dependent upon a number of third party payors that pay
      a
      portion or all of the Rx cost on behalf of the customers, “Third Party
      Customers.” Prescriptions generated by Third Party Customers represented
      approximately 96% and 93%, respectively of Rx revenues for the three months
      ended March 31, 2007 and April 1, 2006, respectively.





21




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




***Net
      Revenues***




Net
      revenue performance is detailed below:




**Three
                  months Ended**
                **March
                  31, 2007**
              
              **Three
                  months Ended**
                **April
                  1, 2006**Net
                  Rx and non-Rx revenues (in millions) (1)
              
              $
              51.4
              
              $
              55.1Familymeds
                  Medical Supply
              
              
              1.0
              
              
              0.9Total
                  net revenues (in millions)
              
              $
              52.4
              
              $
              56.0Rx
                  % of location net revenues
              
              
              93.3
              %
              
              94.4
              %Third
                  party % of Rx net revenues
              
              
              96.4
              %
              
              93.0
              %Number
                  of Company locations
              
              
              64
              
              
              78Average
                  location net revenue per location (in millions)
              
              $
              0.8
              
              $
              0.7




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




**Three Months**
                **Ended****March
                  31,**
                **2007****versus**
                **April
                  1, 2006**Net
                    revenues increases (decreases) are as follows (in
                    millions):Net
                  effect of location openings/closings (1)
              
              $
              (4.6
              )Rx
                  revenues (2)
              
              
              0.7Non-Rx
                  revenues
              
              
              0.2Familymeds
                  Medical Supply (3)
              
              
              0.1Net
                  decrease
              
              $
              (3.6
              )




*(1)*
              
              **The
                  net effect of location openings/closing represents the revenues
                  of
                  locations that were not open during the full periods
                  compared.**




*(2)*
                
                *Represents
                    the net impact of price increases for brand name prescription
                    products
                    offset by an increase in the number of prescriptions filled for
                    lower
                    priced generic prescription
                    products.*




*(3)*
                *Represents
                    Familymeds Medical Supply revenues related to direct distribution
                    to
                    physicians, medical clinics and other health care providers.
                    In October
                    2006, this operation was moved to Farmington, Connecticut and
                    is now doing
                    business as Familymeds Medical
                    Supply.*




22


***Gross
      Margin***




Gross
      margin was $9.8 million or 18.6% for the three months ended March 31, 2007
      in
      gross margin percentage. This compares to $10.9 million or 19.5% for the three
      months ended April 1, 2006. The decrease in gross margin percentage reflects
      the
      adverse effect of the efforts of managed care organizations, pharmacy benefit
      managers and other third party payors to reduce their prescription costs, as
      well as the impact of Medicare Part D. In recent years, our industry has
      undergone significant changes driven by various efforts to reduce costs. As
      employers and managed care organizations continue to focus on the costs of
      branded and specialty pharmaceuticals, we expect there will continue to be
      negative pressure on gross margins. The Company, like several others in the
      pharmacy industry, continues to experience a significant negative impact on
      gross margins due to the increasing number of prescriptions filled under
      Medicare Part D.





Information
      that helps explain our gross margin trend is detailed below:





**Three
                  months**
                **Ended****March
                  31,**
                **2007****Versus**
                **April
                  1, 2006**Gross
                  margin increases (decreases) are as follows (in millions):Net
                  effect of location openings/closings
              
              $
              (0.9
              )Rx
                  gross margin
              
              
              (1.2
              )Non-Rx
                  gross margin
              
              
              0.5Familymeds
                  Medical Supply
              
              
              0.5Net
                  decrease
              
              $
              (1.1
              )





23


***Operating
      Expenses and Income***




Operating
      expenses include selling, general and administrative (“SG&A”) expenses,
      depreciation and amortization expense and gains on the sales of pharmacy assets.
      Net operating expenses were $9.4 million or 17.9% of net revenues for the three
      months ended March 31, 2007. This compared to $13.8 million or 24.7% of net
      revenues for the three months ended April 1, 2006.





Information
      that helps explain our operating expense trend is detailed
      below:




**Three
                  months**
                **Ended****March
                  31,**
                **2007****versus**
                **April
                  1, 2006**Changes
                  in net operating expenses are as follows (in millions):Selling,
                  general and administrative expenses (1)
              
              $
              (1.0
              )Gain
                  on sale of pharmacy assets (2)
              
              
              (3.1
              )Depreciation
                  and amortization (3)
              
              
              (0.3
              )Net
                  decrease
              
              $
              (4.4
              )




*(1)*
            *The
                decrease in selling, general and administrative expenses is mainly
                due to
                decreases in payroll and benefits of $0.3 million, recruiting $0.2
                million, stock option expense of $0.1 million, professional services
                of
                $0.1 million, delivery in the drug distribution business of $0.2
                million.*





*(2)*
            *The
                gain on sale of pharmacy assets relates to the completion of sales
                of
                certain stores related to our Plan of Complete Liquidation and Dissolution
                of the Company and represents the excess of the proceeds of the sale
                of 10
                pharmacy locations over the net book value of the assets
                sold.*




*(3)*
            *Depreciation
                and amortization expense was approximately $0.5 million and $0.8
                million
                for the three months ended March 31, 2007 and April 1, 2006,
                respectively.*




***Interest
      Expense***




Interest
      expense was $1.0 million for the three months ended March 31, 2007 versus $1.4
      million for the three months ended April 1, 2006. The decrease was due to a
      lower outstanding debt balances.





***Income
      Taxes***




No
      income
      taxes have been recorded in any period presented due to the uncertainty of
      realization of any related deferred tax assets.




***Net
      Loss***




Net
      loss
      for the three months ended March 31, 2007 was $0.6 million versus a net loss
      of
      $4.1 million for the three months ended April 1, 2006.  Factors impacting
      these results are discussed above.




24


***Inflation
      and Seasonality***




Management
      believes that inflation had no material effect on the operations or our
      financial condition for the three months ended March 31, 2007 and April 1,
      2006.
      Historically, our third quarter business has been affected by seasonality and
      has been lower than our other three fiscal quarters’ business due to the effect
      of reduced patient visits and doctor referrals during typical summer vacation
      months.





**LIQUIDITY
      AND CAPITAL RESOURCES**




We
      have
      financed our operations and have met our capital requirements primarily through
      private issuances of equity securities, convertible notes, bank borrowings,
      trade creditors and cash generated from operations.  Our principal sources
      of liquidity as of March 31, 2007, consisted of cash and cash equivalents of
      approximately $0.8 million along with approximately $1.8 million in estimated
      availability under our $65.0 million revolving credit facility.





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




If
      the
      Company does not complete the Asset Sale, then it will be required to raise
      additional financing to continue funding its operations. If our capital
      resources are insufficient to satisfy our liquidity requirements, we may seek
      to
      sell additional equity securities or debt securities or obtain other debt
      financing. The sale of additional equity securities or convertible debt
      securities would result in additional dilution to our shareholders. Additional
      debt would result in increased expenses and could result in covenants that
      would
      restrict our operations. We have explored obtaining additional financing and
      there is no assurance that financing will be available in amounts or on terms
      acceptable to us, if at all.





In
      the
      absence of such financing, the Company may not able to service its debts and
      may
      be required to continue to scale back or terminate operations and/or seek
      protection under applicable United States bankruptcy laws.




**Credit
      Facility**





On
      October 12, 2005, the Company entered into a Loan and Security Agreement with
      Wells Fargo Retail Finance, LLC (“WFRF”), pursuant to which WFRF will provide
      the Company with a senior secured revolving credit facility up to $65.0 million
      (the “New Credit Facility”). On that same date the Company terminated its $65.0
      million Amended and Restated Credit Agreement with General Electric Capital
      Corporation (“GECC”) and in connection therewith repaid all outstanding amounts
      due under the credit facility to GECC along with a $0.5 million termination
      fee.
      The $65.0 million of maximum availability under the New Credit Facility is
      reduced by a $7.0 million reserve. Available credit is based on eligible
      receivables, inventory and prescription files, as defined in and determined
      pursuant to the agreement, and may be subject to reserves as determined by
      the
      lender from time to time. Interest on the revolving line of credit is calculated
      at the prime index rate plus an applicable prime margin (as defined in the
      agreement), unless the Company or the lender chooses to convert the loan to
      a
      LIBOR-based loan. In each case, interest is adjusted quarterly. The applicable
      prime index margin as of March 31, 2007 and December 30, 2006 was 8.25% and
      8.25%, respectively. As of March 31, 2007 and December 30, 2006,
      the interest rate, including applicable margin, used to calculate accrued
      interest was 8.5% and 8.5%, respectively. Interest is payable monthly.





The
      New
      Credit Facility included an early termination fee of $0.7 million if paid in
      full before October 12, 2008. The New Credit Facility is secured by
      substantially all assets of the Company. As of March 31, 2007, $33.4 million
      was
      outstanding on the revolving line of credit and $1.8 million was estimated
      to be
      available for additional borrowings, based on eligible receivables, inventory
      and prescription files.





25




In
      connection with the Asset Sale, Wells Fargo Retail Finance, LLC, as agent for
      the revolving credit lenders consented to the Asset Sale and the consummation
      of
      the sale, subject to various terms and conditions. Among those conditions,
      we
      agreed that all proceeds received by us from the sale shall be paid to Wells
      Fargo for application to the credit facility until all amounts due under the
      facility are paid in full and the New Credit Facility is terminated.
      Accordingly, on May 11, 2007, the Company terminated its $65 million credit
      facility and
      in
      connection therewith repaid all outstanding amounts under the New Credit
      Facility along with a termination fee of $0.7 million.




**Note
      and Warrant Purchase Agreement**





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





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




Principal
      on each of the Notes is due and payable in successive quarterly installments
      each in the amount of $0.2 million and $0.3 million, respectively, beginning
      on
      September 1, 2006 and on each December 1, March 1, June 1 and September 1
      thereafter and continuing until June 23, 2011, on which date all outstanding
      principal and accrued and unpaid interest is due. The Company intends to payoff
      these notes prior to the end of the second quarter of 2007 and therefore did
      not
      make the March 1, 2007 and does not intend to make the June 1, 2007 principal
      payments.  Deerfield has accepted this arrangement. The Notes bear interest
      at a rate equal to 2.5% for the first year, 5.0% for the second year, 10.0%
      for
      the third year, 15.0% for the fourth year and 17.5% for the fifth year. The
      Notes may be prepaid by the Company at anytime without penalty. Interest expense
      has been estimated over the five year period to be approximately $1.8
      million (excludes the effect of amortization of the debt discount of $2.5
      million discussed below) and due to the increasing interest rate on this
      debt, the Company records the average quarterly interest expense and records
      a
      corresponding asset or liability for the difference not currently payable each
      quarter. As of March 31, 2007, the Company has classified this liability as
      current as it expects to retire this obligation within 12 months of the balance
      sheet date.





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





26




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





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




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





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





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





**Operating,
      Investing and Financing Activities**




***Cash
      Inflows and Outflows***




During
      the three months ended March 31, 2007, the net increase in cash and cash
      equivalents remained unchanged for December 30, 2006 compared to a net decrease
      of $0.2 million during the three months ended April 1, 2006. As reported on
      our
      condensed consolidated statements of cash flows, our change in cash and cash
      equivalents during the three months ended March 31, 2007 and April 1, 2006
      is
      summarized as follows:




**Three
                  months ended****Dollars
                  in thousands**
              
              **March
                  31,**
                **2007**
              
              **April
                  1,**
                **2006**Net
                  cash (used in) provided by operating activities
              
              $
              (867
              )
              $
              1,028Net
                  cash provided by (used in) investing activities
              
              
              4,983
              
              
              (1,089
              )Net
                  cash used in financing activities
              
              
              (4,107
              )
              
              (163
              )Change
                  in cash and cash equivalents
              
              $
              9
              
              $
              (224
              )




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




*Operating
      Activities:* During
      the three months ended March 31, 2007, we used $0.9 million in cash and cash
      equivalents in operating activities as compared with $1.0 million provided
      by
      during the same prior year period. For the three months ended March 31, 2007,
      this was comprised primarily of net loss of $0.6 million and a decrease in
      working capital of $1.8 million and is partially offset by non-cash charges
      totaling $2.1 million. For the three months ended April 1, 2006, the use of
      cash
      consisted primarily of a net loss of $4.1 million offset by a decrease in
      working capital of $3.7 million and is offset by non-cash items of $1.4 million.
      Components of our significant non-cash adjustments for the three months ended
      March 31, 2007 and April 1, 2006 are as follows:




**Non-cash
                  Adjustments**
              
              **Three
                  months ended**
                **March
                  31,**
                **2007**
                **(amounts in**
                **thousands)**
              
              **Three
                  months ended**
                **April
                  1,**
                **2006**
                **(amounts in**
                **thousands)**
              
              **Explanation
                  of Non-cash Activity**Depreciation
                  and amortization
              
              $
              524
              
              $
              838
              
              
              Consists
                  of depreciation of property and equipment as well as amortization
                  of
                  intangibles.Non
                  cash interest expense
              
              
              126
              
              
              314
              
              
              Interest
                  expense related to the Deerfield notes paid in common stock and
                  ABDC
                  principal payment shortfalls paid in common stock.Gain
                  on sale of pharmacy assets
              
              
              (3,100
              )
              
              -
              
              
              Gain
                  on the sale of pharmacy assets.Other
                  non-cash items, net
              
              
              409
              
              
              227
              
              
              Other
                  non-cash items include amortization of deferred financing fees,
                  adjustments to our allowance for doubtful accounts and non-cash
                  stock-based compensation.Total
                  non-cash adjustments to net income
              
              $
              (2,041
              )
              $
              1,379




*Investing
      Activities:* Cash
      provided by investing activities was $3.2 million for the three months ended
      March 31, 2007, as compared with $1.1 million used in investing activities
      in
      the three months ended April 1, 2006. Specific investing activity during the
      three months ended March 31, 2007 and April 1, 2006 was as follows:





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





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




27




*Financing
      Activities:* Net
      cash
      used in financing activities was $4.1 million during the three months ended
      March 31, 2007, as compared with $0.2 million used in the three months ended
      April 1, 2006. Specific financing activity during the three months ended March
      31, 2007 and April 1, 2006 was as follows:


·
            During
                the three months ended March 31, 2007, we repaid $4.1 million of
                our
                revolving credit facility. This compares to $0.2 million in net proceeds
                in the same period of 2006.·
            During
                the three months ended March 31, 2007, we did not make any scheduled
                debt
                repayments under our outstanding subordinated notes. This compares
                to $0.4
                million for scheduled debt repayments in the same period of
                2006.




·
            During
                the first three months of 2007, we also did not receive any proceeds
                from
                the issuance of common stock under our employee stock plans. This
                compares
                to $0.003 million for proceeds related to employee stock option exercises
                in the same period of 2006.




***Off-Balance
      Sheet Arrangements***





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





***Critical
      Accounting Policies and Estimates***




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




28


**Goodwill
      and Identifiable Intangible Assets**




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





**Impairment
      of Other Long-lived Assets**





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





Our
      impairment loss calculations contain uncertainty since we must use judgment
      to
      estimate future revenues, profitability and cash flows. When preparing these
      estimates, we consider historical results and current operating trends and
      our
      consolidated revenues, profitability and cash flow results and forecasts. These
      estimates can be affected by a number of factors including, but not limited
      to,
      general economic conditions, the cost of real estate, the continued efforts
      of
      third party customers to reduce their prescription drug costs, regulatory
      changes the continued efforts of competitors to gain market share and consumer
      spending patterns. If these projections change in the future, we may be required
      to write-down our long-lived assets. Long-lived assets evaluated for impairment
      include property and equipment as well as intangible assets, which as of March
      31, 2007 were approximately $5.7 million and $1.1 million, respectively and
      at
      December 30, 2006 were approximately $6.3 million and $1.3 million,
      respectively.




**Trade
      Receivables**





At
      March
      31, 2007 and December 30, 2006, trade receivables reflected approximately $17.5
      million and $19.7 million, respectively, of amounts due from various insurance
      companies, governmental agencies and individual customers. Of these amounts,
      there was approximately $4.0 million and $3.7 million reserved as of March
      31,
      2007 and December 30, 2006, respectively, for a balance of net trade receivables
      of $13.5 million and $16.0 million, respectively. We use historical experience,
      market trends and other analytical data to estimate our allowance for doubtful
      accounts. Based upon these factors, the reserve at March 31, 2007 is considered
      adequate. Although we believe that the reserve estimate is reasonable, actual
      results could differ from our estimate, and such differences could be material.
      If the estimate is too low, we may incur higher bad debt expenses in the future
      resulting in lower net income or higher net losses. If the estimate is too
      high,
      we may experience lower bad debt expense in the future resulting in higher
      net
      income or lower net losses.





29




**Inventories**





Inventories
      consist of pharmaceuticals and other retail merchandise owned by us. Inventories
      are stated at the lower of cost (first-in, first-out method for pharmaceutical
      inventory and retail method for retail merchandise inventory) or market.
      Physical inventory counts are taken on a regular basis in each location to
      ensure that the amounts reflected in the unaudited condensed consolidated
      financial statements are properly stated. We use historical data to estimate
      our
      inventory loss reserves and we have not made any material changes in the
      accounting methodology used to establish our inventory loss reserves during
      the
      past three years. If the estimate of inventory losses is too low we may incur
      higher cost of sales in the future resulting in lower net income or higher
      net
      losses. If the estimate of inventory losses incurred is too high, we may
      experience lower cost of sales in the future resulting in higher net income
      or
      lower net losses. Inventories as of March 31, 2007 and December 30, 2006 were
      approximately $22.2 million and $25.0 million, respectively, net of
      approximately $3.8 million and $2.6 million of inventory loss reserves,
      respectively.





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




As
      of
      March 31, 2007, $33.4 million and $9.0 million were outstanding on our revolving
      credit facility and Deerfield Notes, respectively. These borrowings are at
      a
      variable rate of interest. Assuming total debt of $42.4 million was outstanding
      for a full year, a 1% change in interest rates would change our interest expense
      by $0.4 million annually.





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





**Item
      4. CONTROLS AND PROCEDURES.**





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




**Conclusion
      Regarding the Effectiveness of Disclosure Controls and
      Procedures.** We
      carried out an evaluation, under the supervision and with the participation
      of
      our Chief Executive Officer and Chief Financial Officer, of the effectiveness
      of
      the design and operation of our disclosure controls and procedures as of the
      end
      of the period covered by this report pursuant to Exchange Act Rule 13a-15.
      Our
      disclosure controls and procedures include, without limitation, controls and
      procedures designed to ensure that information required to be disclosed by
      us in
      reports that we file or submit pursuant to the Securities Exchange Act of 1934,
      as amended, are accumulated and communicated to our management, including our
      Chief Executive Officer and Chief Financial Officer, as appropriate to allow
      timely decisions regarding required disclosure.  Based on this evaluation,
      our Chief Executive Officer and Chief Financial Officer concluded that our
      disclosure controls and procedures were effective as of the end of the period
      covered by this report.  In designing and evaluating the disclosure
      controls and procedures, management recognized that any controls and procedures,
      no matter how well designed and operated, can provide only reasonable assurance
      of achieving the desired control objectives, and in reaching a reasonable level
      of assurance, management necessarily was required to apply its judgment in
      evaluating the cost-benefit relationship of possible controls and procedures.





30




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





**PART
      II - OTHER INFORMATION**




**Item
      1. LEGAL PROCEEDINGS.**




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





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 statements.





**Item
      1A. RISK FACTORS.**





There
      have been no material changes to the Risk Factors described in the Company’s
      fiscal 2006 Form 10-K, as amended.




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





None.





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




None.




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




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




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




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




There
      were no broker non-votes for this item.




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




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




31




There
      were no broker non-votes for this item.




**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.




32


**SIGNATURES**




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




**Familymeds
                Group, Inc.**Date:
                May 21, 2007
            By:
            */s/
                Edgardo A. Mercadante*Edgardo
              A. Mercadante
              President,
                Chief Executive Officer and Chairman of the Board
              (Principal
                Executive Officer)


Date: May
                21, 2007
            By:
            */s/
                James A. Bologa*James
                A. Bologa
              Senior
                Vice President, Chief Financial Officer and Treasurer
              (Principal
                Financial and Accounting Officer)




33