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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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



For the fiscal year ended March 31, 2003



OR



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



Commission File No. 1-15445



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DRUGMAX, INC.,

formerly known as DrugMax.com, Inc.

(Exact name of registrant as specified in its charter)



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



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



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



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



Common stock, Par value $.001 per share

(Title of Class)



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



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



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



The aggregate market value of the Common Stock, $.001 par value, held by non-affiliates of the Registrant based upon the last price at which the common
stock was sold as of the last business day of the Registrants most recently completed second fiscal quarter, September 30, 2002, as reported on the NASDAQ Stock Market was approximately $4,833,000. Shares of Common Stock held by each officer
and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for
other purposes.



The number of shares outstanding of common
stock as of July 9, 2003, was 7,178,976.



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DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Registrants definitive Proxy Statement to be used in connection with the Registrants 2003 Annual Meeting of
Stockholders, which will be filed on or before July 29, 2003, are incorporated by reference in Part III, Items 10-13 of this Form 10-K. Except with respect to information specifically incorporated by reference in this Form 10-K, the Proxy Statement
is not deemed to be filed as a part hereof.



CAUTIONARY
STATEMENTS



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



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



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TABLE OF CONTENTS



|ITEM |  |                                                                                       |  | PAGE
|---- |  | ------------------------------------------------------------------------------------- |  | ----
|     |  | PART I                                                                                |  |     
|     |  |                                                                                      
|1.   |  | Business                                                                              |  | 4   
|2.   |  | Properties                                                                            |  | 14  
|3.   |  | Legal Proceedings                                                                     |  | 14  
|4.   |  | Submission of Matters to a Vote of Security Holders                                   |  | 15  
|     |  |                                                                                      
|     |  | PART II                                                                               |  |     
|     |  |                                                                                      
|5.   |  | Market for Registrants Common Equity and Related Stockholder Matters                 |  | 15  
|6.   |  | Selected Financial Data                                                               |  | 16  
|7.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 17  
|7A.  |  | Quantitative and Qualitative Disclosures About Market Risks                           |  | 25  
|8.   |  | Financial Statements and Supplementary Data                                           |  | 25  
|9.   |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 53  
|     |  |                                                                                      
|     |  | PART III                                                                              |  |     
|     |  |                                                                                      
|10.  |  | Directors and Executive Officers of the Registrant                                    |  | 53  
|11.  |  | Executive Compensation                                                                |  | 53  
|12.  |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 53  
|13.  |  | Certain Relationships and Related Transactions                                        |  | 54  
|14.  |  | Controls and Procedures                                                               |  | 54  
|     |  |                                                                                      
|     |  | PART IV                                                                               |  |     
|     |  |                                                                                      
|15.  |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 54  
|     |  |                                                                                      
|     |  | Signatures                                                                            |  | 59  



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PART I



|Item 1. |  | BUSINESS.
|------- |  | ---------



General



DrugMax, Inc. (Nasdaq: DMAX)
is a full-line, wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care aids, nutritional supplements and other related products. The Company is headquartered in Clearwater, Florida and maintains distribution
centers in Pennsylvania, Ohio, and Louisiana. The Company distributes its products primarily to independent pharmacies in the continental United States, and secondarily to small and medium-sized pharmacy chains, alternative care facilities and other
wholesalers. The Company maintains an inventory in excess of 20,000 stock keeping units from leading manufacturers and holds licenses to ship to all 50 states and Puerto Rico.



History



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



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



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



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



In March 2000, the Company
diversified its operations by acquiring all of the issued and outstanding shares of common stock of Desktop Corporation, a Texas corporation located in Dallas, Texas. In addition, in May 2000, the Company formed Desktop Media Group, Inc.
(Desktop Media) a Florida corporation, to develop web based and Internet software for the Company. On September 15, 2000, Desktop Corporation and Desktop Media executed Articles of Merger whereby Desktop Corporation was merged into
Desktop Media, with Desktop Media Group, Inc. (Desktop) being the surviving entity. Desktop, in addition to being a designer and developer of customized Internet solutions, owned, at the time of acquisition, 50% of the outstanding shares
of common stock of VetMall, LLC (later converted to a newly formed Florida corporation VetMall, Inc.) (VetMall), with the remaining shares being owned by W.A. Butler & Company (Butler), one of the nations largest
veterinary products distributors. Concurrent with the acquisition of Desktop, the Company acquired an additional 20% interest in VetMall from Butler. In April 2003, Butler and the Company executed an agreement (the April 2003 Agreement)
whereby Butler transferred its remaining 30% ownership in VetMall to the Company; accordingly, the Company now owns 100% of VetMall stock. Neither VetMall nor Desktop currently have any operations, and management anticipates the dissolution of these
entities.



On April 19, 2000, the Company acquired Valley Drug Company
(Valley), a full-line, primary wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care products and general merchandise. This acquisition helped the



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Company expand its customer base, product line and market share, and provided the Company with the additional ability to serve its customers as a primary,
full-line wholesale distributor, and offer them the convenience of one-stop shopping. Valley has been in operation since 1950, and its offices are located in Youngstown, Ohio. See Acquisitions.



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



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



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



Pursuant to the Avery Agreement, the
Company acquired accounts receivable, inventory, equipment, furniture, the trade name and a patent pending for the process of the manufacture of vials for the respiratory therapy industry, which preliminarily totals $1,062,518. The liabilities
assumed, which were comprised principally of trade payables, upon preliminary investigation, amounted to $912,518, and capital injected of $60,000. In addition, the Company executed a promissory note to the predecessor companys 50%
shareholder, as additional consideration. The $318,000 note includes a right of set off for accounts payable in excess of an agreed upon amount assumed at closing. The original note may not be reduced below $90,000 after set off, which management
believes will be the adjusted note amount. Terms of the note provide for principal payments due monthly beginning July 5, 2003 through the due date of January 5, 2006. Interest on the note is due quarterly beginning September 5, 2003 at the rate of
6% per annum. Also, the Company executed a Consulting and Non-Competition Agreement (Consulting Agreement) with John VerVynck (VerVynck) an officer and shareholder of Avery and Infinity. The Consulting Agreement provides for
the payment to VerVynck of $39,360, payable bi-monthly, over the six-month term of the Consulting Agreement. The Consulting Agreement prohibits VerVynck from competing for one year following his termination and the six-month term of the consulting
agreement.



Industry Overview



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



Wholesale distributors are
critical links in the pharmaceutical supply chain, helping fuel the majority of the $192.2 billion in total prescription drug sales to retailers and institutions in 2001. The Unites States prescription drug sales increased 11.9% from $172
billion in 2001 to $192.2 billion in 2002. Prescription drug sales are expected to grow at an annual compound rate of 10% to 11% through 2003 according to IMS Health. The principal factors contributing to this historical and expected growth are the
following:



| |  |  | Aging of Population. The number of individuals over age 50 in the United States is projected to grow from 28% of the population presently to 40% of the population in 2005.
The aging populations therapy needs will be in predictable categories that require continued treatment for diabetes, high cholesterol, heart disease and other health problems. This demographic group represents the largest percentage of new
prescriptions filled and obtains more prescriptions per capita annually than any other age group.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Importance of the Wholesale Distribution Channel. Over the past decade, as the cost and complexity of maintaining inventories and arranging for delivery of pharmaceutical
products has risen, manufacturers of pharmaceuticals have significantly increased the distribution of their products through wholesalers. Drug wholesalers are generally able to offer their customers more efficient distribution and inventory
management than pharmaceutical manufacturers. According to
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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the Healthcare Distribution Management Association (HDMA), this channel saves healthcare systems over $186 billion each year by maximizing
economies of scale, creating efficiencies, lowering expenses, and simplifying distribution.



| |  |  | Rising Pharmaceutical Costs. From 1990 to 2000, the average retail price of a prescription increased from $22.06 to $45.79. The Company believes that price increases for
branded pharmaceutical products by manufacturers will continue to equal or exceed the overall increases in the Consumer Price Index (CPI). In 2000, actual pharmaceutical prices increased 3.9%, in line with the CPI increase of 3.4%.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Increased Drug Utilization. In recent years, a number of factors have contributed to the increased utilization of drug-based therapies to prevent and to treat disease.
Manufacturers spent over $2.6 billion in direct-to-consumer advertising and $16 billion to reach physicians in 2001. In 2000, pharmaceutical manufacturers spent approximately $22.5 billion in research and development, up from approximately $1.6
billion in 1980. New drug offerings continue to grow, with 8,191 products in 2000 compared to 5,492 in 1995.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company believes that its size, operating structure, strategy and high level of customer service allow it to benefit from the trends impacting the industry. Further,
the Company believes that the increasing size, scale and consolidation of the wholesale pharmaceutical industrys national participants and their strategy to be primary or major distributors to national pharmacy chains create opportunities for
smaller distributors such as the Company, which focus sales primarily on independent pharmacies and secondarily on small and medium-sized pharmacy chains, alternative care facilities and other wholesalers.



Objectives and Strategy



The Companys primary business objective is to become a leading full-line wholesale distributor of pharmaceuticals, over-the-counter
products, health and beauty care products, nutritional supplements and other related products, with a focus on sales primarily to independent pharmacies and secondarily on small and medium-sized pharmacy chains, and alternative care facilities.
Historically, the Company has primarily grown its business through strategic acquisitions. In the future, the Company intends to continue to:



| |  |  | provide quality products and efficient service at competitive prices;
| | - |  | ---------------------------------------------------------------------



| |  |  | undertake beneficial strategic acquisitions;
| | - |  | --------------------------------------------



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



| |  |  | develop strategic relationships that increase the Companys product offerings;
| | - |  | ------------------------------------------------------------------------------



| |  |  | maintain technology focus and expertise to improve efficiency and ease of use of its web site; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | attract and retain exceptional employees.
| | - |  | -----------------------------------------



Sales and Marketing, Customer Service and Support



The Company is a full-line, wholesale distributor of pharmaceuticals, over-the-counter products, health and beauty care aids, nutritional supplements and other related
products. The majority of the Companys sales are in the pharmaceutical product line. The Companys pharmaceutical products are divided into generic and brand products. In general, brand products offer smaller margins than generic products
or the other products offered by the Company. Accordingly, while the Company continues to distribute brand products as requested by its customers, it is currently focusing its efforts on growing its generic pharmaceutical, over-the-counter and other
products lines. Additionally, from time to time the Company seeks to acquire additional complimentary product lines, as it did with its acquisitions of Avery and Infinity. See Acquisitions.



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



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



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



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



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



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



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



| |  |  | enhancing online content and ease of use of the Company web site;
| | - |  | -----------------------------------------------------------------



| |  |  | enhancing customer service and technical support; and
| | - |  | -----------------------------------------------------



| |  |  | advertising in trade journals and at industry trade shows.
| | - |  | ----------------------------------------------------------



During the years ended March 31, 2003, 2002 and 2001, the Companys 10 largest customers accounted for approximately 44%, 37% and 39%, respectively, of the
Companys net sales. The Companys two largest customers during fiscal 2003, Supreme Distributors and QK Healthcare, accounted for approximately 17% and 11%, respectively, of net sales. In fiscal 2002, the Companys largest customer,
QK Healthcare, accounted for approximately 13% of net sales, and the Companys largest customer in fiscal 2001, Penner and Welsch, Inc., accounted for approximately 16% of net sales.



Distribution



The Companys wholesale distribution business is supported by three distribution centers located in Pittsburgh, Pennsylvania; Youngstown, Ohio; and St. Rose,
Louisiana. These locations enable the Company to deliver approximately 95% of its products to its customers via next day delivery. The remaining product is distributed by its delivery vans in regions of eastern Ohio and western Pennsylvania, or by
common carrier to more distant customers.



Purchasing



The Company purchases over 20,000 stock keeping units primarily from manufacturers and
secondarily from other wholesalers and distributors. The Company utilizes sophisticated inventory control and purchasing software to track inventory, to analyze demand history and to project future demand. The system is designed to enhance profit
margins by eliminating the manual ordering process, allowing for automatic inventory replenishment and identifying inventory buying opportunities. In addition, the Companys purchasing department constantly monitors the market to take advantage
of periodic volume discounts, market discounts and pricing changes.



The
Company purchases products from approximately 400 vendors, such as Pfizer, Inc., Eli Lilly and Company, Merck and others. The Company initiates purchase orders with vendors through its information system. During fiscal years 2003, 2002 and 2001, the
Companys 10 largest vendors accounted for approximately 40% (by dollar volume) of the Companys purchases for each year. Historically, the Company has not experienced difficulty in purchasing desired products from suppliers. The Company
believes that its relationships with its suppliers are good.



Competition



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



| |  |  | secure merchandise from vendors on more favorable terms;
| | - |  | --------------------------------------------------------



| |  |  | devote greater resources to marketing and promotional campaigns; and
| | - |  | --------------------------------------------------------------------



| |  |  | adopt more aggressive pricing or inventory availability policies.
| | - |  | -----------------------------------------------------------------



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In addition, certain of the Companys competitors, such as McKesson HBOC, Inc., AmerisourceBergen Company, and
Cardinal Health, Inc. have developed or may be able to develop e-commerce operations that compete with the Companys e-commerce operations, and may be able to devote substantially more resources to web site development and systems development
than the Company. The online commerce market is rapidly evolving and intensely competitive. The Company expects competition to intensify in the future because barriers to entry are minimal, and current and new competitors can launch new web sites at
relatively low cost.



Government Regulations and Legal Uncertainties



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



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



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



Intellectual Property



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



Employees



The Company employs 81 persons, 73 of which are full-time employees, and one consultant.
Labor unions do not represent any of these employees. The Company considers its employee relations to be good.



Employees are permitted to participate in employee benefit plans of the Company that may be in effect from time to time, to the extent eligible. Each of the employees is eligible for stock option grants in accordance
with the provisions of the Companys 1999 Stock Option Plan, as determined by the Administrator of the Plan.



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In August 1999, the Companys Board of Directors adopted the Companys 1999 Stock Option Plan (1999
Plan). The purpose of the 1999 Plan is to enable the Company to attract and retain top-quality executive employees, officers, directors and consultants and to provide such executive employees, officers, directors and consultants with an
incentive to enhance stockholder return. The 1999 Plan provides for the grant to officers, directors, or other key employees and consultants of the Company, of options to purchase an aggregate of 2,000,000 shares of common stock.



ACQUISITIONS



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



Valley Drug Company



On April 19, 2000, DrugMax Acquisition Corporation, a wholly owned subsidiary of the Company, Valley Drug Company (Valley),
Ronald J. Patrick (Patrick) and Ralph A. Blundo (Blundo and together with Patrick, the Sellers) signed a Merger Purchase Agreement pursuant to which the Company acquired Valley. In connection with the merger, the
Sellers received an aggregate of 226,666 shares of the Companys common stock and cash in the amount of $1.7 million. Valley loaned the Sellers $170,000, of which $100,000 is outstanding at March 31, 2003, to pay for a portion of the flow
through effects of their S Corporation taxable income resulting from the sale of Valley. These interest-free notes receivable are to be repaid upon the Sellers sale of Company common stock, which was restricted stock subject to a holding
period which ended April 19, 2001. In addition, the Sellers deposited 22,666 shares of the Companys common stock with an escrow agent (the Holdback Shares). Based on audited financial statements of Valley as of April 19, 2000, the
stockholders equity amounted to $400,667, which was $141,160 less than the threshold amount of $541,827. Therefore, 9,411 of the Holdback Shares have been returned to the Company. After consideration of the return of the Holdback Shares, a
total of 217,255 shares at $10.125 per share were issued for the acquisition.



Penner and Welsch, Inc.



On October 25, 2001, Discount, a
wholly-owned subsidiary of the Company, purchased substantially all of the net assets of Penner & Welsch, Inc. (Penner), a wholesale distributor of pharmaceuticals based in Louisiana, pursuant to an Agreement for the Purchase and
Sale of Assets dated October 12, 2001 (the Agreement). As previously reported by the Company, Penner was a Chapter 11 debtor which had voluntarily filed for Chapter 11 protection in the US Bankruptcy Court Eastern Division of Louisiana.
Prior to this acquisition, commencing in September 2000, the Company managed the day-to-day operations of Penner, in exchange for a management fee equal to a percentage of the gross revenues of Penner each month. During the management period, the
Company provided Penner with a collateralized revolving line of credit for the sole purpose of purchasing inventory from the Company. Pursuant to the Agreement, Penner received an aggregate of 125,418 shares of restricted common stock of the
Company, valued at $5.98 per share, cash in the amount of $488,619, and forgiveness of $1,604,793 in trade accounts payable and management fees owed to Discount. The source of the funds used to acquire Penners assets was the working capital of
the Company. The Agreement, including the nature and amount of the consideration paid to Penner, was negotiated between the parties and, on October 15, 2001, was approved by the US Bankruptcy Court, Eastern Division of Louisiana. The Company
operates the acquired business under Valley Drug Company South, Inc., its wholly owned subsidiary.



Avery Pharmaceuticals, Inc.



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



Pursuant to the Avery Agreement, the
Company acquired accounts receivable, inventory, equipment, furniture, the trade name and a patent pending for the process of the manufacture of vials for the respiratory therapy industry, which preliminarily totals $1,062,518. The liabilities
assumed, which were comprised principally of trade payables, upon preliminary investigation, amounted to $912,518, and capital injected of $60,000. In addition, the Company executed a promissory note to the predecessor companys 50%
shareholder, as additional consideration. The $318,000 note includes a right of set off for accounts payable in excess of an agreed upon amount assumed at closing. The original note may not be reduced below $90,000 after set off, which management
believes will be the adjusted note amount. Terms of the note provide for principal payments due monthly beginning July 5, 2003 through the due date of January 5, 2006. Interest on the note is due quarterly beginning September 5, 2003 at the rate of
6% per annum. Also, the Company executed a Consulting and Non-Competition Agreement (Consulting Agreement) with John VerVynck (VerVynck) an officer and shareholder of Avery and Infinity. The Consulting Agreement provides for
the payment to VerVynck of $39,360, payable bi-monthly, over the six-



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month term of the Consulting Agreement. The Consulting Agreement prohibits VerVynck from competing for one year following his termination and the six-month
term of the consulting agreement.



RISK FACTORS



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



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



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



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



Over the past decade, participants in the wholesale pharmaceutical distribution industry
have experienced declining gross and operating margin percentages. Industry sources estimate that the average gross margin percentage of companies in the industry has decreased from approximately 7.35% in 1990 to approximately 4.20% in 1999. The
Companys gross margin percentage decreased from approximately 3.11% in 2001 to approximately 2.77% in 2002, and increased to approximately 2.78% in 2003. The profitability of wholesale distributors, including the Company, is largely dependent
upon earning volume incentives, cash discounts and rebates from pharmaceutical manufacturers. The Companys profitability is also increasingly dependent on its ability to purchase inventory in advance of anticipated or known manufacturer price
increases. Although investment buying opportunities may enable the Company to increase its gross margin percentage when manufacturers increase prices, such buying requires subjective assessments of future price changes as well as significant working
capital. If the Companys gross margin percentages decline significantly, or if the Companys assessments of future price changes are incorrect, or if the Company does not have the necessary working capital to take advantage of buying
opportunities, the Companys profitability could be materially adversely affected. To increase its margins, while the Company continues to distribute brand products as requested by its customers, it is currently focusing its efforts on growing
its generic pharmaceutical, over-the-counter and other products lines. Additionally, from time to time the Company seeks to acquire additional complimentary product lines, as it did with its acquisition of Avery and Infinity. See
Acquisitions. However, there can be no assurances that the Company will be successful in this regard. Growth in higher-margin products requires significant marketing and sales efforts, which may not be successful. Low demand for
higher-margin products could prevent the Company from increasing its sales of these products, and increased competition in higher-margin products could reduce the margins on these products.



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



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



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



The pharmaceutical and over-the-counter product industries are intensely competitive. To
strategically respond to changes in the competitive environment, the Company may sometimes make pricing, service or marketing decisions or acquisitions that could materially hurt its business. The Company cannot guarantee that it can compete
successfully against current and future competitors. See BusinessCompetition.



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



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



The Companys business could suffer if it is unable to complete and integrate acquisitions successfully.



One aspect of the Companys growth and operating strategy is to pursue strategic acquisitions of other pharmaceutical wholesalers and companies that expand or
complement the Companys business. The Company cannot assure that suitable acquisition candidates will be identified, that acquisitions can be consummated on acceptable terms, that any acquired companies can be integrated successfully into the
Companys operations or that the Company will be able to retain an acquired companys significant customer and supplier relationships or otherwise realize the intended benefits of any acquisition. Any such expansion could require
significant capital resources and divert managements attention from the Companys existing business. Such acquisitions could also result in liabilities being incurred that were not known at the time of acquisition or the creation of tax
and accounting problems. Failure to accomplish future acquisitions could limit the Companys revenues and earnings potential.



The Company intends to continue to seek investments in complementary businesses, product lines and technology. If the Company buys a company, or an operating division,
the Company could have difficulty in assimilating the personnel and operations. In addition, the key personnel of an acquired company may decide not to work for the Company and customers and vendors of the acquired company may decide not to do
business with the Company. The Company could also have difficulty in assimilating the acquired business, products or technology into its operations. These difficulties could disrupt its ongoing business, distract its management and employees and
increase its expenses. In addition, future acquisitions could have a negative impact on its business, financial condition and results of operations. Furthermore, the Company may have to incur debt or issue equity securities to pay for any future
acquisition, the issuance of which may be dilutive to its existing stockholders.



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



The Companys growth has placed, and its anticipated continued growth will continue to
place, significant demands on its managerial and operational resources. The Companys failure to manage its growth efficiently may divert managements attention from the operation of its business and render the Company unable to keep pace
with its customers demands.



The Company may require additional
capital in the future which may not be available to the Company.



The
Company has recently entered into a new line of credit agreement with Congress Financial Corporation, which the Company believes is sufficient for its immediately foreseeable needs. However, the Companys future capital requirements will depend
upon many factors, including, but not limited to:



| |  |  | the extent to which the Company can develop and brand the Companys name;
| | - |  | -------------------------------------------------------------------------



| |  |  | the frequency with which the Company can make future acquisitions;
| | - |  | ------------------------------------------------------------------



| |  |  | the rate at which the Company can hire additional personnel;
| | - |  | ------------------------------------------------------------



| |  |  | the rate at which the Company can expand the services that it offers; and
| | - |  | -------------------------------------------------------------------------



| |  |  | the extent to which the Company can develop and upgrade the Companys technology.
| | - |  | ---------------------------------------------------------------------------------



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Because of these factors, the Companys actual revenues and costs are uncertain and may vary considerably. These
variations may significantly affect the Companys future need for capital. The actual amount and timing of the Companys future capital requirements may differ materially from the Companys estimates. In particular, the Companys
estimates may be inaccurate as a result of changes and fluctuations in the Companys revenues, operating costs and development expenses. The Companys revenues, operating costs and development expenses will be negatively affected by any
inability to:



| |  |  | effectively and efficiently manage the expansion of the Companys operations;
| | - |  | -----------------------------------------------------------------------------



| |  |  | negotiate favorable contracts and relationships with manufacturers, distributors and wholesalers; and
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | obtain brand recognition, attract a sufficient number of customers or increase the volume of e-commerce sales of the Companys products.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



Adequate funds may not be available when needed or may not be available on favorable terms.
If funding is insufficient at any time in the future, the Company may be unable to develop or enhance its products or services, take advantage of business opportunities or respond to competitive pressures, any of which could harm the Companys
business.



The Companys stock price may be volatile.



The market price of the Companys common stock may be subject to significant
fluctuations in response to various factors, including:



| |  |  | quarterly fluctuations in the Companys operating results;
| | - |  | ----------------------------------------------------------



| |  |  | changes in securities analysts estimates of the Companys future earnings; and
| | - |  | -------------------------------------------------------------------------------



| |  |  | the Companys loss of significant customers or suppliers or significant business developments relating to the Companys competitors.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



The Companys common stocks market price also may be affected by the
Companys ability to meet analysts expectations, and any failure to meet such expectations, even if minor, could cause the market price of the Companys common stock to decline. Because the number of shares of common stock publicly
traded is small relative to the number of publicly traded shares of many other companies, the market price of the common stock may be more susceptible to fluctuation. In addition, stock markets have generally experienced a high level of price and
volume volatility, and the market prices of equity securities of many companies have experienced wide price fluctuations not necessarily related to the operating performance of such companies. These broad market fluctuations may adversely affect the
common stocks market price.



The Companys operations and
quarterly results are not subject to seasonality and variability.



Management believes that the Companys business is not seasonal; however, significant promotional activities can have a direct impact on sales volumes in any given quarter.



Changes in the healthcare industry could adversely affect the Company.



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



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



The healthcare industry is more heavily regulated than many other industries. As a distributor of certain controlled substances and
prescription pharmaceuticals, the Company is required to register with and obtain licenses and permits from certain federal and state agencies and must comply with operating and security measures prescribed by those agencies. The Company is also
subject to various



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regulations including the 1987 Prescription Drug Marketing Act, an amendment to the federal Food, Drug and Cosmetic Act, which regulates the purchase,
storage, security and distribution of prescription pharmaceuticals. The Companys compliance with these regulations is monitored through periodic site inspections conducted by various governmental agencies. Any failure to comply with these
regulations or to respond to changes in these regulations could result in penalties on the Company such as fines, restrictions on the Companys operations or a temporary or permanent closure of the Companys facilities. These penalties
could harm the Companys operating results. The Company cannot assure that future changes in applicable laws or regulations will not materially increase the costs of conducting business or otherwise have a material adverse effect on the
Companys business, results of operations and financial condition. See Business.



The Company may not successfully protect its intellectual property.



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



To date, the
Companys business has not been interrupted as the result of any claim of infringement. However, the Company cannot guarantee it will not be adversely affected by the successful assertion of intellectual property rights belonging to others. The
effects of such assertions could include requiring the Company to alter or withdraw existing trademarks or products, delaying or preventing the introduction of products, or forcing the Company to pay damages if the products have been introduced. The
steps it takes to protect its proprietary rights may be inadequate, or third parties might infringe or misappropriate its trade secrets, copyrights, trademarks, trade dress and similar proprietary rights. In addition, others could independently
develop substantially equivalent intellectual property. The Company may have to litigate in the future to enforce its intellectual property rights, to protect its trade secrets or to determine the validity and scope of the proprietary rights of
others. Such litigation could result in substantial costs and the diversion of its management and technical resources which could harm the Companys business.



The Company also utilizes the registered domain names www.drugmax.com. and www.penwel.com. Currently, the acquisition and maintenance
of domain names is regulated by governmental agencies and their designees. The regulation of domain names in the United States and in foreign countries is expected to change in the near future. These changes could include the introduction of
additional top level domains, which could cause confusion among web users trying to locate its sites. As a result, the Company may not be able to maintain its domain names. Furthermore, the relationship between regulations governing domain names and
laws protecting trademarks and similar proprietary rights is unclear. The Company may be unable to prevent third parties from acquiring domain names that are similar to those belonging to the Company. The acquisition of similar domain names by third
parties could cause confusion among web users attempting to locate the Companys site and could decrease the value of its brand name.



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



The Company is dependent on the Companys information systems to receive and process customer orders, initiate orders with product
suppliers, distribute products to the Companys customers in a timely and cost-effective manner, track and secure inventory and maintain compliance with federal and state regulations. Any disruption in the Companys information systems
could thus have a material adverse effect on the Companys business, results of operations and financial condition.



The Company hosts and maintains its web site and contracts with a third party that provides backup web hosting services. The backup provider delivers a secure platform
for server hosting with uninterruptible power supply and back up generators, fire suppression, raised floors, heating ventilation and air-conditioning, separate cooling zones, operations twenty-four-hours-a-day, seven-days-a-week. To protect the
customer information the Company receives, the Company uses SSL (Secure Socket Layer) encrypted protocol, user names and passwords, and other tools. The Company also has its own certificate server from Microsoft that encrypts the registration
session to protect the customer information. In addition, the Company has taken steps to protect the registration information residing in its servers by using firewalls, backups and other preventive measures designed to protect the privacy of its
customers. The Company restricts access to customer personal and financial data to those authorized employees who have a need for these records. The Company does not release information about its customers to third parties without the prior written
consent of its customers unless otherwise required by law.



Notwithstanding
these precautions, the Company cannot assure that the security mechanisms will prevent security breaches or service breakdowns. Despite the network security measures the Company has implemented, its servers may be vulnerable to computer viruses,



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physical or electronic break-ins or other similar disruptions. Such a disruption could lead to interruptions or delays in its service, loss of data, or its
inability to accept and fulfill customer orders. Any of these events could materially affect the Companys business.



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



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



|Item 2. |  | PROPERTIES.
|------- |  | -----------



The Company does not own or hold any legal or equitable interest in any real estate. The Company leases its principal administrative, marketing and customer service facility containing approximately 5,216
square feet of air-conditioned office space, located at 25400 US Highway 19 North, Suite 137, Clearwater Florida 33763. The term of the lease for the Clearwater office is for five years expiring January 14, 2008, with an initial monthly lease
payment of $6,303. The Company leases for its Pittsburgh facility, 1,424 square feet of office and 1,176 square feet of warehouse space located at 203 Parkway West Industrial Park, Pittsburgh, Pennsylvania 15205. The term of the lease for the
Pittsburgh facility is for three years expiring February 28, 2006, with a monthly lease payment of $1,658. The Youngstown facility is located at 318 West Boardman Street, Youngstown, Ohio 44503 and consists of approximately 30,000 square feet of
office (approximately 3,000 air conditioned space for offices), warehouse, shipping and distribution space. The premises are leased pursuant to a lease with a base term of five years expiring December 30, 2003, with a monthly lease payment of
$6,000, renewable for an additional five years under the same terms. Management believes that a more modern and efficient warehouse facility would be beneficial to Valleys operations, and expects to enter into a long-term lease arrangement
with a property development company, which is owned by certain officers, directors, shareholders and key employees of the Company, with terms and conditions negotiated at market rate, with an expected occupancy date in December 2003, which will
replace the existing lease for the Youngstown facility. The Company leases for its subsidiary, Discount, a building located at 10016 River Road, St. Rose, Louisiana, 70087, from River Road Real Estate LLC, a related party (See Note 13 of the
consolidated financial statements.) The building consists of approximately 39,000 square feet of air-conditioned office and warehouse space. The lease for the St. Rose location is for a term of five years expiring October 2006, and carries a monthly
lease payment of $15,000.



|Item 3. |  | LEGAL PROCEEDINGS.
|------- |  | ------------------



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



The Company previously executed an engagement letter with GunnAllen Financial
(GAF) with an effective date of August 20, 2001, for consulting services over a three month period from the effective date, and renewable month to month thereafter until terminated by either party with a thirty day notice. The GAF
agreement required that the Company pay to GAF, for consulting services performed, $5,000 per month plus expenses capped at $2,000 per month, and further required the Company to issue a warrant to GAF exercisable for a period of five years to
purchase 100,000 shares of the Companys common stock at an exercise price of $5.80 per share. However, on October 12, 2001, the Company terminated the agreement with GAF and informed GAF that GAF was in breach of contract under the Agreement
and that, accordingly, no warrants would be issued to GAF and no further fees would be paid to GAF. The Company also demanded the return of all fees previously paid to GAF. At March 31, 2003, no warrants had been issued to GAF. As of July 9, 2003
GAF had not instituted any legal proceedings against the Company. The Company cannot reasonably estimate any future possible loss as a result of this matter. The Company has made no provision in the accompanying consolidated financial statements for
resolution of this matter.



In March 2000, the Company acquired all of the
issued and outstanding shares of common stock of Desktop Corporation, a Texas corporation located in Dallas, Texas, pursuant to an Agreement and Plan of Reorganization by and among the Company, K. Sterling Miller, Jimmy L. Fagala and HCT Capital
Corp. (the Reorganization Agreement). On February 7, 2002, Messrs. Miller and Fagala filed a complaint against the Company in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, Florida, alleging,



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among other things, that the Company had breached the Reorganization Agreement by failing to pay 38,809 shares of the Companys common stock to
plaintiffs. The complaint also includes a count of conversion and further alleges that the Company breached its employment agreements with Messrs. Miller and Fagala, for which the plaintiffs seek monetary damages. On March 11, 2002, the Company
filed its answer, affirmative defenses and counterclaim against plaintiffs and HCT Capital Corp., in which it alleged, among other things, that plaintiffs had breached the Reorganization Agreement by misrepresenting the state of the acquired
business, that the Company was entitled to set off its damages against the shares which the plaintiffs are seeking and further seeking contractual indemnity against the plaintiffs. On April 16, 2002, HCT Capital Corp. filed its answer, counterclaim
against the Company and cross-claim against the plaintiffs. In September of 2002, Plaintiffs served the Company with written discovery requests. Since then there has been no activity by Plaintiffs or HCT, and the Company is currently considering how
to proceed in light of this inactivity. The Company intends to vigorously defend the actions filed against it and to pursue its counterclaim. The Company cannot reasonably estimate any future possible loss as a result of this matter. The Company has
made no provision in the accompanying consolidated financial statements for resolution of this matter.



On May 1, 2002, the Company filed suit against an established customer of the Companys Pittsburgh distribution center for collection of past due accounts receivable. The customer accounted for approximately $4.1
million, or 1.5%, of the gross revenue of the Company in the fiscal year ended March 31, 2002. The Company has an unconditional personal guaranty signed by the customers owner. On May 23, 2002, the customer filed a voluntary petition in
bankruptcy in the U.S. Bankruptcy Court, under Chapter Eleven of the United States Bankruptcy Act, subsequent to which the customer failed to file the proper financial data with the court, causing the voluntary bankruptcy filing to be withdrawn.
Management is continuing to pursue its claim for payment through the courts and working with the major creditors to process return of inventory. In the fiscal year ended March 31, 2003, the Company has established an allowance for the account
receivable of $669,000 and accrued $19,132 for legal costs.



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



Not applicable.



PART II



|Item 5. |  | MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
|------- |  | ----------------------------------------------------------------------



The Companys common stock is traded on the Nasdaq SmallCap Market under the symbol DMAX. The following table sets forth
the closing high and low bid prices for the Companys common stock on the Nasdaq SmallCap Market for each calendar quarter during the Companys last two fiscal years, as reported by Nasdaq. Prices represent inter-dealer quotations without
adjustment for retail markups, markdowns or commissions and may not represent actual transactions.





|     |  |                |  | Common Stock
|---- |  | -------------- |  | ------------
|     |  |                |  | High        
|2002 |  | First Quarter  |  | $           
|     |  | Second Quarter |  | $           
|     |  | Third Quarter  |  | $           
|     |  | Fourth Quarter |  | $           
|     |  |                | 
|2003 |  | First Quarter  |  | $           
|     |  | Second Quarter |  | $           
|     |  | Third Quarter  |  | $           
|     |  | Fourth Quarter |  | $           
|     |  |                | 
|2004 |  | First Quarter  |  | $           



As of July 9, 2003, there were
approximately 780 shareholders of record of the Companys common stock.



Historically, the Company has not declared or paid any cash dividends on its common stock. It currently intends to retain any future earnings to fund the development and growth of its business. Any future determination to pay dividends on
the common stock will depend upon the Companys results of operations, financial condition and capital requirements, applicable restrictions under any credit



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facilities or other contractual arrangements and such other factors deemed relevant by the Companys Board of Directors. The Companys current
credit facility prohibits the payment of dividends.



Equity Compensation
Plan Information



The following table sets forth certain information
regarding the Companys equity compensation plan as of March 31, 2003:



|Plan Category                                                 |  | Number of securities to beissued upon exercise ofoutstanding options,warrants and rights |  | Weighted-average exerciseprice of outstanding options,warrants and rights |       | Number of securitiesremaining available forfuture issuance under equitycompensation
plans(excluding securities reflectedin column (a))
|------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------- | ----- | --------------------------------------------------------------------------------------------------------------------------------------
|                                                              |  | (a)                                                                                      |  | (b)                                                                       |       | (c)                                                                                                                                   
|Equity compensation plan approved by securities holders (1)   |  | 1,656,634                                                                                |  | $                                                                         | 4.25  |                                                                                                                                       
|Equity compensation plan not approved by security holders (2) |  | 150,000                                                                                  |  | $                                                                         | 16.50 |                                                                                                                                       
|                                                              |  |                                                                                          |  |                                                                           |       |                                                                                                                                       
|Total                                                         |  | 1,806,634                                                                                |  | $                                                                         | 5.25  |                                                                                                                                       
|                                                              |  |                                                                                          |  |                                                                           |       |                                                                                                                                       

---

|1. |  | Reflects options to purchase shares of the Companys common stock and shares available for issuance under the Companys 1999 Stock Option Plan.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------

|2. |  | Represents a warrant to purchase 150,000 shares of common stock at an exercise price of $16.50 granted to the Companys underwriters in connection with its 1999 public
offering. See Note 12 to the consolidated financial statements.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|Item 6. |  | SELECTED FINANCIAL DATA.
|------- |  | ------------------------



The following selected financial data should be read in conjunction with the Companys Consolidated Financial Statements and related Notes and
Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Annual Report. The statement of operations data for the years ended March 31, 2003, 2002 and 2001 and the balance sheet
data as of March 31, 2003 and 2002, are derived from, and are qualified by reference to our audited Consolidated Financial Statements included in this Annual Report. The statement of operations data for the years ended March 31, 2000 and 1999 and
the balance sheet data as of March 31, 2001, 2000 and 1999 are derived from the Companys audited Consolidated Financial Statements which are not included in this Annual Report. When appropriate, certain amounts have been reclassified to
conform with the presentation for fiscal year ended March 31, 2003. Historical results are not necessarily indicative of results which may be expected for any future period.



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|                                                               |  | Fiscal year ended March 31, (amounts in thousands, except per share amounts) |        
|-------------------------------------------------------------- |  | ---------------------------------------------------------------------------- | -------
|                                                               |  | 2003(a)                                                                      |        
|Statement of Operations:                                       |  |                                                                              |        
|Revenues                                                       |  | $                                                                            | 291,752
|Gross profit                                                   |  |                                                                              | 8,105  
|Selling, general and administration expenses                   |  |                                                                              | 7,762  
|Depreciation and amortization                                  |  |                                                                              | 325    
|Goodwill, intangible asset, and asset impairment loss          |  |                                                                              | 12,468 
|Operating (loss) income                                        |  |                                                                              | (12,450
|(Loss) income before extraordinary item and income tax benefit |  |                                                                              | (13,476
|Net (loss) income                                              |  |                                                                              | (13,162
|Earnings per sharebasic                                       |  |                                                                              |        
|(Loss) income before extraordinary item                        |  |                                                                              | (1.85  
|Net income (loss)                                              |  |                                                                              | (1.85  
|Earnings per sharediluted                                     |  |                                                                              |        
|(Loss) Income before extraordinary item                        |  |                                                                              | (1.85  
|Net (loss) income                                              |  |                                                                              | (1.85  
|Balance Sheet:                                                 |  |                                                                              |        
|Cash and cash equivalents and restricted cash                  |  | $                                                                            | 2,161  
|Accounts receivablenet                                        |  |                                                                              | 11,340 
|Inventory                                                      |  |                                                                              | 19,459 
|Property and equipmentnet                                     |  |                                                                              | 768    
|Goodwill                                                       |  |                                                                              | 13,105 
|Total assets                                                   |  |                                                                              | 50,274 
|Accounts payable                                               |  |                                                                              | 14,619 
|Credit line payable                                            |  |                                                                              | 15,944 
|Stockholders equity                                           |  |                                                                              | 18,284 
|Total liabilities and stockholders equity                     |  |                                                                              | 50,274 

---

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

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

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

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

|(e) |  | Net sales reported in fiscal 1999 were derived from the Companys e-commerce business started in September 1998.
|--- |  | ----------------------------------------------------------------------------------------------------------------



The Company historically has primarily grown its business through strategic acquisitions. The
Company currently has three distribution centers, all of which were acquired as follows: In November 1999, the Company acquired Becan (and its subsidiary, Discount), in April 2000, the Company acquired Valley, and in October 2001, the Company
acquired Penner. Thus, while fiscal years 2003 and 2002 include full-year sales for all three distribution centers, prior years do not. The fiscal year 2001 consists of full-year sales for the Pennsylvania distribution center (acquired when the
Company purchased Becan), but only approximately eleven months of sales for the Ohio distribution center (acquired when the Company purchased Valley) and approximately seven months of sales for the Louisiana distribution center (which is the period
of time the Company managed Penner prior to the Companys acquisition of Penner in October 2001). See Acquisitions.



|Item 7. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
|------- |  | --------------------------------------------------------------------------------------



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



Overview



DrugMax, Inc. (Nasdaq: DMAX) is a full-line, wholesale distributor of pharmaceuticals,
over-the-counter products, health and beauty care aids, nutritional supplements and related products. The Company is headquartered in Clearwater, Florida and maintains distribution centers in Pennsylvania, Ohio, and Louisiana. The Company
distributes its products primarily to independent pharmacies in the continental United States, and secondarily to small and medium-sized pharmacy chains, alternative care facilities and other wholesalers. The Company maintains an inventory in excess
of 20,000 stock keeping units from leading manufacturers and holds licenses to ship to all 50 states and Puerto Rico.



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Critical Accounting Policies And Estimates



Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) contains a discussion of
the Companys consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On
an on-going basis, the Company evaluates its estimates and judgments, including those related to customer incentives, product returns, bad debts, inventories, intangible assets, income taxes, and contingencies and litigation. The Company bases its
estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.



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



Revenue Recognition



The Company recognizes revenue when goods are shipped and title or risk of loss resides with unaffiliated customers, and at which time the appropriate provisions are
recorded for estimated contractual chargeback credits from the manufacturers based on the Companys contract with the manufacturer. Rebates and allowances are recorded as a component of cost of sales in the period they are received from the
vendor or manufacturer unless such rebates and allowances are reasonably estimable at the end of a reporting period. The Company records chargeback credits due from its vendors in the period when the sale is made to the customer which is eligible
for contract pricing from the manufacturer.



The Company accepts return of
product from its customers for product which is saleable, in unopened containers and carries a current date. Generally, product returns are received via the Companys own delivery vehicles, thereby eliminating a direct shipping cost from being
incurred by the customer or the Company. Depending on the length of time the customer has held the product, the Company may charge a handling and restocking fee. Overall, the percentage of the return of product to the Company is extremely low. The
Company has no sales incentive or rebate programs with its customers.



Inventory Valuation



Inventory is stated at the lower of cost
of market. Cost is determined using the first-in, first-out basis of accounting. Inventories consist of brand and generic drugs, over-the-counter products, health and beauty aids, and nutritional supplements for resale. The inventories of the
Companys three distribution centers are constantly monitored for out of date or damaged products, which if exist, are reclassed and physically relocated out of saleable inventory to a holding area, referred to as the morgue
inventory, for return to and credit from the manufacturer. However, if market acceptance of the Companys existing products or the successful introduction of new products should significantly decrease, inventory write-downs could be required.
As of March 31, 2003, 2002 and 2001, no inventory valuation allowances were necessary.



Goodwill and Intangible Assets



The Company has completed
several acquisitions which have generated significant amounts of goodwill and intangible assets and related amortization. The values assigned to goodwill and intangibles, as well as their related useful lives, are subject to judgment and estimation
by the Company. In addition, upon adoption of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS No. 142), the Company ceased amortization of goodwill effective April
2001, and reviews goodwill annually for impairment. Goodwill and intangibles related to acquisitions are determined based on purchase price allocations. Valuation of intangible assets is generally based on the estimated cash flows related to those
assets, while the initial value assigned to goodwill is the residual of the purchase price over the fair value of all identifiable assets acquired and liabilities assumed. Thereafter, the value of goodwill cannot be greater than the excess of the
fair value of the Companys reportable unit over the fair value of identifiable assets and liabilities, based on the annual impairment test. Useful lives are determined based on the expected future period of benefit of the asset, the assessment
of which considers various characteristics of the asset, including historical cash flows.



Impairment of Long-Lived Assets



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



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write-down due to impairment. The impairment write-down would be the difference between the carrying amounts and the fair value of these assets. Losses on
impairments are recognized by a charge to earnings.



Allowance for Deferred
Income Tax Asset



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



Recent Accounting Pronouncements



In August 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144), which addresses the financial accounting and reporting for the impairment or disposal of
long-lived assets. This statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of, and was effective for the Company on April 1, 2002. The adoption of SFAS No. 144 did not
have an impact on the results of operations or financial position of the Company.



In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections (SFAS No. 145). SFAS No. 145 will rescind SFAS No. 4, which
required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax benefit. As a result of SFAS No. 145, the criteria in APB No. 30 will be used to classify
those gains and losses. The provisions of SFAS No. 145 related to of the rescission of FASB No. 13 shall be applied in fiscal years beginning after May 15. 2002. Early application of the provisions of SFAS No. 145 related to the rescission of FSAB
No. 13 is encouraged. The components of SFAS No. 145 adopted in the current year did not have an impact on the results of operations or financial position of the Company. The adoption of SFAS No. 145 would require the Company to restate the
extraordinary loss on extinguishment of debt in 2001 to operating expenses.



In
July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146), which replaces Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity.SFAS No. 146 requires that liabilities associated with exit or disposal activities be recognized when they are incurred. Under EITF Issue No. 94-3, a liability for exit
costs is recognized at the date of a commitment to an exit plan. SFAS No. 146 also requires that the liability be measured and recorded at fair value. Accordingly, the adoption of this standard may affect the timing of recognizing future
restructuring costs as well as the amounts recognized. The Company will adopt the provisions of SFAS No. 146, for any restructuring activities initiated after December 31, 2002.



In November 2002, the FASB issued Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also requires that at
all times a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements.
The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company will apply the provisions of FIN 45 to any guarantees issued after December 31, 2002. As
of March 31, 2003, the Company did not have any guarantees outstanding.



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



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containing financial statements for interim periods beginning after December 15, 2002. The Company has elected to continue to apply the intrinsic value-based
method of accounting as allowed by APB No. 25.



In January 2003, the FASB
issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 clarifies the application of Accounting Research Bulletin No. 51 for certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies to variable interest entities
created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in July 2003 to variable interest entities in which the Company may hold a variable interest that is acquired
before February 1, 2003. The provisions of FIN 46 require that the Company immediately disclose certain information if it is reasonably possible that the Company will be required to consolidate or disclose variable interest entities when FIN 46
becomes effective. The Company is currently assessing the impact of the adoption of FIN 46 as it relates to the Company.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, (SFAS No.
150). SFAS No. 150 establishes standards for how an issuer classifies and measurers in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with SFAS No. 150,
financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 shall be effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. The Company is currently assessing the impact of SFAS No. 150.



Results of Operations



Revenues



The Company generated
revenues of $291.8 million, $271.3 million and $177.7 million for the fiscal years ended March 31, 2003, 2002 and 2001, respectively, which represents an increase of approximately $20.5 million or 7.5% for fiscal year 2003 over fiscal year 2002, and
an increase of approximately $93.6 million or 52.7% for fiscal year 2002 over fiscal year 2001. The increase in revenues is a direct result of aggressive marketing, expanded sales efforts and cross selling to common customers, and the Companys
commitment to expand its generic and over-the-counter and other products lines. Going forward, management believes that the Companys growth will continue to be fueled by the growth of the pharmaceutical industry market and as a result of its
focus on higher-margin products. The following schedule summarizes the Companys sales in three product lines over the last three years:



|                           |  | For the Fiscal YearEnded March 31, 2003 |             | For the Fiscal YearEnded March 31, 2002 |   | For the Fiscal YearEnded March 31, 2001
|-------------------------- |  | --------------------------------------- | ----------- | --------------------------------------- | - | ---------------------------------------
|Revenue from:              |  |                                         |             |                                         |   |                                        
|Branded pharmaceuticals    |  | $                                       | 268,443,471 |                                         | $ | 252,526,812                            
|Generic pharmaceuticals    |  |                                         | 14,722,530  |                                         |   | 12,525,736                             
|Over-the-counter and other |  |                                         | 8,585,770   |                                         |   | 6,235,440                              
|                           |  |                                         |             |                                         |   |                                        
|Total revenues             |  | $                                       | 291,751,771 |                                         | $ | 271,287,988                            
|                           |  |                                         |             |                                         |   |                                        



The Company historically has primarily
grown its business through strategic acquisitions. The Company currently has three distribution centers, all of which were acquired as follows: In November 1999, the Company acquired Becan (and its subsidiary, Discount), in April 2000, the Company
acquired Valley, and in October 2001, the Company acquired Penner. Thus, while fiscal years 2003 and 2002 include full-year sales for all three distribution centers, prior years do not. For example, fiscal year 2001 consists of full-year sales for
the Pennsylvania distribution center (acquired when the Company purchased Becan), but only approximately eleven months of sales for the Ohio distribution center (acquired when the Company purchased Valley) and approximately seven months of sales for
the Louisiana distribution center (which is the period of time the Company managed Penner prior to the Companys acquisition of Penner in October 2001). See Acquisitions.



Gross Profit



The Company achieved gross profits of $8.1 million, $7.5 million and $5.5 million for the years ended March 31, 2003, 2002 and 2001, respectively, for an increase of
approximately $.6 million for fiscal year 2003 over fiscal year 2002, and $2 million for fiscal year 2002 over fiscal year 2001. The Companys margin, as a percentage of revenue, was 2.8% for fiscal years 2003 and 2002, and 3.1% for the fiscal
year 2001. The decrease in the gross margin percentage was primarily due to the impact of lower selling margins, as a result of a highly competitive market and a greater mix of high volume customers, coupled with an increase in sales of branded
pharmaceutical drugs, which, generally are high sales dollar items with low gross profit margins. Management believes that the



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Companys continued emphasis on the expansion of generic drug sales should result in improved gross profit margins for the Companys future
operations. See Risk Factors.



Operating Expense



The Company incurred operating expenses of approximately $20.6 million, $5.6 million and
$12.4 million for the fiscal years ended March 31, 2003, 2002 and 2001, respectively. Operating expenses in the fiscal year ended March 31, 2003 include selling, general, administrative and other direct operating expenses of approximately $7.8
million, depreciation and amortization of approximately $.3 million, and a goodwill and intangible asset impairment loss of approximately $12.5 million. In addition, operating expenses for fiscal 2003 include approximately $1.1 million reserve for
bad debt due in part to one customer. The Company does not expect the anticipated relocation of the Ohio distribution center to have a significant impact on operating expenses in future fiscal periods. Operating expenses in the fiscal year ended
March 31, 2002 include approximately $5.4 million in selling, general administrative, other direct operating expenses, and depreciation and amortization expense of approximately $.3 million. For the year ended March 31, 2001, the selling, general,
administrative, other direct operating expenses were approximately $5.2 million, depreciation expense was approximately $.2 million, and costs for amortization of goodwill was $2.6 million associated with the acquisitions of Becan, Valley, Desktop
and VetMall, and an impairment of assets loss of approximately $4.4 million. Operating expenses for the year ended March 31, 2003 include full operating expenses for the three distribution centers and the corporate headquarters. Operating expenses
for the year ended March 31, 2002 include operating expenses for the Pennsylvania and Ohio distribution centers and the corporate headquarters, and approximately 6 months of full operating expenses for the Louisiana distribution from its acquisition
by the Company in October 2001. The year ended March 31, 2001 include operating expenses for the Pittsburgh distribution center, the corporate headquarters and approximately 11 months of operating expenses for the Ohio distribution center. The
percentage of selling, general, administrative and other direct operating expenses before amortization and depreciation was 2.7%, 2.0% and 3.0% for fiscal years 2003, 2002 and 2001, respectively, as compared to revenues.



Interest Expense



Interest expense was approximately $1.2 million for fiscal year ended March 31, 2003, $1.1 for the fiscal year ended March 31, 2002, and
$2.1 million for the fiscal year ended March 31, 2001. On October 24, 2000, the Company obtained a new revolving line of credit and term loan with Mellon Bank N.A. (Mellon), the proceeds of which were used to satisfy the prior Merrill
Lynch and National City credit facilities. In March 2001, the certificate of deposit with First Community Bank matured and was used to satisfy the associated outstanding line of credit with First Community Bank. On October 29, 2001, the Company
executed a loan modification agreement modifying its original line of credit with Standard Federal Bank National Association (Standard), formerly Michigan National Bank as successor in interest to Mellon. In the fiscal year ended March
31, 2003 and 2002, $199,888 and $119,957, respectively, in deferred financing costs associated with the Standard line of credit were amortized to interest expense. Included in the deferred financing costs charged to interest expense in fiscal year
ended 2003, is $78,913 of additional unamortized financing costs because of the early termination of the Standard line of credit in April 2003 with the new Congress Financial Corporation (Congress) credit facility. Accordingly in April
2003, the Company will recognize the remaining $78,913 unamortized deferred financing costs, an early termination fee of $351,000, and a fee for the waiver of the 90-day notice of termination of $30,000, related to the Standard line of credit.
During 2001, deferred financing costs associated with the Merrill Lynch line of credit totaling approximately $.9 million were amortized to interest expense. The decrease in interest expense realized in fiscal year ended March 31, 2003 over 2002 and
2001 is primarily attributable to the increased levels of borrowing offset by lower interest rates under the Companys current revolving line of credit and term loan. The Company does not anticipate the Congress credit facility to have a
material affect on interest expense for fiscal 2004 as compared to fiscal 2003.



Extraordinary Loss on Extinguishment of Debt



Upon the early
extinguishment of the Merrill Lynch line of credit in October 2000, the Company recognized an extraordinary loss of $572,244, which represented the unamortized balance of deferred financing costs related to a warrant issued to a director and
non-employee consultant as a result of the directors acting as a guarantor of the Merrill Lynch line of credit.



Income Taxes



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



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Net Income (Loss) Per Share



Earnings per share (EPS) is calculated by dividing the net income (loss) by the weighted average number of shares of common
stock outstanding for the period. Diluted EPS is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period, adjusted for the dilutive effect of options and warrants, using the
treasury stock method. The net loss per share for the fiscal year ended March 31, 2003 amounted to $1.85 per basic and diluted share. The fiscal year ended March 31, 2002 reported a net income of $.29 per basic and $.28 per diluted share. The fiscal
year ended March 31, 2001 reported a net loss of $1.45 per basic and diluted share. The Company recorded a goodwill and intangible asset impairment loss in its second quarter of the fiscal year ended March 31, 2003 of approximately $12.5 million,
which increased the net loss per basic and diluted share by $1.75. The Company recorded for the fiscal year ended March 31, 2003 an income tax benefit of approximately $.3 million, which decreased the loss per basic and diluted share by $.04. During
the year ended March 31, 2002, the Company reduced its entire valuation allowance, and booked approximately $1.1 million of deferred income tax benefit, net of the current year deferred income tax expense of approximately $.4 million, which provided
the Company with net income of $.16 per basic and $.15 per diluted share. In the fiscal year ended March 31, 2001, the Company recorded an extraordinary loss on extinguishment of debt of approximately $.6 million, or $.09 per basic and diluted
share, and if goodwill amortization expense had not been included in fiscal 2001, as presented in the fiscal years ended March 31, 2003 and 2002 under SFAS 142, it would have had the effect of decreasing the basic and diluted net loss per share by
$.40 for the year ended March 31, 2001.



Diluted EPS for the fiscal year ended
March 31, 2002 includes the effect of 199,055, dilutive common stock options. The Company had issued and outstanding 1,619,325 options to purchase shares of the Companys common stock, in addition to warrants to purchase 350,000 shares of the
Companys common stock, which were anti-dilutive and not included in the computation of diluted EPS for the fiscal year ended March 31, 2003. These anti-dilutive shares could potentially dilute the basic EPS in the future.



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



|                                                            |  | For the Year EndedMarch 31, 2003 |  | For the Year EndedMarch 31, 2002 |  | For the Year EndedMarch 31, 2001
|----------------------------------------------------------- |  | -------------------------------- |  | -------------------------------- |  | --------------------------------
|Basic shares                                                |  | 7,119,172                        |  | 7,034,969                        |  | 6,419,950                       
|Additional shares assuming effect of dilutive stock options |  |                                 |  | 199,055                          |  |                                
|                                                            |  |                                  |  |                                  |  |                                 
|Diluted shares                                              |  | 7,119,172                        |  | 7,234,024                        |  | 6,419,950                       
|                                                            |  |                                  |  |                                  |  |                                 



Transactions with Related Parties



GO2 Pharmacy, Inc., a publicly traded company, formerly Innovative Health
Products, Inc. (GO2), is a supplier of manufactured dietary supplements and health and beauty care products. Mr. Taneja is a Director and Chairman of the Board of GO2 and of the Company. In the fiscal years ended March 31, 2003, 2002 and
2001, the Company purchased approximately $3,200, $5,200 and $220,000, respectively, of products for resale from GO2.



On September 13, 2000, the Company entered into a management agreement with Penner and Welsch, Inc., (Penner), pursuant to which it agreed to manage the
day-to-day operations of Penner during the bankruptcy proceeding in exchange for a management fee equal to a percentage of the gross revenues of Penner each month. In turn, the Company entered into a management agreement with Dynamic Health
Products, Inc. (Dynamic) pursuant to which Dynamic provided accounting support services to the Company in connection with the Companys management responsibilities relating to Penner. Pursuant to this agreement, Dynamic was entitled
to receive one-third of all fees collected by the Company from Penner. In fiscal 2002 and fiscal 2001, the total fees paid to Dynamic by the Company were $225,226 and $229,417, respectively. Mr. Taneja is a Director and Chairman of the Board of
Dynamic and the Company. Both agreements were terminated in October 2001, in connection with the closing of the acquisition of certain assets from Penner by the Company.



In April 2000, in connection with the acquisition of Valley, the Company loaned the sellers of Valley a total of $170,000 to pay for a
portion of the flow through effects of their S Corporation taxable income resulting from the sale of Valley. These are interest-free notes receivable and are to be repaid by Mr. Patrick, Chief Financial Officer of the Company, and Mr. Blundo, the
President of Valley, upon their sale of the Company stock, which is restricted stock subject to a holding period which ended on April 19, 2001. At March 31, 2003 and 2002, the outstanding balance on the notes was $100,000.



Mr. Blundo, the President of Valley, and Mr. Patrick, the Chief Financial Officer of the
Company, together are 2/3 owners of Professional Pharmacy Solutions, LLC (PPS), a pharmacy management company. Valley sells products to PPS under Valleys normal terms and conditions. During the fiscal year ended March 31, 2003, the
Company generated revenues of approximately $1.5



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million, and generated revenues of approximately $1.1 million for each of the fiscal years ended March 31, 2002 and 2001 from PPS. The receivable balance due
from PPS at March 31, 2003 and 2002 was approximately $400,000 and $590,000, respectively.



In October 2001, the Company executed a Commercial Lease Agreement (the Lease) with River Road Real Estate, LLC (River Road), a Florida limited liability company, to house the operations of
Valley South in St. Rose, Louisiana. The officers of River Road are Taneja, a Director, Chief Executive Officer, Chairman of the Board and a majority shareholder of the Company; William L. LaGamba, a Director, Chief Operating Officer, and the
President of the Company; Stephen M. Watters, a former Director of the Company; and Johns, an employee of the Company and the former owner of Penner. The Lease is for an initial period of five years with a base monthly lease payment of $15,000, and
an initial deposit of $15,000 made to River Road by the Company. In the fiscal years ended March 31, 2003 and 2002, the Company paid $180,000 and $90,000, respectively, to River Road, which was a charge to rent expense.



Advanced Pharmacy, Inc. (Advanced), is a retail pharmacy for prescription drugs
owned by Mihir Taneja, a stockholder of the Company and the adult son of Taneja, the Chairman and CEO of the Company, and Michelle LaGamba, the spouse of William L. LaGamba, the President, COO and a Director of the Company. The Company sells
products to Advanced under normal terms and conditions. In the fiscal years ended March 31, 2003, 2002 and 2001, the Company generated revenues of approximately $4.9 million, $18,000 and $19,000, respectively, from Advanced. At March 31, 2003, 2002
and 2001, the receivable balance due from Advanced was approximately $255,000, $19,000 and $18,000, respectively. At March 31, 2003, the Company also had an additional receivable from Advanced for approximately $95,000 representing start up
inventory purchased by Advance, which will be paid within one year.



In the
fiscal year ended March 31, 2003, the Company advanced to its employee and former owner of Penner, Gregory M. Johns (Johns), funds in the amount of approximately $107,000, which is secured by a note executed by Johns. The note bears no
interest and is being paid by Johns through deductions from his compensation from the Company. At March 31, 2003, the outstanding balance due from Johns was approximately $101,266.



Inflation and Seasonality



Management believes that there was no material effect on operations or the financial condition of the Company as a result of inflation for the years ended March 31, 2003,
2002 and 2001. Management also believes that its business is not seasonal; however, significant promotional activities can have a direct impact on sales volume in any given quarter.



Financial Position, Liquidity and Capital Resources



The Company has working capital and cash and cash equivalents of $3.3 million and $2.2 million, respectively, including restricted cash of
$2 million, at March 31, 2003. On April 15, 2003, the Company obtained from Congress Financial Corporation (Congress) a $40 million revolving line of credit and a $400,000 term note to satisfy the outstanding line of credit and term loan
with Standard, and to provide working capital for possible future acquisitions. The credit facility is collateralized by all assets of the Company. The revolving line of credit enables the Company to borrow a maximum of $40 million, with borrowings
limited to 85% of eligible accounts receivable and 65% of eligible inventory. The revolving line of credit and the term note currently bear interest at the rate of 0.50% per annum in excess of the Prime Rate. The term note and revolving line of
credit are payable over a 36-month period. The Congress credit facility imposes certain restrictive covenants on tangible net worth and EBITA.



The Companys principal commitments at March 31, 2003 were leases on computer and office equipment and on its office and warehouse space, one consulting agreement
and two employment agreements. There were no material commitments for capital expenditures at that date. The following are contractual obligations of the Company at March 31, 2003:



|Contractual Obligations          |  | Total |            | Less than 1year |   | 1-3years   |  | 3-5years |            | Morethan 5years
|-------------------------------- |  | ----- | ---------- | --------------- | - | ---------- |  | -------- | ---------- | ---------------
|Operating leases                 |  | $     | 1,236,624  |                 | $ | 54,000     |  | $        | 927,223    |                
|Credit line payable              |  |       | 15,943,619 |                 |   | 15,943,619 |  |          |           |                
|Term note payable                |  |       | 451,199    |                 |   | 451,199    |  |          |           |                
|Capital leases                   |  |       | 54,824     |                 |   | 18,977     |  |          | 35,847     |                
|Consulting agreement             |  |       | 36,187     |                 |   | 36,187     |  |          |           |                
|Employment agreements            |  |       | 10,416     |                 |   | 10,416     |  |          |           |                
|Purchase agreements with vendors |  |       | 38,150,000 |                 |   | 18,000,000 |  |          | 20,150,000 |                
|                                 |  |       |            |                 |   |            |  |          |            |                
|Total contractual obligations    |  | $     | 55,882,869 |                 | $ | 34,514,398 |  | $        | 21,113,070 |                
|                                 |  |       |            |                 |   |            |  |          |            |                



Net cash provided by operating
activities was approximately $3.8 million for the fiscal year ended March 31, 2003, and net cash used in operating activities was approximately $5.9 million and $6.8 million for the fiscal years ended March 31, 2002 and 2001,



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respectively. Cash provided by operating activities for the fiscal year ended March 31, 2003 is primarily due to decreases in accounts receivable of
approximately $1.4 million, inventory of approximately $1.2 million, notes receivable of approximately $.1 million, and an increase in accounts payable of approximately $.9 million, along with increases in other assets and notes receivable. The
usage of cash for the fiscal year ended March 31, 2002 is primarily attributable to increases in accounts receivable of approximately $.4 million and inventory of $9.3 million, as a result of increased sales and inventory associated with the
acquisition of Penner, along with increases in deposits and prepaid and other assets, and a decrease in accrued expenses, offset by decreases in accounts payable of approximately $2.4 million, and due from affiliates and other assets. Cash used in
operating activities for the fiscal year ended March 31, 2001 of approximately $6.8 million is primarily due to increases in accounts receivable of approximately $7.4 million, inventory of approximately $2.6 million, prepaid expenses, other current
assets, other assets, and accounts payable of approximately $4.3 million, offset by decreases in accrued expenses and current liabilities of approximately $.3 million, shareholder notes receivable, notes receivable and deposits.



Net cash used in investing activities for the fiscal year ended March 31, 2003 was
approximately $.05 million, representing purchases of property and equipment. Net cash used in investing activities for the fiscal year ended March 31, 2002 of approximately $.6 million represents approximately $.5 million cash paid for the
acquisition of Penner, $.07 million for purchases of property and equipment, and $.05 million for the Companys investment in MorepenMax. Net cash used in investing activities for the fiscal year ended March 31, 2001 of approximately $1.9
million, representing purchases of property and equipment of approximately $.1 million and approximately $1.8 million for the acquisition of Valley.



Net cash used in financing activities was approximately $3.7 million for the fiscal year ended March 31, 2003, representing the net change in the Companys revolving
line of credit agreement of approximately $3 million, payment of deferred financing costs of approximately $.06 million and payments on long-term debt and capital leases of approximately $.7 million. Net cash provided by financing activities was
approximately $6.2 million for the year ended March 31, 2002, representing the net change in the Companys revolving line of credit agreement of approximately $7 million, offset by the decrease in due to affiliates of approximately $.05
million, repayments of long-term debt and capital leases of approximately $.7 million, and additional financing costs incurred in connection with the loan modification agreement with Standard of $.05 million. Cash provided by financing activities
for the fiscal year ended March 31, 2001 was approximately $3.1 million, representing the net change in the Companys revolving line of credit agreement of approximately $5.3 million, proceeds from the issuance of a note payable for $2 million
and the net change in proceeds due from affiliated companies of approximately $.04 million, offset by the establishment of a restricted cash account of $2 million as required under the Standard loan agreement, payment of deferred financing costs of
approximately $.3 million and payments of long-term debt and capital leases of approximately $2 million.



On October 24, 2000, the Company obtained from Mellon Bank N.A. (Mellon) a $15 million line of credit and a $2 million term loan to refinance its prior bank indebtedness, to provide additional working
capital and for other general corporate purposes. The line of credit enabled the Company to borrow a maximum of $15 million, with borrowings limited to 85% of eligible accounts receivable and 65% of eligible inventory. The revolving credit facility
bears interest at the floating rate of 0.25% per annum over the base rate. The term loan is payable over a 36-month period with interest at 0.75% per annum over the base rate, which is the higher of Mellons prime rate or the effective federal
funds rate plus 0.50% per annum. In conjunction with the closing of the credit facility, the Company deposited $2 million in a restricted cash account with Mellon. The credit facility prohibits the payment of dividends. On October 29, 2001, the
Company executed a loan modification agreement modifying the original Mellon line of credit with Standard Federal Bank National Association (Standard), formerly Michigan National Bank as successor in interest to Mellon, increasing the
line to $23 million. On October 28, 2002, the Company executed a Fourth Amendment and Modification to Loan and Security Agreement with Standard. The amendment extended the contract period of the loan and security agreement to expire on October 24,
2004, from the original contract period which would have expired on October 24, 2003. In addition, the amendment modified the borrowing base, quarterly and annual net income, net worth and current ratio covenants commencing with the fiscal quarter
ended September 30, 2002, and the applicable interest rate margin commencing April 1, 2003. The amendment also imposed certain accounts receivable limitations and instituted a new indebtedness to net worth ratio for the fiscal year ending March 31,
2003 and for each fiscal year end thereafter. The interest rate on the term loan was 5.5%, and the interest rate on the revolving credit facility was 4.25% at March 31, 2003. The outstanding balances on the revolving line of credit and term loan
were approximately $15.9 million and $.5 million, respectively, as of March 31, 2003. The availability on the line of credit at March 31, 2003 was approximately $.5 million, based on eligible borrowing limits at that date. The Company was not in
compliance with the net worth covenant and the net worth to indebtedness covenant ratios as required by Standard at March 31, 2003. On April 15, 2003 the Company satisfied the outstanding balance of the Standard line of credit and term loan with the
new Congress credit facility and the restricted cash account with Mellon.



Management believes the Company has sufficient capital resources to fund the Companys operations for at least the next twelve months. Management does not believe the acquisition of Avery and the relocation of the Youngstown Ohio
location will have a material impact on the liquidity of the Company.



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##### Table of Contents

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



The Company is subject to market risk from exposure to changes in interest rates based on its financing and cash management activities, which could effect its results of
operations and financial condition. At March 31, 2003, the Companys outstanding debt with Standard was approximately $15.9 million on the line of credit and $.5 million on the term loan. The interest rates charged on the line of credit and
term loan are floating rates subject to periodic adjustment. At March 31, 2003, the interest rates charged on the line of credit and term loan were 4.25% and 5.5%, respectively. The company manages its risk by choosing the most advantageous interest
option offered by its lender. See Managements Discussion and Analysis of Financial Condition and Results of OperationsFinancial Condition, Liquidity and Capital Resources. The Company holds several notes receivable from its
customers which do not carry variable interest rates. The Company does not currently utilize derivative financial instruments to address market risk.



|Item 8. |  | FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
|------- |  | ------------------------------------------



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##### Table of Contents

Report of Independent Certified Public Accountants



Board of Directors and Stockholders

DrugMax, Inc.

Clearwater, FL



We have audited the accompanying consolidated balance
sheet of DrugMax, Inc. and subsidiaries (the Company) as of March 31, 2003 and the related consolidated statements of operations, stockholders equity, and cash flows for the year then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audit.



We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in
all material respects, the financial position of DrugMax, Inc. and subsidiaries at March 31, 2003, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the
United States of America.



BDO Seidman, LLP



Miami, FL



July 2, 2003



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INDEPENDENT AUDITORS REPORT



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



We have audited the accompanying consolidated balance sheet of DrugMax, Inc. and subsidiaries (the Company) as of March 31,
2002, and the related consolidated statements of operations, stockholders equity, and cash flows for each of the two years in the period ended March 31, 2002. These financial statements are the responsibility of the Companys management.
Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



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



As discussed in Note 2 to the consolidated financial statements, in 2002 the
Company changed its method of accounting for goodwill to conform to Statement of Financial Accounting Standards No. 142 and discontinued amortization of goodwill.



As discussed in Note 17, the 2002 and 2001 consolidated financial statements have been restated.



/s/ DELOITTE & TOUCHE LLP

Certified Public Accountants



Tampa, Florida

June 27, 2002

(November 22, 2002 as to Note 17)



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DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2003 and 2002



|                                                                                                         |  | 2003 |             |   | 2002 |  
|-------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | -
|ASSETS                                                                                                   |  |      |             |   |      |  
|Current assets:                                                                                          |  |      |             |   |      |  
|Cash and cash equivalents                                                                                |  | $    | 161,489     |   |      | $
|Restricted cash                                                                                          |  |      | 2,000,000   |   |      |  
|Accounts receivable, net of allowance for doubtful accounts of $1,253,829 and $340,575                   |  |      | 11,339,842  |   |      |  
|Inventory                                                                                                |  |      | 19,458,940  |   |      |  
|Due from affiliates                                                                                      |  |      | 10,470      |   |      |  
|Net deferred income tax assetcurrent                                                                    |  |      | 668,294     |   |      |  
|Prepaid expenses and other current assets                                                                |  |      | 1,079,740   |   |      |  
|                                                                                                         |  |      |             |   |      |  
|Total current assets                                                                                     |  |      | 34,718,775  |   |      |  
|Property and equipment, net                                                                              |  |      | 767,550     |   |      |  
|Goodwill                                                                                                 |  |      | 13,105,000  |   |      |  
|Intangible assets, net                                                                                   |  |      |            |   |      |  
|Stockholder notes receivable                                                                             |  |      | 100,000     |   |      |  
|Notes receivable                                                                                         |  |      | 625,329     |   |      |  
|Net deferred income tax assetlong term                                                                  |  |      | 749,336     |   |      |  
|Deferred financing costs, net                                                                            |  |      | 78,912      |   |      |  
|Other assets                                                                                             |  |      | 95,660      |   |      |  
|Deposits                                                                                                 |  |      | 33,561      |   |      |  
|                                                                                                         |  |      |             |   |      |  
|Total assets                                                                                             |  | $    | 50,274,123  |   |      | $
|                                                                                                         |  |      |             |   |      |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                     |  |      |             |   |      |  
|Current liabilities:                                                                                     |  |      |             |   |      |  
|Accounts payable                                                                                         |  | $    | 14,619,341  |   |      | $
|Accrued expenses and other current liabilities                                                           |  |      | 415,065     |   |      |  
|Credit lines payable                                                                                     |  |      | 15,943,619  |   |      |  
|Current portion of long-term debt and capital leases                                                     |  |      | 470,176     |   |      |  
|Due to affiliates                                                                                        |  |      | 4,377       |   |      |  
|                                                                                                         |  |      |             |   |      |  
|Total current liabilities                                                                                |  |      | 31,452,578  |   |      |  
|Long-term debt and capital leases                                                                        |  |      | 35,847      |   |      |  
|Other long-term liabilities                                                                              |  |      | 501,561     |   |      |  
|                                                                                                         |  |      |             |   |      |  
|Total liabilities                                                                                        |  |      | 31,989,986  |   |      |  
|                                                                                                         |  |      |             |   |      |  
|Commitments and contingencies                                                                            |  |      |             |   |      |  
|                                                                                                         |  |     
|Stockholders equity:                                                                                    |  |      |             |   |      |  
|Preferred stock, $.001 par value; 2,000,000 shares authorized; no preferred shares issued or outstanding |  |      |            |   |      |  
|Common stock, $.001 par value; 24,000,000 shares authorized; 7,119,172 shares issued and outstanding     |  |      | 7,120       |   |      |  
|Additional paid-in capital                                                                               |  |      | 40,967,355  |   |      |  
|Accumulated deficit                                                                                      |  |      | (22,690,338 | ) |      |  
|                                                                                                         |  |      |             |   |      |  
|Total stockholders equity                                                                               |  |      | 18,284,137  |   |      |  
|                                                                                                         |  |      |             |   |      |  
|Total liabilities and stockholders equity                                                               |  | $    | 50,274,123  |   |      | $
|                                                                                                         |  |      |             |   |      |  



See accompanying notes
to consolidated financial statements.



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DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Fiscal Years Ended March 31,



|                                             |  | 2003 |             |   | 2002 |   |             | 2001 | 
|-------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- | 
|Revenues                                     |  | $    | 291,751,771 |   |      | $ | 271,287,988 |      | 
|Cost of goods sold                           |  |      | 283,647,064 |   |      |   | 263,775,382 |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Gross profit                                 |  |      | 8,104,707   |   |      |   | 7,512,606   |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Selling, general and administrative expenses |  |      | 7,762,088   |   |      |   | 5,388,633   |      | 
|Amortization expense                         |  |      | 18,000      |   |      |   | 15,053      |      | 
|Depreciation expense                         |  |      | 306,577     |   |      |   | 245,280     |      | 
|Goodwill and asset impairment loss           |  |      | 12,209,298  |   |      |   |            |      | 
|Intangible impairment loss                   |  |      | 258,914     |   |      |   |            |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Total operating expenses                     |  |      | 20,554,877  |   |      |   | 5,648,966   |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Operating income (loss)                      |  |      | (12,450,170 | ) |      |   | 1,863,640   |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Other income (expense):                      |  |      |             |   |      |   |             |      | 
|Interest income                              |  |      | 94,685      |   |      |   | 63,553      |      | 
|Other income and expenses, net               |  |      | 48,086      |   |      |   | 98,612      |      | 
|Interest expense                             |  |      | (969,053    | ) |      |   | (1,002,274  | )    | 
|Interest expenseloan costs                  |  |      | (199,888    | ) |      |   | (119,957    | )    | 
|                                             |  |      |             |   |      |   |             |      | 
|Total other expense                          |  |      | (1,026,170  | ) |      |   | (960,066    | )    | 
|                                             |  |      |             |   |      |   |             |      | 
|Income (loss) before income tax benefit      |  |      | (13,476,340 | ) |      |   | 903,574     |      | 
|Income tax benefit                           |  |      | 313,882     |   |      |   | 1,103,548   |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Income (loss) before extraordinary item      |  |      | (13,162,458 | ) |      |   | 2,007,122   |      | 
|Extraordinary loss on extinguishment of debt |  |      |            |   |      |   |            |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Net income (loss)                            |  | $    | (13,162,458 | ) |      | $ | 2,007,122   |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Basic net income (loss) per common share:    |  |      |             |   |      |   |             |      | 
|Income (loss) before extraordinary item      |  | $    | (1.85       | ) |      | $ | 0.29        |      | 
|Extraordinary loss on extinguishment of debt |  |      |            |   |      |   |            |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Net income (loss) per common share-basic     |  | $    | (1.85       | ) |      | $ | 0.29        |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Diluted net income (loss) per common share:  |  |      |             |   |      |   |             |      | 
|Income (loss) before extraordinary item      |  | $    | (1.85       | ) |      | $ | 0.28        |      | 
|Extraordinary loss on extinguishment of debt |  |      |            |   |      |   |            |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Net income (loss) per common share-diluted   |  | $    | (1.85       | ) |      | $ | 0.28        |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Weighted average shares outstandingbasic    |  |      | 7,119,172   |   |      |   | 7,034,969   |      | 
|                                             |  |      |             |   |      |   |             |      | 
|Weighted average shares outstandingdiluted  |  |      | 7,119,172   |   |      |   | 7,234,024   |      | 
|                                             |  |      |             |   |      |   |             |      | 



See accompanying notes
to consolidated financial statements.



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DRUGMAX, INC, AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

For the Fiscal Years
ended March 31, 2003, 2002 and 2001



|                                                                    |  | CommonStock |       | AdditionalPaid-inCapital |   | AccumulatedDeficit |  |   | Total StockholdersEquity |  
|------------------------------------------------------------------- |  | ----------- | ----- | ------------------------ | - | ------------------ |  | - | ------------------------- | -
|Balances at April 1, 2000                                           |  | $           | 6,202 |                          | $ | 35,704,957         |  | $ | (2,228,836                | )
|Issuance of 217,255 shares for acquisition of Valley Drug Co.       |  |             | 217   |                          |   | 2,199,490          |  |   |                          |  
|Issuance of 50,000 shares to Utendahl Capital Partners LP           |  |             | 50    |                          |   | 196,825            |  |   |                          |  
|Issuance of 1,000 shares                                            |  |             | 1     |                          |   | 5,483              |  |   |                          |  
|Net loss                                                            |  |             |      |                          |   |                   |  |   | (9,306,166                | )
|                                                                    |  |             |       |                          |   |                    |  |   |                           |  
|Balances at March 31, 2001                                          |  |             | 6,470 |                          |   | 38,106,755         |  |   | (11,535,002               | )
|Issuance of 500,000 shares to Dynamic Health Products, Inc.         |  |             | 500   |                          |   | 1,968,250          |  |   |                          |  
|Issuance of 125,418 shares for Acquisition of Penner & Welsch, Inc. |  |             | 125   |                          |   | 749,875            |  |   |                          |  
|Issuance of 25,000 shares for Non-compete agreement                 |  |             | 25    |                          |   | 142,475            |  |   |                          |  
|Net income                                                          |  |             |      |                          |   |                   |  |   | 2,007,122                 |  
|                                                                    |  |             |       |                          |   |                    |  |   |                           |  
|Balance at March 31, 2002                                           |  |             | 7,120 |                          |   | 40,967,355         |  |   | (9,527,880                | )
|Net loss                                                            |  |             |      |                          |   |                   |  |   | (13,162,458               | )
|                                                                    |  |             |       |                          |   |                    |  |   |                           |  
|Balance at March 31, 2003                                           |  | $           | 7,120 |                          | $ | 40,967,355         |  | $ | (22,690,338               | )
|                                                                    |  |             |       |                          |   |                    |  |   |                           |  



See accompanying notes
to consolidated financial statements.



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DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Fiscal Years Ended March 31,



|                                                                                                   |  | 2003 |             |   | 2002 |   |            | 2001 | 
|-------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ---------- | ---- | 
|OPERATING ACTIVITIES                                                                               |  |      |             |   |      |   |            |      | 
|Net income (loss)                                                                                  |  | $    | (13,162,458 | ) |      | $ | 2,007,122  |      | 
|Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: |  |      |             |   |      |   |            |      | 
|Amortization of financing costs charged to interest expense                                        |  |      | 199,888     |   |      |   | 119,957    |      | 
|Extraordinary loss on extinguishment of debt                                                       |  |      |            |   |      |   |           |      | 
|Depreciation and amortization                                                                      |  |      | 324,577     |   |      |   | 260,333    |      | 
|Goodwill, intangible asset and asset impairment loss                                               |  |      | 12,468,212  |   |      |   |           |      | 
|Provision for loss on accounts receivable                                                          |  |      | 1,114,539   |   |      |   | 35,757     |      | 
|Reversal of forgiven accounts payable items                                                        |  |      | (83,458     | ) |      |   |           |      | 
|Loss on disposal of property and equipment                                                         |  |      | 921         |   |      |   | 5,303      |      | 
|Increase in net deferred income tax asset                                                          |  |      | (313,882    | ) |      |   | (1,103,548 | )    | 
|Expense on issuance of common stock                                                                |  |      |            |   |      |   |           |      | 
|Changes in operating assets and liabilities:                                                       |  |      |             |   |      |   |            |      | 
|Accounts receivable                                                                                |  |      | 1,346,118   |   |      |   | (385,375   | )    | 
|Merchandise inventory                                                                              |  |      | 1,223,499   |   |      |   | (9,270,331 | )    | 
|Due from affiliated companies                                                                      |  |      | 13,028      |   |      |   | 2,363      |      | 
|Prepaid expenses and other current assets                                                          |  |      | (397,392    | ) |      |   | (29,175    | )    | 
|Other assets                                                                                       |  |      | 55,566      |   |      |   | 105,662    |      | 
|Shareholder notes receivable                                                                       |  |      |            |   |      |   |           |      | 
|Notes receivable                                                                                   |  |      | 125,144     |   |      |   |           |      | 
|Deposits                                                                                           |  |      | 11,182      |   |      |   | (31,072    | )    | 
|Accounts payable                                                                                   |  |      | 858,033     |   |      |   | 2,396,293  |      | 
|Accrued expenses and other current liabilities                                                     |  |      | (6,253      | ) |      |   | (3,074     | )    | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                                                |  |      | 3,777,264   |   |      |   | (5,889,785 | )    | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|INVESTING ACTIVITIES                                                                               |  |      |             |   |      |   |            |      | 
|Purchases of property and equipment                                                                |  |      | (56,483     | ) |      |   | (68,250    | )    | 
|Proceeds from sale of property and equipment                                                       |  |      | 2,756       |   |      |   | 2,660      |      | 
|Investment in MorepenMax, Inc.                                                                     |  |      |            |   |      |   | (49,000    | )    | 
|Cash paid for acquisitions, net                                                                    |  |      |            |   |      |   | (488,619   | )    | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|NET CASH USED IN INVESTING ACTIVITIES                                                              |  |      | (53,727     | ) |      |   | (603,209   | )    | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|FINANCING ACTIVITIES                                                                               |  |      |             |   |      |   |            |      | 
|Increase in restricted cash                                                                        |  |      |            |   |      |   |           |      | 
|Net change under revolving line of credit agreements                                               |  |      | (2,985,956  | ) |      |   | 6,985,078  |      | 
|Increase in deferred financing costs                                                               |  |      | (63,321     | ) |      |   | (50,500    | )    | 
|Payments of long-term debt and capital leases                                                      |  |      | (680,144    | ) |      |   | (663,878   | )    | 
|Proceeds from issuance of note payable                                                             |  |      |            |   |      |   |           |      | 
|(Payments to)/ proceeds from affiliated companiesnet                                              |  |      |            |   |      |   | (46,720    | )    | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES                                                |  |      | (3,729,421  | ) |      |   | 6,223,980  |      | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|DECREASE IN CASH AND CASH EQUIVALENTS                                                              |  |      | (5,884      | ) |      |   | (269,014   | )    | 
|Cash and cash equivalents at beginning of year                                                     |  |      | 167,373     |   |      |   | 436,387    |      | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|CASH AND CASH EQUIVALENTS AT END OF YEAR                                                           |  | $    | 161,489     |   |      | $ | 167,373    |      | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|SUPPLEMENTAL DISCLOSURES OF CASH FLOWS ACTIVITIES                                                  |  |      |             |   |      |   |            |      | 
|Cash paid for interest                                                                             |  | $    | 987,406     |   |      | $ | 996,276    |      | 
|                                                                                                   |  |      |             |   |      |   |            |      | 
|Cash paid for income taxes                                                                         |  | $    |            |   |      | $ |           |      | 
|                                                                                                   |  |      |             |   |      |   |            |      | 



(continued)



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##### Table of Contents

DRUGMAX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended March 31,



|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  | 2003 |        | 2002 |   | 2001     
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | ---- | - | ---------
|Supplemental schedule of non-cash investing and financing activities:                                                                                                                                                                                                                                                                                                                                                                         |  |      |        |      |   |          
|In April 2000, the Company purchased all of the capital stock of Valley Drug Company for $1,757,481 in cash and 217,255 shares of
common stock (fair value of $2,199,707). In conjunction with the acquisition, liabilities were assumed as follows:                                                                                                                                                                                          |  |      |        |      |   |          
|Fair value of assets acquired                                                                                                                                                                                                                                                                                                                                                                                                                 |  |      |        |      |   |          
|Cash and stock issued for Valley capital stock                                                                                                                                                                                                                                                                                                                                                                                                |  |      |        |      |   |          
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|Liabilities assumed                                                                                                                                                                                                                                                                                                                                                                                                                           |  |      |        |      |   |          
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|In December 2000, the Company issued 50,000 shares of common stock to Utendahl Capital Partners, L.P., in connection with the
termination agreement as lead managing underwriter for a proposed offering.                                                                                                                                                                                                                                     |  |      |        |      |   |          
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|In January 2001, the Company issued 1,000 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                             |  |      |        |      |   |          
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|In July 2001, the Company released from escrow 500,000 shares of common stock (fair value of $1,968,750) due to Dynamic Health
Products, Inc., earned through the contingent consideration clauses in conjunction with the acquisition of Becan Distributors, Inc.                                                                                                                                                                            |  |      |        |      | $ | 1,968,750
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|In October 2001, the Company purchased substantially all the assets of Penner & Welsch, Inc. for $488,619 cash, 125,418 shares
of the common stock (fair value of $750,000), and $1,604,793 in forgiveness of debt owed to the Company. The Company also issued 25,000 shares of common stock (fair value of $142,500) in conjunction with a non-compete agreement. In conjunction with
the acquisition, liabilities were assumed as follows: |  |      |        |      |   |          
|Fair value of assets acquired                                                                                                                                                                                                                                                                                                                                                                                                                 |  |      |        |      | $ | 3,090,058
|Cash and stock issued for acquisition                                                                                                                                                                                                                                                                                                                                                                                                         |  |      |        |      |   | 1,381,119
|Forgiveness of debt owed to the Company                                                                                                                                                                                                                                                                                                                                                                                                       |  |      |        |      |   | 1,604,793
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|Liabilities assumed                                                                                                                                                                                                                                                                                                                                                                                                                           |  |      |        |      | $ | 104,146  
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|Conversion of accounts receivable to notes receivable.                                                                                                                                                                                                                                                                                                                                                                                        |  |      |        |      | $ | 740,281  
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          
|In August 2002, the Company entered into a capital lease agreement                                                                                                                                                                                                                                                                                                                                                                            |  | $    | 31,602 |      |   |          
|                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |      |        |      |   |          



See accompanying notes
to consolidated financial statements.



(concluded)



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##### Table of Contents

DRUGMAX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MARCH 31,
2003, 2002 AND 2001



NOTE 1BUSINESS



The Company is a full-line, wholesale distributor of pharmaceuticals, over-the-counter
products, health and beauty care aids, nutritional supplements and other related products. The Company is headquartered in Clearwater, Florida and maintains distribution centers in Pennsylvania, Ohio, and Louisiana. The Company distributes its
products primarily to independent pharmacies in the continental United States, and secondarily to small and medium-sized pharmacy chains, alternative care facilities and other wholesalers. The Company maintains an inventory in excess of 20,000 stock
keeping units from leading manufacturers and holds licenses to ship to all 50 states and Puerto Rico.



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Principles of Consolidation



The
accompanying consolidated financial statements include the accounts of DrugMax, Inc. (formerly known as DrugMax.com, Inc.) and its wholly-owned subsidiaries, Discount Rx, Inc. (Discount), Valley Drug Company (Valley) and its
wholly-owned subsidiary Valley Drug Company South (Valley South), Desktop Ventures, Inc., and Desktop Media Group, Inc. (Desktop); and its wholly-owned subsidiary VetMall, Inc. (VetMall), (collectively referred to
as the Company). All significant intercompany accounts and transactions have been eliminated.



Use of Estimates



The preparation of
consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



Fiscal Year



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



Cash and Cash Equivalents



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



Restricted Cash



Restricted cash includes amounts restricted
as collateral for the credit facility with Standard Federal Bank National Association (Standard), formerly Michigan National Bank as successor in interest to Mellon Bank N.A. (Mellon).



Accounts Receivable



Accounts receivable are customer obligations due under normal trade terms. The Company sells its products primarily to independent
pharmacies from traditional distribution channels and to companies and pharmacies through e-commerce business. The Company performs continuing credit evaluations of its customers financial condition and although it generally does not require
collateral, letters of credit or personal guarantees may be required from its customers under certain circumstances. Senior management reviews accounts receivable on a regular basis to determine if any accounts will potentially be uncollectible. The
Company includes any accounts receivable balances that are determined to be uncollectible, along with a general reserve, in its overall allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is
written off against the allowance. Based on the information available to management, it believes the Companys allowance for doubtful accounts as of March 31, 2003 is adequate. However, actual write-offs might exceed the recorded allowance.



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##### Table of Contents

Investments



On August 31, 2001, the Company reached an initial agreement with India-based Morepen Laboratories Ltd. (Morepen), to form a joint venture company, and on
September 10, 2001, MorepenMax, Inc, (MorepenMax), a Florida corporation, was formed. Morepen is the 51% majority shareholder of MorepenMax. On March 22, 2002, the Company funded its investment of $49,000 in MorepenMax, representing its
49% interest. MorepenMax plans to utilize the Morepen facilities to develop low-cost generic pharmaceuticals in the United States. The Company will be the exclusive distributor throughout the United States of the products developed by MorepenMax. In
June 2003, MorepenMax introduced its first generic product for distribution through the Company. This investment is accounted for under the equity method and is included in other assets.



Inventory



Inventory is stated at the lower of cost or market. Cost is determined using the first-in, first-out basis of accounting. Inventories at March 31, 2003 and 2002 consist
of brand and generic drugs, nutritional supplements, health and beauty aids and over the counter products, which when purchased by the Company as finished goods, are pre-packaged and ready for resale to the Companys customers. The inventories
of the Companys three distribution centers are constantly monitored for out of date or damaged products, which if exist, are reclassed and physically relocated out of saleable inventory to a holding area, referred to as the morgue
inventory, for return to and credit from the manufacturer. However, if market acceptance of the Companys existing products or the successful introduction of new products should significantly decrease, inventory write-downs could be required.
As of March 31, 2003, 2002 and 2001, no inventory valuation allowances were necessary.



Property and Equipment



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



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



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



Goodwill



The excess of cost over the fair value of net assets
acquired (goodwill) relates to the acquisitions discussed in Note 3. Prior to April 1, 2001, the excess of cost over net assets acquired was amortized over 15 years for acquisitions of Becan, Discount, and Valley using the straight-line method.
Accumulated amortization totaled approximately $2,225,000 at March 31, 2001. Goodwill relating to the acquisitions of Desktop and VetMall was assigned a life of 5 years and amortized for eleven months of the fiscal year ended March 31, 2001 on
straight-line method. An impairment of goodwill was recorded in March 2001 relative to the remaining goodwill for both Desktop and VetMall (see Note 4).



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



A reconciliation of previously reported net income (loss) and earnings (loss) per share to
the amounts adjusted for the exclusion of goodwill amortization, net of the related income tax effect, follows:



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|                                                                  |  | For the YearEnded March 31,2003 |             |   | For the YearEnded March 31,2002 |   | For the YearEnded March 31,2001 | 
|----------------------------------------------------------------- |  | ------------------------------- | ----------- | - | ------------------------------- | - | ------------------------------- | 
|Reported income (loss) before extraordinary item                  |  | $                               | (13,162,458 | ) |                                 | $ | 2,007,122                       | 
|Add: Goodwill amortization, net of income tax                     |  |                                 |            |   |                                 |   |                                | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Adjusted income (loss) before extraordinary item                  |  | $                               | (13,162,458 | ) |                                 | $ | 2,007,122                       | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Reported net income (loss)                                        |  | $                               | (13,162,458 | ) |                                 | $ | 2,007,122                       | 
|Add: Goodwill amortization, net of income tax                     |  |                                 |            |   |                                 |   |                                | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Adjusted net income (loss)                                        |  | $                               | (13,162,458 | ) |                                 | $ | 2,007,122                       | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Basic income (loss) before extraordinary item per common share:   |  |                                 |             |   |                                 |   |                                 | 
|Reported income (loss) before extraordinary item                  |  | $                               | (1.85       | ) |                                 | $ | 0.29                            | 
|Goodwill amortization, net of income tax                          |  |                                 |            |   |                                 |   |                                | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Adjusted income (loss) before extraordinary item                  |  | $                               | (1.85       | ) |                                 | $ | 0.29                            | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Diluted income (loss) before extraordinary item per common share: |  |                                 |             |   |                                 |   |                                 | 
|Reported income (loss) before extraordinary item                  |  | $                               | (1.85       | ) |                                 | $ | 0.28                            | 
|Goodwill amortization, net of income tax                          |  |                                 |            |   |                                 |   |                                | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Adjusted income (loss) before extraordinary item                  |  | $                               | (1.85       | ) |                                 | $ | 0.28                            | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Basic net income (loss) per common share:                         |  |                                 |             |   |                                 |   |                                 | 
|Reported net income (loss)                                        |  | $                               | (1.85       | ) |                                 | $ | 0.29                            | 
|Goodwill amortization, net of income tax                          |  |                                 |            |   |                                 |   |                                | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Adjusted net income (loss)                                        |  | $                               | (1.85       | ) |                                 | $ | 0.29                            | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Diluted net income (loss) per common share:                       |  |                                 |             |   |                                 |   |                                 | 
|Reported net income (loss)                                        |  | $                               | (1.85       | ) |                                 | $ | 0.28                            | 
|Goodwill amortization, net of income tax                          |  |                                 |            |   |                                 |   |                                | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 
|Adjusted net income (loss)                                        |  | $                               | (1.85       | ) |                                 | $ | 0.28                            | 
|                                                                  |  |                                 |             |   |                                 |   |                                 | 



Deferred Financing Costs



In March 2000, the Company recorded deferred financing costs of
$1,625,000 for a warrant issued to a director and non-employee consultant as a result of the directors acting as a guarantor of the Merrill Lynch line of credit (see Notes 9, 12 and 17). The Merrill Lynch line of credit was paid in full on
October 24, 2000, with proceeds from the new Mellon credit facility; therefore, the unamortized balance of deferred financing costs of $572,244 was written off in October 2000. In conjunction with the closing of the Mellon credit facility in October
2000, and the loan modification agreement executed October 2001 with Standard (see Note 9), and subsequent amendments to the loan agreement, the Company capitalized approximately $454,000 in financing costs incurred in obtaining the loans. These
costs are being amortized over the life of the term loans, under the effective interest rate method. Amortization of deferred financing costs was $199,888, $119,957 and $981,593 for the years ended March 31, 2003, 2002 and 2001, respectively. This
increase in fiscal 2003 was due to the acceleration of amortization expense because of the April 2003 refinancing. Accumulated amortization of deferred financing costs was $374,836 and $174,948 at March 31, 2003 and 2002, respectively.



Impairment of Long-Lived Assets



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



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##### Table of Contents

the difference between the carrying amounts and the fair value of these assets. Losses on impairments are recognized by a charge to earnings.



Income Taxes



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



Earnings Per Share



Basic earnings per share (EPS)
is calculated by dividing the net income (loss) by the weighted average number of shares of common stock outstanding for the period. Diluted EPS is calculated by dividing net income (loss) by the weighted average number of shares of common stock
outstanding for the period, adjusted for the dilutive effect of options and warrants, using the treasury stock method. The net loss per share for the fiscal year ended March 31, 2003 amounted to $1.85 per basic and diluted share. The fiscal year
ended March 31, 2002 reported a net income of $.29 per basic and $.28 per diluted share. The fiscal year ended March 31, 2001 reported a net loss of $1.45 per basic and diluted share. The Company recorded a goodwill and intangible asset impairment
loss in its second quarter of the fiscal year ended March 31, 2003 of approximately $12.5 million, which increased the net loss per basic and diluted share by $1.75. The Company recorded for the fiscal year ended March 31, 2003 an income tax benefit
of approximately $.3 million, which decreased the loss per basic and diluted share by $.04. During the year ended March 31, 2002, the Company reduced its entire valuation allowance, and booked approximately $1.1 million of deferred income tax
benefit, net of the current year deferred income tax expense of approximately $.4 million, which provided the Company with net income of $.16 per basic and $.15 per diluted share. In the fiscal year ended March 31, 2001, the Company recorded an
extraordinary loss on extinguishment of debt of approximately $.6 million, or $.09 per basic and diluted share, and if goodwill amortization expense had not been included in fiscal 2001, as presented in the fiscal years ended March 31, 2003 and 2002
under SFAS No. 142, it would have had the effect of decreasing the basic and diluted net loss per share by $.40 for the year ended March 31, 2001.



At March 31, 2003, 2002 and 2001, the Company had 1,656,634, 705,500 and 290,300 options, respectively, to purchase shares of the Companys common stock, in addition
to warrants to purchase 150,000 shares of the Companys common stock, which were anti-dilutive and not included in the computation of diluted EPS for the years ended March 31, 2003, 2002 and 2001. These anti-dilutive shares could potentially
dilute the basic EPS in the future.



Stock Based Compensation



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



|                                                                                                                                            |  | For the Fiscal Year Ended March 31, |            
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------- | -----------
|                                                                                                                                            |  | 2003                                |            
|Net (loss) income as reported                                                                                                               |  | $                                   | (13,162,458
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related
tax effects |  |                                     | 661,958    
|                                                                                                                                            |  |                                     |            
|Pro forma net (loss) income                                                                                                                 |  | $                                   | (13,824,416
|                                                                                                                                            |  |                                     |            
|(Loss) income per common share as reported:                                                                                                 |  |                                     |            
|Basic                                                                                                                                       |  | $                                   | (1.85      
|Diluted                                                                                                                                     |  | $                                   | (1.85      
|(Loss) income per common sharepro forma:                                                                                                   |  |                                     |            
|Basic                                                                                                                                       |  | $                                   | (1.94      
|Diluted                                                                                                                                     |  | $                                   | (1.94      



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For purposes of the above disclosure, the determination of the fair value of stock options granted in fiscal years 2003,
2002 and 2001 was based on the following: (i) a risk free interest rate of 6%, 3.94% to 5.31% and 5.38% respectively; (ii) expected option lives of 5-10 years in 2003 and 2002, and 10 years in 2001; and (iii) expected volatility in the market price
of the Companys common stock of 117%, 67%, and 85%, respectively.



The
weighted average fair value of options granted to employees were $1.29, $2.77, and $10.11 per share for the fiscal years ended March 31, 2003, 2002 and 2001, respectively.



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



Fair Value of Financial Instruments



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



Advertising and Sales Promotion Costs



Advertising costs are charged to expense as incurred. Advertising expense totaled
approximately $35,000, $59,000 and $131,000 for fiscal years ended March 31, 2003, 2002 and 2001, respectively.



Revenue Recognition



The Company recognizes revenue when goods are shipped and title or risk of loss resides with unaffiliated customers or when services are provided. Rebates and allowances are recorded as a component of cost of goods
sold in the period they are received from the vendor or manufacturer unless such rebates and allowances are reasonably estimable at the end of a reporting period. The Company records chargeback credits due from its vendors in the period when the
sale is made to the customer which is eligible for contract pricing from the manufacturer.



The Company accepts return of product from its customers for product which is saleable, in unopened containers and carries a current date. Generally, product returns are received via the Companys own delivery
vehicles, thereby eliminating a direct shipping cost from being incurred by the customer or the Company. Depending on the length of time the customer has held the product, the Company may charge a handling and restocking fee. Overall, the percentage
of the return of product to the Company is extremely low. The Company has no sales incentive or rebate programs with its customers.



Reclassifications



Certain amounts in the 2002 and 2001 consolidated financial statements have been reclassified to conform to 2003 presentation.



Recent Accounting Pronouncements



In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144), which addresses the
financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of, and was effective for
the Company on April 1, 2002. The adoption of SFAS No. 144 did not have an impact on the results of operations or financial position of the Company.



In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections
(SFAS No. 145). SFAS No. 145 will rescind SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax benefit. As a result
of SFAS No. 145, the criteria in APB No. 30 will be used to classify those gains and losses. The provisions of SFAS No. 145 related to of the rescission of FASB No. 13 shall be applied in fiscal years beginning after May 15. 2002. Early application
of the provisions of SFAS No. 145 related to the rescission of FSAB No. 13 is encouraged. The components of SFAS No. 145 adopted in



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the current year did not have an impact on the results of operations or financial position of the Company. The adoption of SFAS No.145 would require the
Company to restate the extraordinary loss on extinguishment of debt in 2001 to operating expenses.



In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146), which replaces Emerging Issues Task Force (EITF) Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.SFAS No. 146 requires that liabilities associated with exit or disposal activities be recognized when they are incurred. Under EITF
Issue No. 94-3, a liability for exit costs is recognized at the date of a commitment to an exit plan. SFAS No. 146 also requires that the liability be measured and recorded at fair value. Accordingly, the adoption of this standard may affect the
timing of recognizing future restructuring costs as well as the amounts recognized. The Company will adopt the provisions of SFAS No. 146, for any restructuring activities initiated after December 31, 2002.



In November 2002, the FASB issued Interpretation No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby
letters of credit. It also requires that at all times a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligations it assumes under that guarantee and must disclose that information in
its interim and annual financial statements. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company will apply the provisions of FIN 45 to any
guarantees issued after December 31, 2002. As of March 31, 2003, the Company did not have any guarantees outstanding.



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



In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 clarifies the application of Accounting Research Bulletin No. 51 for certain
entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other
parties. FIN 46 applies to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in July 2003 to variable interest entities in which the
Company may hold a variable interest that is acquired before February 1, 2003. The provisions of FIN 46 require that the Company immediately disclose certain information if it is reasonably possible that the Company will be required to consolidate
or disclose variable interest entities when FIN 46 becomes effective. The Company is currently assessing the impact of the adoption of FIN 46 as it relates to the Company.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and
Equity, (SFAS No. 150). SFAS No. 150 establishes standards for how an issuer classifies and measurers in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In
accordance with SFAS No. 150, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 shall be effective for financial instruments entered into or modified after May 31, 2003, and
otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The Company is currently assessing the impact of SFAS No. 150.



NOTE 3ACQUISITIONS



On April 19, 2000, the Company, Valley, Ronald J. Patrick (Patrick) and Ralph A. Blundo (Blundo and together with Patrick, the
Sellers) signed a Merger Purchase Agreement (the Agreement). In connection with the merger, the Sellers received an aggregate of 226,666 shares of the Companys common stock and cash in the amount of $1.7 million. In
addition, the Sellers deposited 22,666 shares of the Companys common stock with an escrow agent (the Holdback Shares). Based on audited financial statements of Valley as of April 19, 2000, the stockholders equity amounted to
$400,667, which was $141,160 less than the threshold amount of $541,827. Therefore, 9,411 of the Holdback Shares have been returned to the Company. After consideration of the return of the Holdback Shares, a total of 217,255 shares at $10.125 per
share were issued for the acquisition. The acquisition was accounted for using the purchase method of accounting and accordingly $3.6 million of goodwill was recorded. Prior to April 1, 2001, goodwill was amortized over a fifteen (15) year period.



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On April 18, 2000, Valley loaned the Sellers $170,000, of which $100,000 is outstanding at March 31, 2003 and 2002, to
pay for a portion of the flow through effects of their S Corporation taxable income resulting from the sale of Valley. These interest-free notes receivable are to be repaid upon the Sellers sale of Company common stock, which is restricted
stock subject to a holding period that ended on April 19, 2001.



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



On October 19, 2001, the Company entered into an Employment Agreement with Gregory M. Johns
(Johns), former owner of Penner, for an annual salary of $125,000, payable bi-weekly for an initial term of three years, through October 18, 2004, renewable for subsequent terms of one year thereafter. In accordance with the Employment
Agreement, the Company agreed to issue a total of 100,000 employee non-qualified stock options (the Options) to Johns at a price of $8.00 per share contingent upon the attainment of gross profit goals by Discount over the three year term
of the Employment Agreement. The Options, provided the goals are attained, would be issued one third of the total 100,000 each year for three years, and would be issued within sixty days of each anniversary date of the Employment Agreement. In
conjunction with the Employment Agreement, on October 19, 2001, Johns executed a Restrictive Covenants Agreement and Agreement Not to Compete (Non Compete Agreement) with the Company. The Non Compete Agreement constrains Johns during the
minimum three year term of the Employment Agreement in addition to a period of one year following his termination. In consideration for Johns execution of the Non Compete Agreement, the Company issued to Johns 25,000 shares of common stock of
the Company, with a fair market value of $142,500. The Non Compete Agreement was recorded as an intangible asset with associated amortization of $15,000 in fiscal 2002. In fiscal 2003, an intangible impairment loss was recorded for the unamortized
balance (see Note 4).



The business combinations of Valley and Penner were
accounted for by the purchase method of accounting. The results of operations of the above named businesses are included in the consolidated financial statements from their respective purchase dates. The Company acquired the following assets and
liabilities (net of cash received from Valley of $53,207 for fiscal year ended March 31, 2001) in the above business combinations:



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



The unaudited pro forma effect of the
acquisitions of Valley and Penner on the Companys revenues, net income (loss) and net income (loss) per basic and diluted share, had the acquisitions occurred on April 1, 2000 is as follows:



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|                                                           |  | For the Year Ended March 31, 2002 |             |   | For the Year Ended March 31, 2001 |  
|---------------------------------------------------------- |  | --------------------------------- | ----------- | - | --------------------------------- | -
|Revenues                                                   |  | $                                 | 273,944,559 |   |                                   | $
|Loss before extraordinary item                             |  | $                                 | (22,483     | ) |                                   | $
|Net loss                                                   |  | $                                 | (22,483     | ) |                                   | $
|Basic and diluted loss before extraordinary item per share |  | $                                 | (0.00       | ) |                                   | $
|Basic and diluted net loss per share                       |  | $                                 | (0.00       | ) |                                   | $



The proforma information for the
fiscal years ended March 31, 2002 and 2001 has been presented after the elimination of revenues and net income derived from the sales to Penner by Discount prior to the acquisition. In addition, the proforma information for the fiscal years ended
March 31, 2002 and 2001 has been presented after the elimination of non-recurring charges from the Penner operations as follows:



|                |  | For the Year EndedMarch 31, 2002 |         | For the Year EndedMarch 31, 2001
|--------------- |  | -------------------------------- | ------- | --------------------------------
|Management fees |  | $                                | 547,220 |                                 
|Trustee fees    |  |                                  | 25,000  |                                 
|Legal fees      |  |                                  | 160,577 |                                 



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



Pursuant to the Avery Agreement, the Company acquired
accounts receivable, inventory, equipment, furniture, the trade name and a patent pending for the process of the manufacture of vials for the respiratory therapy industry, preliminarily totaling $1,062,518. The liabilities assumed, which were
comprised principally of trade payables, upon preliminary investigation amounted to $912,518, and capital injected of $60,000. In addition, the Company executed a promissory note to the predecessor companys 50% shareholder, as additional
consideration. The $318,000 note includes a right of set off for accounts payable in excess of an agreed upon amount assumed at closing. The original note may not be reduced below $90,000 after set off, which management believes will be the adjusted
note amount. Terms of the note provide for principal payments due monthly beginning July 5, 2003 through the due date of January 5, 2006. Interest on the note is due quarterly beginning September 5, 2003 at the rate of 6% per annum. Also, the
Company executed a Consulting and Non-Competition Agreement (Consulting Agreement) with John VerVynck (VerVynck) an officer and shareholder of Avery and Infinity. The Consulting Agreement provides for the payment to VerVynck
of $39,360, payable bi-monthly, over the six-month term of the Consulting Agreement. The Consulting Agreement prohibits VerVynck from competing for one year following his termination and the six-month term of the consulting agreement. The Company
will operate the acquisition under a ficiticous name filing for Avery Pharmaceuticals, and anticipates that Avery will have a positive impact on the Companys fiscal 2004. The acquisition will be accounted for under the purchase accounting
method.



NOTE 4IMPAIRMENT OF ASSETS



The Company has completed several acquisitions which have generated significant amounts of
goodwill and intangible assets and related amortization. The values assigned to goodwill and intangibles, as well as their related useful lives, are subject to judgment and estimation by the Company. In addition, upon adoption of SFAS No. 142, the
Company ceased amortization of goodwill effective April 2001, and reviews goodwill annually for impairment. Goodwill and intangibles related to acquisitions are determined based on purchase price allocations. Valuation of intangible assets is
generally based on the estimated cash flows related to those assets, while the initial value assigned to goodwill is the residual of the purchase price over the fair value of all identifiable assets acquired and liabilities assumed. Thereafter, the
value of goodwill cannot be greater than the excess of the fair value of the Companys reportable unit over the fair value of identifiable assets and liabilities, based on the annual impairment test. Useful lives are determined based on the
expected future period of benefit of the asset, the assessment of which considers various characteristics of the asset, including historical cash flows. During the second quarter of fiscal 2003, the Company completed its annual two-step process of
the goodwill



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impairment test prescribed in SFAS No. 142, based upon September 30, 2002 values. The first step of the impairment test was the measurement of the
Companys fair market value versus book value, as defined under SFAS No. 142. Because the Companys fair market value, as determined by independent valuation using a discounted cash flow approach, was below book value at September 30,
2002, the Company was required to perform the second step of the impairment test. The second step involved comparing the implied fair value of the Companys goodwill to its fair market value to measure the amount of impairment. The goodwill
impairment test resulted in the Company recognizing a non-cash goodwill impairment loss of approximately $12.2 million relating to the goodwill recorded with the acquisitions of Becan Distributors, Inc. (Becan) in November 1999, Valley
in April 2000 and Penner in October 2001. During the second quarter of fiscal 2003, the Company also reviewed for impairment the Non-Compete Agreement and the domain name that were recorded as a result of the acquisition of Penner in October 2001.
These other intangible assets were determined by an independent appraisal to have no value. Accordingly, the Company recognized an impairment loss of $258,914 related to these other intangible assets.



Since the acquisitions of Desktop and VetMall, management has been faced with substantial
changes to the original business plans. The offices of Desktop and VetMall were relocated from Dallas, Texas to the Companys corporate office facilities in Clearwater, Florida during August 2000. The primary function of Desktop was to design
and develop customized Internet solutions for businesses and to a greater extent to continue to design, develop and maintain the VetMall web site. The amount of transition expense, loss of customer base, and problems with the web site and the delay
of its startup, are all factors which contributed to a negative cash flow for the twelve months ending March 31, 2001. Currently, the Company has no plan for business development for either Desktop or VetMall which would generate a positive cash
flow.



During the fourth quarter of the fiscal year ended March 31, 2001, the
Company reassessed the value of the goodwill and property, equipment and software recorded by the Company as a result of the acquisitions of Desktop and VetMall. Prior to that reassessment, the unamortized balances of the goodwill and real assets
consisted of $4,748,100 of goodwill, and $462,300 of acquired property, equipment and software. Management assessed the value of the related goodwill and property, equipment and software and concluded that the carrying value exceeded the fair value
of the assets. In determining the fair value of the impaired assets, management assumed that there would be no future cash flows from the acquired Desktop and VetMall businesses. Based on the lack of future cash flows and an estimated fair value of
zero, management concluded that an impairment of goodwill and certain software existed. Management determined that the remaining acquired property, equipment and software would be deployed within the Company; therefore, no impairment of these assets
existed. The economic factors indicated above caused management to revise downward its estimates of future cash flows from current and future revenues associated with the Desktop and VetMall businesses. As a result of managements analysis, and
using the best information available, management recorded impairment of asset charges of $3,877,580 in goodwill and $105,424 for software, during the fourth quarter of fiscal 2001. Additionally, the Company determined that approximately $456,700
capitalized in fiscal year 2001, which related to a delayed secondary offering of securities, had no future value and because market conditions were not conducive to a successful secondary offering of securities (see Note 12), the Company wrote off
these costs in the fourth quarter of fiscal 2001.



NOTE 5PROPERTY AND
EQUIPMENT



At March 31, 2003 and 2002 property and equipment consist of
the following:



|                                  |  | 2003 |           |   | 2002 |  
|--------------------------------- |  | ---- | --------- | - | ---- | -
|Furniture, equipment and vehicles |  | $    | 787,790   |   |      | $
|Computer software                 |  |      | 483,049   |   |      |  
|Leasehold improvements            |  |      | 75,417    |   |      |  
|                                  |  |      |           |   |      |  
|Total                             |  |      | 1,346,256 |   |      |  
|Accumulated depreciation          |  |      | (578,706  | ) |      |  
|                                  |  |      |           |   |      |  
|Property and equipment, net       |  | $    | 767,550   |   |      | $
|                                  |  |      |           |   |      |  



Depreciation expense for the years
ended March 31, 2003, 2002 and 2001 was $306,577, $245,280 and $247,868, respectively.





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NOTE 6GOODWILL AND OTHER INTANGIBLE ASSETS



Changes in the carrying amount of goodwill for the fiscal years ended March 31, 2003 and 2002, are as follows:



|Balance as of March 31, 2001 |  | $ | 25,179,255  |  
|---------------------------- |  | - | ----------- | -
|Goodwill acquired            |  |   | 135,043     |  
|                             |  |   |             |  
|Balance as of March 31, 2002 |  |   | 25,314,298  |  
|Goodwill impairment charge   |  |   | (12,209,298 | )
|                             |  |   |             |  
|Balance as of March 31, 2003 |  | $ | 13,105,000  |  
|                             |  |   |             |  



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



The following table reflects the components of other intangible assets:



|                                   |  | March 31, 2003      |   | March 31, 2002         
|---------------------------------- |  | ------------------- | - | -----------------------
|                                   |  | GrossCarryingAmount |   | AccumulatedAmortization
|Amortizable intangible assets:     |  |                     |   |                        
|Non compete agreement              |  | $                   |  |                        
|Domain name                        |  |                     |  |                        
|                                   |  |                     |   |                        
|Total                              |  | $                   |  |                        
|                                   |  |                     |   |                        
|Non-amortizable intangible assets: |  |                     |   |                        
|Domain name                        |  | $                   |  |                        
|                                   |  |                     |   |                        



Amortization expense for the fiscal
years ended March 31, 2003, 2002 and 2001 was $18,000, $15,044 and $2,550,260, respectively.



NOTE 7NOTES RECEIVABLE



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



On November 8, 2002, the Company renegotiated a note
receivable maturing in November 2007, which originated on March 28, 2002, with one of its customers for an account receivable. The renegotiated note bears interest at 2.5%, is collateralized by the customers accounts receivable and inventory,
and requires any subsequent charges after the date of the note to be paid currently in addition to the repayment of the note balance. The outstanding balance on the note at March 31, 2003 and 2002 was $268,763 and $329,012, respectively, of which
$57,990 and $65,520, respectively, representing the portion due within one year, is included in other current assets.



On November 8, 2002, the Company renegotiated a note receivable maturing in November 2007, which originated on March 28, 2002, with one of its customers for an account
receivable. The note bears interest at 2.5%, is unsecured, and requires any subsequent charges after the date of the note to be paid currently in addition to the repayment of the note balance. The outstanding balance on the note at March 31, 2003
and 2002 was $344,261 and $411,269, respectively, of which $85,246 and $67,344, respectively, representing the portion due within one year, is included in other current assets.



On January 16, 2003, the Company arranged a note with one of its customers for an account receivable. The note is unsecured, does not
carrying any interest, and requires the customer to make regular payments with the final payment due on August 7, 2003. The outstanding balance on the note which was reflected on the Companys accounts receivable at March 31, 2003 was $510,043.



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NOTE 8INCOME TAXES



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



|                                                                                   |  | Federal |          |   | State |   |          | Total | 
|---------------------------------------------------------------------------------- |  | ------- | -------- | - | ----- | - | -------- | ----- | 
|Fiscal year ended March 31, 2003:                                                  |  |         |          |   |       |   |          |       | 
|Current                                                                            |  |         |         |   |       |   |         |       | 
|Deferred                                                                           |  | $       | (282,927 | ) |       | $ | (30,955  | )     | 
|                                                                                   |  |         |          |   |       |   |          |       | 
|Total                                                                              |  | $       | (282,927 | ) |       | $ | (30,955  | )     | 
|                                                                                   |  |         |          |   |       |   |          |       | 
|Fiscal year ended March 31, 2002:                                                  |  |         |          |   |       |   |          |       | 
|Current                                                                            |  | $       |         |   |       | $ |         |       | 
|Deferred                                                                           |  |         | (950,084 | ) |       |   | (153,464 | )     | 
|                                                                                   |  |         |          |   |       |   |          |       | 
|Total                                                                              |  | $       | (950,084 | ) |       | $ | (153,464 | )     | 
|                                                                                   |  |         |          |   |       |   |          |       | 
|The Company had no income tax expense (benefit) for the year ended March 31, 2001. |  |         |          |   |       |   |          |       | 



The benefit for income taxes differs
from the amount computed by applying the U.S. federal income tax rate of 34% to income (loss) before income taxes for 2003, 2002 and 2001 as follows:



|                                                   |  | 2003   |            |   | 2002          |        |    | 2001   |  
|-------------------------------------------------- |  | ------ | ---------- | - | ------------- | ------ | -- | ------ | -
|Rate Reconciliation                                |  | Amount |            |   | EffectiveRate |        |    | Amount |  
|Statutory federal rate                             |  | $      | (4,581,956 | ) |               | (34.00 | %) |        | $
|State income taxes                                 |  |        | (47,133    | ) |               | (0.35  | %) |        |  
|Goodwill amortization and impairment               |  |        | 4,151,161  |   |               | 30.80  | %  |        |  
|Warrant expense                                    |  |        |           |   |               |       |    |        |  
|Other                                              |  |        | (5,634     | ) |               |       |    |        |  
|Understatement of prior years net operating losses |  |        | (410,420   | ) |               | (3.04  | %) |        |  
|Change in valuation allowance                      |  |        | 580,100    |   |               | 4.0    | %  |        |  
|                                                   |  |        |            |   |               |        |    |        |  
|                                                   |  | $      | (313,882   | ) |               | (2.59  | %) |        | $
|                                                   |  |        |            |   |               |        |    |        |  



Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of deferred income tax assets and liabilities, net of valuation
allowance, as of March 31, 2003 and 2002 are as follows:



|                                                               |  | 2003 |           |   | 2002 |  
|-------------------------------------------------------------- |  | ---- | --------- | - | ---- | -
|Net operating losses                                           |  | $    | 1,091,562 |   |      | $
|Net operating lossesacquired                                  |  |      | 190,384   |   |      |  
|Use of cash basis method of accounting for income tax purposes |  |      | (128,500  | ) |      |  
|Uniform capitalization of inventory cost                       |  |      | 229,935   |   |      |  
|Basis difference in property and equipment                     |  |      | (47,078   | ) |      |  
|Basis difference on deductible goodwill and other intangibles  |  |      | 55,010    |   |      |  
|Other                                                          |  |      | 7,555     |   |      |  
|Bad debt and other accruals                                    |  |      | 598,862   |   |      |  
|                                                               |  |      |           |   |      |  
|Net deferred income tax assets                                 |  |      | 1,997,730 |   |      |  
|Valuation allowance                                            |  |      | 580,100   |   |      |  
|                                                               |  |      |           |   |      |  
|Net deferred income tax asset after valuation allowance        |  | $    | 1,417,630 |   |      | $
|                                                               |  |      |           |   |      |  



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At March 31, 2003, the net operating loss and acquired tax loss carry forward benefits of approximately $2.9 million and
$.5 million expire through 2023. Due to the Companys acquisition of Desktop, the Companys ability to utilize the acquired net operating loss carry forward of $500,000 will be limited by IRS Section 382 to $113,000 per year.



SFAS No. 109 requires a valuation allowance to reduce the deferred income tax assets
reported, if based on the weight of the evidence, it is more likely than not that a portion or all of the deferred income tax assets will not be realized. As such, a valuation allowance of $1,458,500 was established at March 31, 2001.



In assessing the realizability of deferred income tax assets, management considers whether it
is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which
those temporary differences become deductible. Management evaluated the scheduled reversal of deferred income tax liability, the Companys profitability for the year ended March 31, 2002, reviewed the Companys business model, and future
earnings projections, and believes the evidence indicates that the Company will be able to generate sufficient taxable income to utilize the deferred income tax asset; therefore, the Company recognized the full $1,458,500 deferred income tax asset,
offset by current year deferred income tax expense of $354,952, for a net deferred income tax benefit of $1,103,548 for the year ended March 31, 2002.



The Company determines a valuation allowance based on its analysis of amounts available in the statutory carryback period, consideration of future deductible amounts, and
assessment of future profitability. As a result of the substantial operating losses incurred during fiscal year 2003, the Company established valuation allowances for a portion of the net deferred tax asset in the amount of $580,100 as of March 31,
2003, as it will take more than a few years to realize the deferred tax asset.



NOTE 9DEBT



On March 17, 2000, the Company signed a
$1,000,000 line of credit agreement with First Community Bank of America. Terms of the agreement provided for interest to be charged at 1% over the rate of interest paid on the Companys $1,000,000 certificate of deposit held by First Community
Bank of America and used to collateralize the loan facility. The balance on the line of credit became due on October 1, 2000. On November 6, 2000, documents were executed to extend the line of credit agreement for an additional six-month period with
a due date of April 1, 2001. The First Community Bank of America certificate of deposit matured on March 15, 2001, and on March 19, 2001, was used to satisfy the line of credit agreement.



In March 2000, the Company entered into a line of credit agreement with Merrill Lynch. The line of credit enabled the Company to borrow a
maximum of $5,000,000 with borrowings limited to 80% of eligible accounts receivable and 50% of inventory (capped at $1,000,000). The Merrill Lynch line of credit was paid in full on October 24, 2000, with proceeds from the new Mellon credit
facility. In conjunction with this repayment, the unamortized deferred loan costs associated with the line of credit were written off as an extraordinary loss on the early extinguishment of debt.



On October 24, 2000, the Company obtained from Mellon Bank N.A. (Mellon) a $15
million line of credit and a $2 million term loan to refinance its prior bank indebtedness, to provide additional working capital and for other general corporate purposes. The line of credit enabled the Company to borrow a maximum of $15 million,
with borrowings limited to 85% of eligible accounts receivable and 65% of eligible inventory. The line of credit bears interest at the floating rate of 0.25% per annum over the base rate. The term loan is payable over a 36-month period with interest
at 0.75% per annum over the base rate, which is the higher of Mellons prime rate or the effective federal funds rate plus 0.50% per annum. In conjunction with the closing of the Mellon credit facility, the Company deposited $2 million in a
restricted cash account with Mellon. The credit facility prohibits the payment of dividends. On October 29, 2001, the Company executed a loan modification agreement modifying the original Mellon line of credit with Standard Federal Bank National
Association (Standard), formerly Michigan National Bank as successor in interest to Mellon, increasing the line to $23 million. On October 28, 2002, the Company executed a Fourth Amendment and Modification to Loan and Security Agreement
with Standard. The amendment extended the contract period of the loan and security agreement to expire on October 24, 2004, from the original contract period which would have expired on October 24, 2003. In addition, the amendment modified the
borrowing base, quarterly and annual net income, net worth and current ratio covenants commencing with the fiscal quarter ended September 30, 2002, and the applicable interest rate margin commencing April 1, 2003. The amendment also imposed certain
accounts receivable limitations and instituted a new indebtedness to net worth ratio for the fiscal year ending March 31, 2003 and for each fiscal year end thereafter. The Company was not in compliance with the net worth covenant and the net worth
to indebtedness ratio covenant with Standard at March 31, 2003. The interest rate on the term loan was 5.5%, and the interest rate on the revolving credit facility was 4.25% at March 31, 2003. The outstanding balances on the revolving line of credit
and term loan were approximately $15.9 million and $18.9 million, and $.5 million and $1.1 million, respectively, as of March 31, 2003 and 2002. The availability on the line of credit at March 31, 2003 was approximately $.5 million, based on
eligible borrowing limits at March 31, 2003.



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The Standard line of credit and term loan were paid in full with the April 15, 2003 Congress Financial Corporation (Congress) credit facility and
the restricted cash account with Mellon. In March 2003, the Company expensed 50% of the unamortized financing costs to interest expense related to the early termination of the Standard credit facility, and will record the remaining balance of the
unamortized financing costs to interest expense in April 2003, in addition to an early termination fee of $351,000, and a fee for the waiver of the 90-day notice of termination of $30,000.



On April 15, 2003, the Company obtained from Congress a $40 million revolving line of credit
and a $400,000 term note. The Congress credit facility along with the Mellon restricted cash account of $2 million were used to satisfy the outstanding line of credit and tern loan with Standard. The Congress revolving line of credit enables the
Company to borrow a maximum of $40 million, with borrowings limited to 85% of eligible accounts receivable and 65% of eligible inventory. The revolving line of credit and the term note bear interest at the rate of 0.50% per annum in excess of the
Prime Rate. The Congress credit facility is collateralized by all the Companys assets. The line of credit is for a term of 36 months, and the term note is payable over the same 36-month period. The Congress credit facility imposes certain
restrictive covenants on tangible net worth and EBITDA. All costs associated with the Congress credit facility will be amortized as interest expense over the term of the loan.



On April 15, 2003, Jugal K. Taneja (Taneja), the Chairman of the Board, CEO and a Director of the Company executed a Guarantee
(the Guarantee) in favor of Congress. The Guarantee provides Congress with Tanejas unconditional guaranty of all obligations, liabilities, and indebtedness of any kind of the Company to Congress. In June 2003, the Company issued
57,143 shares of common stock of the Company to Taneja as compensation for his guarantee in favor of Congress. Notwithstanding anything to the contrary, the liability of the guarantor shall not exceed $2 million in year 1; reduced to $1.5 million in
year 2; and further reduced to $1 million in year 3, subject to the Company achieving collateral availability objectives.



NOTE 10COMMITMENTS AND CONTINGENCIES



Leases



The Company has operating leases for facilities that expire at various dates through 2007. Certain leases provide an option to extend the lease term. Certain leases provide for payment by the Company of any increases
in property taxes, insurance, and common area maintenance over a base amount and others provide for payment of all property taxes and insurance by the Company.



The Company leases computer and office equipment with original lease terms ranging from three to five years. These leases expire at various dates through fiscal 2007.



The Company leases vehicles for delivery and sales purposes with original
lease terms ranging from one to five years. These leases expire at various dates through fiscal 2006.



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



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



|Year Ending March 31                          |  | Operating Leases |         | Capital Leases |  
|--------------------------------------------- |  | ---------------- | ------- | -------------- | -
|2004                                          |  | $                | 319,890 |                | $
|2005                                          |  |                  | 311,227 |                |  
|2006                                          |  |                  | 267,159 |                |  
|2007                                          |  |                  | 89,094  |                |  
|2008 and thereafter                           |  |                  |        |                |  
|                                              |  |                  |         |                |  
|Total payments                                |  | $                | 987,370 |                |  
|                                              |  |                  |         |                |  
|Less amount representing interest             |  |                  |         |                |  
|                                              |  |                  |         |                |  
|Total present value of minimum lease payments |  |                  |         |                | $
|                                              |  |                  |         |                |  



Total rent expense for the years ended
March 31, 2003, 2002 and 2001 was approximately $344,000, $226,000 and $177,700, respectively.



Purchase Commitments



The Company
currently has purchase commitments with three vendors which require the Company to annually purchase a minimum of approximately $20,150,000. These commitments expire through November 2004, except for a $50,000 vendor agreement which is ongoing until
terminated by either party.



Litigation



The Company previously executed an engagement letter with GunnAllen Financial
(GAF) with an effective date of August 20, 2001, for consulting services over a three month period from the effective date, and renewable month to month thereafter until terminated by



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either party with a thirty day notice. The GAF agreement required that the Company pay to GAF, for consulting services performed, $5,000 per month plus
expenses capped at $2,000 per month, and further required the Company to issue a warrant to GAF exercisable for a period of five years to purchase 100,000 shares of the Companys common stock at an exercise price of $5.80 per share. However, on
October 12, 2001, the Company terminated the agreement with GAF and informed GAF that GAF was in breach of contract under the Agreement and that, accordingly, no warrants would be issued to GAF and no further fees would be paid to GAF. The Company
also demanded the return of all fees previously paid to GAF. At March 31, 2003, no warrants had been issued to GAF. As of June 30, 2003 GAF had not instituted any legal proceedings against the Company. The Company cannot reasonably estimate any
future possible loss as a result of this matter. The Company has made no provision in the accompanying consolidated financial statements for resolution of this matter.



In March 2000, the Company acquired all of the issued and outstanding shares of common stock of Desktop Corporation, a Texas corporation
located in Dallas, Texas, pursuant to an Agreement and Plan of Reorganization by and among the Company, K. Sterling Miller, Jimmy L. Fagala and HCT Capital Corp. (the Reorganization Agreement). On February 7, 2002, Messrs. Miller and
Fagala filed a complaint against the Company in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, Florida, alleging, among other things, that the Company had breached the Reorganization Agreement by failing to pay 38,809
shares of the Companys common stock to plaintiffs. The complaint also includes a count of conversion and further alleges that the Company breached its employment agreements with Messrs. Miller and Fagala, for which the plaintiffs seek monetary
damages. On March 11, 2002, the Company filed its answer, affirmative defenses and counterclaim against plaintiffs and HCT Capital Corp., in which it alleged, among other things, that plaintiffs had breached the Reorganization Agreement by
misrepresenting the state of the acquired business, that the Company was entitled to set off its damages against the shares which the plaintiffs are seeking and further seeking contractual indemnity against the plaintiffs. On April 16, 2002, HCT
Capital Corp. filed its answer, counterclaim against the Company and cross-claim against the plaintiffs. In September of 2002, Plaintiffs served the Company with written discovery requests. Since then, there has been no activity by Plaintiffs or
HCT, and the Company is currently considering how to proceed in light of this inactivity. The Company intends to vigorously defend the actions filed against it and to pursue its counterclaim. The Company has made no provision in the accompanying
consolidated financial statements for resolution of this matter.



On May 1,
2002, the Company filed suit against an established customer of the Companys Pittsburgh distribution center for collection of past due accounts receivable. The customer accounted for approximately $4.1 million, or 1.5%, of the gross revenue of
the Company in the fiscal year ended March 31, 2002. The Company has an unconditional personal guaranty signed by the customers owner. On May 23, 2002, the customer filed a voluntary petition in bankruptcy in the U.S. Bankruptcy Court, under
Chapter Eleven of the United States Bankruptcy Act, subsequent to which the customer failed to file the proper financial data with the court, causing the voluntary bankruptcy filing to be withdrawn. Management is continuing to pursue its claim for
payment through the courts and working with the major creditors to process return of inventory; therefore based upon Managements participation in the discovery phase of the suit, the allowance account has been reduced to $669,000, representing
approximately 75% of the account balance reserved at March 31, 2003.



The Company is, from time to time, involved in litigation relating to claims arising out of its operations in the ordinary course of business. The Company believes that none of the claims that were outstanding as of March 31, 2003 should
have a material adverse impact on its financial position, results of operations, or cash flows.



NOTE 11EMPLOYEE BENEFIT PLAN



In
January 2002, the Company adopted the DrugMax, Inc. 401(k) Plan (the 401(k) Plan). Full time employees are eligible to participate in the 401(k) Plan beginning the next quarterly enrollment date after completion of one year of employment
with the Company. Eligible employees may contribute up to $12,000 and $11,000 of their annual compensation on a pre-tax basis for the 2003 and 2002, respectively, 401(k) Plan years. Participant contributions are immediately vested. In addition,
under the terms of the 401(k) Plan, for each plan year, the Company may contribute an amount of matching contributions determined by the Company at its discretion. Participants become vested in the Company matching contributions over a six-year
period. The Company made no contributions to the 401(k) Plan in the fiscal years ended March 31, 2003 and 2002.



NOTE 12STOCK AND BENEFIT PLANS



Offering



On November 1, 2000, the Company filed a registration statement with the Securities and Exchange Commission for a proposed secondary offering of 2,000,000 shares of the Companys common stock. Utendahl Capital
Partners, L.P. (Utendahl) was contracted to act as lead managing underwriter of the proposed offering. However, on December 29, 2000, the Company and Utendahl agreed to



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terminate their agreement and Utendahl received 50,000 shares of the Companys common stock, valued at $3.9375 per share, for full release of the
agreement.



The total costs incurred by the Company were approximately
$456,700, and were capitalized during the third quarter of 2001. During the fourth quarter of 2001, management determined that market conditions were not conducive to a successful secondary offering of securities and cancelled the registration. As
such, all costs incurred and capitalized, relative to this offering, were expensed as an impairment of assets during 2001. On October 30, 2001, the Company filed Form RW with the Securities and Exchange Commission requesting consent to withdraw the
Companys Registration Statement on Form SB-2.



Warrants



In connection with an offering on November 22, 1999, and as additional
compensation to the underwriters, the Company issued warrants for the purchase of 150,000 shares of common stock. The warrants are exercisable, in whole or in part, between the first and fifth years, at an exercise price of $16.50. The underwriters
shall have the option to require the Company to register the warrants and/or the common stock underlying the warrants. The warrants had an estimated fair market value of approximately $839,000 on the date of issuance, determined under the
Black-Scholes Model, assuming an expected life of 5 years, a risk-free interest rate of 6.56%, expected volatility of 75%, and no dividends. This amount is included in additional paid in capital along with other issuance costs of the offering.



On January 23, 2000, the Company granted a director and a non-employee
consultant to the Company, a three-year warrant to purchase 200,000 shares of common stock at an exercise price of $15.98, which approximates the 30-day weighted average of the stock price from January 23, 2000 to February 22, 2000. The warrants
were immediately vested on January 23, 2000. The grant was made as a result of the director acting as a guarantor of the $5,000,000 Merrill Lynch line of credit (see Note 9). The warrants had an estimated fair value of approximately $1,625,000,
which was determined using the Black-Scholes Model, assuming an expected life of 3 years, a risk-free interest rate of 6.63%, expected volatility of 75%, and no dividends. The fair value of the warrant was amortized over the term of the line of
credit. The Merrill Lynch line of credit was paid in full on October 24, 2000 with proceeds from the new Mellon credit facility; therefore, the unamortized balance of the financing costs of $572,244 was recognized as an extraordinary loss on the
early extinguishment of debt in October 2000.



Stock Options



In August 1999, the Companys Board of Directors adopted a stock option plan (the
Plan), which was approved by the Companys shareholders at its annual meeting in August 2000. The Plan provides for the grant of incentive and nonqualified stock options to key employees, including officers, directors and
consultants of the Company. Under the provisions of the Plan, all options, except for incentive options granted to greater-than-10%-stockholders, have an exercise price equal to the fair market value on the date of the grant and expire
no more than ten years after the grant date. The exercise price of incentive options issued to greater-than-10%-stockholders shall not be less than 110% of the fair market value of the common stock on the date of the grant, and such
options shall expire five years after the date of the grant. During the years ended March 31, 2003, 2002 and 2001, no stock options were issued to consultants. At March 31, 2003, options to acquire up to 2,000,000 shares of common stock may be
granted pursuant to the Plan.



Stock option activity is
summarized as follows:



|Incentive and Non-Qualified Stock Options |  | Number ofShares |   |  | WeightedAverageExercisePrice
|----------------------------------------- |  | --------------- | - |  | ----------------------------
|Outstanding March 31, 2000                |  | 261,800         |   |  | $                           
|                                          |  |                
|Granted                                   |  | 75,000          |   |  |                             
|Forfeited                                 |  | (46,500         | ) |  |                             
|                                          |  |                 |   |  |                             
|Outstanding March 31, 2001                |  | 290,300         |   |  |                             
|                                          |  |                
|Granted                                   |  | 950,700         |   |  |                             
|Forfeited                                 |  | (21,900         | ) |  |                             
|                                          |  |                 |   |  |                             
|Outstanding March 31, 2002                |  | 1,219,100       |   |  |                             
|                                          |  |                
|Granted                                   |  | 702,934         |   |  |                             
|Forfeited                                 |  | (265,400        | ) |  |                             
|                                          |  |                 |   |  |                             
|Outstanding at March 31, 2003             |  | 1,656,634       |   |  |                             
|                                          |  |                 |   |  |                             





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Outstanding options under the Plan vest over a one- to three-year period. As of March 31, 2003 and 2002, 1,094,439 and
636,533 options, respectively, with a weighted average exercise price of $5.85 and $7.13, respectively, were exercisable. The following is a summary of stock options outstanding and exercisable as of March 31, 2003.



|ExercisePrice |  | Options Outstanding |  | Weighted AverageRemaining ContractualLife (years) |  | OptionsExercisable
|------------- |  | ------------------- |  | ------------------------------------------------- |  | ------------------
|$10.00        |  | 5,000               |  | 6.66                                              |  | 5,000             
|13.00         |  | 169,800             |  | 6.83                                              |  | 169,800           
|11.38         |  | 7,500               |  | 7.16                                              |  | 7,500             
|10.88         |  | 30,000              |  | 7.25                                              |  | 20,000            
|7.00          |  | 7,500               |  | 7.50                                              |  | 5,000             
|3.50          |  | 497,200             |  | 8.00                                              |  | 249,072           
|5.70          |  | 900                 |  | 8.33                                              |  | 300               
|5.00          |  | 142,500             |  | 8.42                                              |  | 142,500           
|5.75          |  | 40,000              |  | 3.55                                              |  | 40,000            
|6.05          |  | 28,300              |  | 8.58                                              |  | 9,433             
|4.00          |  | 25,000              |  | 9.00                                              |  | 25,000            
|3.25          |  | 25,000              |  | 9.25                                              |  | 25,000            
|3.85          |  | 5,000               |  | 9.25                                              |  |                  
|1.70          |  | 6,000               |  | 9.50                                              |  |                  
|1.55          |  | 242,500             |  | 9.50                                              |  | 242,500           
|1.00          |  | 171,100             |  | 9.58                                              |  |                  
|8.00          |  | 33,334              |  | 9.66                                              |  | 33,334            
|2.00          |  | 220,000             |  | 9.66                                              |  | 120,000           
|              |  |                     |  |                                                   |  |                   
|              |  | 1,656,634           |  |                                                   |  | 1,094,439         
|              |  |                     |  |                                                   |  |                   



Remaining non-exercisable options as
of March 31, 2003 become exercisable as follows:



|2004 |  | 231,933
|---- |  | -------
|2005 |  | 219,500
|2006 |  | 110,702
|     |  |        
|     |  | 562,195
|     |  |        



NOTE 13RELATED PARTY
TRANSACTIONS



GO2 Pharmacy, Inc., a publicly traded company, formerly
Innovative Health Products, Inc. (GO2), is a supplier of manufactured dietary supplements and health and beauty care products. Mr. Taneja is a Director and Chairman of the Board of GO2 and of the Company. In the fiscal years ended March
31, 2003, 2002 and 2001, the Company purchased approximately $3,200, $5,200 and $220,000, respectively, of products for resale from GO2.



On September 13, 2000, the Company entered into a management agreement with Penner and Welsch, Inc., (Penner), pursuant to which it agreed to manage the
day-to-day operations of Penner during the bankruptcy proceeding in exchange for a management fee equal to a percentage of the gross revenues of Penner each month. In turn, the Company entered into a management agreement with Dynamic Health
Products, Inc. (Dynamic) pursuant to which Dynamic provided accounting support services to the Company in connection with the Companys management responsibilities relating to Penner. Pursuant to this agreement, Dynamic was entitled
to receive one-third of all fees collected by the Company from Penner. In fiscal 2002 and fiscal 2001, the total fees paid to Dynamic by the Company were $225,226 and $229,417, respectively. Mr. Taneja is a Director and Chairman of the Board of
Dynamic and the Company. Both agreements were terminated in October 2001, in connection with the closing of the acquisition of certain assets from Penner by the Company.



In April 2000, in connection with the acquisition of Valley, the Company loaned the sellers of Valley a total of $170,000 to pay for a
portion of the flow through effects of their S Corporation taxable income resulting from the sale of Valley. These are interest-free



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notes receivable and are to be repaid by Mr. Patrick, Chief Financial Officer of the Company, and Mr. Blundo, the President of Valley, upon their sale of the
Company stock, which is restricted stock subject to a holding period which ended on April 19, 2001. At March 31, 2003 and 2002, the outstanding balance on the notes was $100,000.



Mr. Blundo, the President of Valley, and Mr. Patrick, the Chief Financial Officer of the Company, together are 2/3 owners of Professional
Pharmacy Solutions, LLC (PPS), a pharmacy management company. Valley sells products to PPS under normal terms and conditions. During the fiscal year ended March 31, 2003, the Company generated revenues of approximately $1.5 million, and
generated revenues of approximately $1.1 million for each of the fiscal years ended March 31, 2002 and 2001 from PPS. The receivable balance due from PPS at March 31, 2003 and 2002 was approximately $400,000 and $590,000, respectively.



In October 2001, the Company executed a Commercial Lease Agreement (the Lease)
with River Road Real Estate, LLC (River Road), a Florida limited liability company, to house the operations of Valley South in St. Rose, Louisiana. The officers of River Road are Taneja, a Director, Chief Executive Officer, Chairman of
the Board and a majority shareholder of the Company; William L. LaGamba, a Director, Chief Operating Officer, and the President of the Company; Stephen M. Watters, a former Director of the Company; and Johns, an employee of the Company and the
former owner of Penner. The Lease is for an initial period of five years with a base monthly lease payment of $15,000, and an initial deposit of $15,000 made to River Road by the Company. In the fiscal years ended March 31, 2003 and 2002, the
Company paid $180,000 and $90,000, respectively, to River Road, which was a charge to rent expense.



Advanced Pharmacy, Inc. (Advanced), is a retail pharmacy for prescription drugs owned by Mihir Taneja, a stockholder of the Company and the adult son of Taneja, the Chairman and CEO of the Company, and
Michelle LaGamba, the spouse of William L. LaGamba, the President, COO and a Director of the Company. The Company sells products to Advanced under normal terms and conditions. In the fiscal years ended March 31, 2003, 2002 and 2001, the Company
generated revenues of approximately $4.9 million, $18,000 and $19,000, respectively, from Advanced. At March 31, 2003, 2002 and 2001, the receivable balance due from Advanced was approximately $255,000, $19,000 and $18,000, respectively. At March
31, 2003, the Company also had an additional receivable from Advanced for approximately $95,000 representing start up inventory purchased by Advance, which will be paid within one year.



In the fiscal year ended March 31, 2003, the Company advanced to its employee and the former owner of Penner, Johns, funds in the amount of
approximately $107,000, which is secured by a note executed by Johns. The note was not associated with or as a result of the Companys acquisition of Penner. The note bears no interest and is being paid by Johns through deductions from his
compensation from the Company. At March 31, 2003, the outstanding balance due from Johns was approximately $101,266.



NOTE 14SEGMENT INFORMATION



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



During the fiscal year ended March 31, 2001, the Company operated two industry segments: wholesale distribution and computer software development. During the fiscal years
ended March 31, 2003 and 2002, the Company did not operate the software development segment and has made the determination to concentrate on the Companys core wholesale distribution businesses. The Company has determined that is has one
reportable segment because all distribution subsidiaries have similar economic characteristics, such as margins, products, customers, distribution networks and regulatory oversight. The distribution line of business represents 100% of consolidated
revenues in fiscal years 2003 and 2002, and substantially all of the consolidated revenues in fiscal year 2001. The accounting policies of the operating segment are those discussed in Note 2, Summary of Significant Accounting Policies.



The Company distributes product both within and outside the United States. Revenues from
distribution within the United States represented approximately 99.5%, 99.8% and 100.0% of gross revenues for the years ended March 31, 2003, 2002 and 2001, respectively. Foreign revenues were generated primarily from distribution to customers in
Puerto Rico.



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



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|                             |  | 2003 |             | 2002 |   | 2001       
|---------------------------- |  | ---- | ----------- | ---- | - | -----------
|Revenue from:                |  |      |             |      |   |            
|Branded pharmaceuticals      |  | $    | 268,443,471 |      | $ | 252,526,812
|Generic pharmaceuticals      |  |      | 14,722,530  |      |   | 12,525,736 
|Over the counter and general |  |      | 8,585,770   |      |   | 6,235,440  
|                             |  |      |             |      |   |            
|Total revenues               |  | $    | 291,751,771 |      | $ | 271,287,988
|                             |  |      |             |      |   |            



NOTE 15MAJOR CUSTOMER
CONCENTRATION



During the years ended March 31, 2003, 2002 and 2001, the
Companys 10 largest customers accounted for approximately 44%, 37% and 39%, respectively, of the Companys net sales. The Companys two largest customers during fiscal 2003, Supreme Distributors and QK Healthcare, accounted for
approximately 17% and 11%, respectively, of net sales. In fiscal 2002, the Companys largest customer, QK Healthcare, accounted for approximately 13% of net sales, and the Companys largest customer in fiscal 2001, Penner and Welsch, Inc.,
accounted for approximately 16% of net sales.



NOTE 16SELECTED
QUARTERLY FINANCIAL DATA (UNAUDITED)



The following tables set forth
certain unaudited quarterly financial data for each of the four quarters in the fiscal years ended March 31, 2003 and 2002:



|                               |  | FISCAL QUARTER |           
|------------------------------ |  | -------------- | ----------
|                               |  | First          |           
|2003                           |  |                |           
|Revenues                       |  | $              | 63,103,819
|Gross profit                   |  |                | 1,980,826 
|Net (loss) income              |  |                | (571,690  
|(Loss) income per common share |  |                |           
|Basic                          |  |                | (0.08     
|Diluted                        |  |                | (0.08     
|                               |  |                |           
|2002                           |  |                |           
|Revenues                       |  | $              | 70,876,312
|Gross profit                   |  |                | 1,801,289 
|Net income                     |  |                | 883,649   
|Income per common share        |  |                |           
|Basic                          |  |                | 0.13      
|Diluted                        |  |                | 0.12      



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



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



(3) In the first quarter of 2002, the Company recognized a deferred income tax benefit of
$494,030, net of deferred income tax expense of $162,200.



(4) In the second
quarter of 2002, the Company recognized a deferred income tax benefit of $616,250, net of deferred income tax expense of $40,000.



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NOTE 17RESTATEMENT



Subsequent to the issuance of the Companys consolidated financial statements as of and for the year ended March 31, 2002, the Company determined that the
accounting treatment for a warrant issued to a director and non-employee consultant on January 23, 2000 as a result of the directors acting as a guarantor of the Companys $5,000,000 Merrill Lynch line of credit (see Note 12) was not in
accordance with guidance established under APB Opinion No. 25 and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25. Because the warrants were issued to a
non-employee director for services outside his role as a director, the warrants should have been accounted for under SFAS No. 123. Accordingly, the fair value of the warrants of $1,625,000 should have been recognized as deferred financing costs in
January 2000 and amortized to interest expense over the one-year term of the line of credit, beginning in March 2000. The Merrill Lynch line of credit was paid in full on October 24, 2000, with proceeds from the new Mellon credit facility (see Note
9); therefore, the unamortized balance of the financing costs of $572,244 should have been recognized as an extraordinary loss on the early extinguishment of debt in October 2000. The Company has not treated the warrant expense as a deductible item
in its tax returns, and has concluded that the warrant expense will be treated as a permanent difference, which does not create tax benefits for the Company. As a result, the consolidated financial statements for the years ended March 31, 2002 and
2001 have been restated from the amounts originally reported in the Companys 2002 Form 10-KSB filed on July 1, 2002. The restatement was reflected in the Companys 2002 Form 10-KSB/A as filed on March 14, 2003



A summary of the significant effects of the restatement on the Companys consolidated
statement of operations for the year ended March 31, 2001 is as follows:



|                                               |  | Year Ended March 31, 2001
|---------------------------------------------- |  | -------------------------
|                                               |  | As OriginallyReported    
|Interest expense                               |  | $                        
|Loss before extraordinary item                 |  |                          
|Extraordinary loss on extinguishment of debt   |  |                          
|Net loss                                       |  |                          
|Net loss per common share  basic and diluted: |  |                          
|Loss before extraordinary item                 |  | $                        
|Extraordinary loss on extinguishment of debt   |  |                          
|                                               |  |                          
|Net loss per common share  basic and diluted  |  | $                        
|                                               |  |                          



A summary of the significant effects
of the restatement on the Companys consolidated balance sheet as of March 31, 2002 is as follows:



|                                           |  | As OriginallyReported |            |   | Adjustments |   |            | As Restated in2002 Form 10-KSB/A | 
|------------------------------------------ |  | --------------------- | ---------- | - | ----------- | - | ---------- | -------------------------------- | 
|Additional paid-in capital                 |  | $                     | 39,342,355 |   |             | $ | 1,625,000  |                                  | 
|Accumulated deficit                        |  |                       | (7,902,880 | ) |             |   | (1,625,000 | )                                | 
|Total stockholders equity                 |  |                       | 31,446,595 |   |             |   |           |                                  | 
|Total liabilities and stockholders equity |  |                       | 66,302,757 |   |             |   |           |                                  | 



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NOTE 18SUBSEQUENT EVENTS



In April 2003, W.A. Butler & Company (Butler), a 30% shareholder of VetMall, executed an agreement with the Company and
VetMall. The terms of the agreement provide for the transfer of Butlers 30% ownership of VetMall stock and the forgiveness of $.5 million of long-term liabilities of the Company to Butler. The agreement also releases Butler from any present
and future operational expenses of VetMall. Since there is no minority interest at March 31, 2003, the transfer of the 30% interest will have no impact on the consolidated financial statements.



52



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##### Table of Contents

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



On February 5, 2003, the Company appointed BDO Seidman, LLP (BDO) as its new independent accountants for the fiscal year ended
March 31, 2003, replacing the firm of Deloitte & Touche, LLP (Deloitte), which served as the Companys independent accountants for the fiscal years ended March 31, 2002, 2001 and 2000. During the two most recent fiscal years and
any subsequent interim period prior to engaging BDO, the Company did not consult with BDO regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might
be rendered on the Companys financial statements; or (ii) any matter that was either the subject matter of a disagreement (as defined in Item 304(a)(1)(iv) of Regulation S-K and related instructions) or a reportable event (as defined in Item
304(a)(1)(v) of Regulation S-K). The appointment of BDO was approved by the Audit Committee and the Companys Board of Directors.



The reports of Deloitte on the Companys financial statements for the past two fiscal years did not contain a disclaimer of opinion or an opinion that was adverse or
was qualified or modified for uncertainty, audit scope, or accounting principle. Furthermore, during the two most recent fiscal years and through the subsequent period ending on February 5, 2003, there were no disagreements with Deloitte on matters
of accounting principle or practice, financial statement disclosure, or audit scope or procedure which, if not resolved to Deloittes satisfaction, would have caused Deloitte to refer to the subject matter of the disagreements in their report.
In addition, during the two most recent fiscal years, there have been no reportable events (as defined in Item 304(a)(1)(v) of Regulation S-K), except as follows:



As previously reported, the Companys Board of Directors, in consultation with Deloitte, determined that a restatement
of the Companys consolidated financial statements for the years ended March 31, 2002 and 2001 and the quarter ended June 30, 2002 was required to appropriately account for a warrant issued to a director and non-employee on January 23, 2000.
The Company has filed the amended Form 10-KSB for its fiscal year ended March 31, 2002, and the amended Form 10-Q for its quarter ended June 30, 2002.



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



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



PART III



|Item 10. |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
|-------- |  | ---------------------------------------------------



The information required by this Item is incorporated herein by reference to the information under the headings ManagementDirectors and Executive
Officers in the Companys definitive Proxy Statement to be used in connection with the Companys Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2003.



|Item 11. |  | EXECUTIVE COMPENSATION
|-------- |  | ----------------------



The information required by this Item is incorporated herein by reference to the information under the headings ManagementCompensation of Executive Officers
and Directors in the Companys definitive Proxy Statement to be used in connection with the Companys Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2003.



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



The information required by this Item is incorporated herein by reference to the information under the headings ManagementSecurity Ownership of Management and
Others in the Companys definitive Proxy Statement to be used in connection with the Companys Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2003.



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##### Table of Contents

|Item 13. |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
|-------- |  | -----------------------------------------------



The information required by this Item is incorporated herein by reference to the information under the headings Certain Relationships and Related Transactions
in the Companys definitive Proxy Statement to be used in connection with the Companys Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before July 29, 2003.



|Item 14. |  | CONTROLS AND PROCEDURES
|-------- |  | -----------------------



Within 90 days prior to the date of filing this Annual Report on Form 10-K, an evaluation was performed under the supervision and with the participation of our
management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our chief executive officer and chief financial
officer concluded that our disclosure controls and procedures were effective as of the evaluation date. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent
to the date of our evaluation.



PART IV



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



|   |  
|-- | -
|(a | )
|   |  
|   |  
|   |  
|   |  
|   |  
|   |  



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##### Table of Contents

Report of Independent Certified Public Accountants



Board of Directors and Stockholders

DrugMax, Inc.

Clearwater, FL



The audit referred to in our report dated July 2, 2003
relating to the 2003 consolidated financial statements of DrugMax, Inc. and subsidiaries, which is contained in Item 8 of this Form 10-K included the audit of the 2003 consolidated financial statement schedule listed in Item 15. This consolidated
financial statement schedule is the responsibility of the Companys management. Our responsibility is to express an opinion on this 2003 consolidated financial statement schedule based upon our audit.



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



BDO Seidman, LLP



Miami, FL



July 2, 2003



55



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##### Table of Contents

INDEPENDENT AUDITORS REPORT



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



We have audited the consolidated financial statements of DrugMax, Inc. (the Company) as of March 31, 2002, and for each of the
two years in the period ended March 31, 2002, and have issued our report thereon dated June 27, 2002 (November 22, 2002 as to Note 17), which report includes two explanatory paragraphs relating to the adoption of a new accounting principle in 2002
and the restatement of the consolidated financial statements. Our audits also included the consolidated financial statement schedule of DrugMax, Inc., listed in Item 15. These consolidated financial statement schedules are the responsibility of the
Companys management. Our responsibility is to express an opinion based on our audits. In our opinion, such 2002 and 2001 consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements
taken as a whole, present fairly in all material respects the information set forth therein.



|                            
|----------------------------
|/s/ DELOITTE & TOUCHE LLP   
|Certified Public Accountants
|                            
|Tampa, Florida June 27, 2002



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##### Table of Contents

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

THREE YEARS ENDED MARCH 31, 2003



|DESCRIPTION                                 |  | BalanceatBeginningof Year |           | AdditionsCharged toCost andExpenses |   |           | Other |  |   | Deductions |      | Balanceat End ofYear
|------------------------------------------- |  | ------------------------- | --------- | ----------------------------------- | - | --------- | ----- |  | - | ---------- | ---- | --------------------
|Allowance for doubtful accounts receivable: |  |                           |           |                                     |   |           |       |  |   |            |      |                     
|Year ended March 31,                        |  |                           |           |                                     |   |           |       |  |   |            |      |                     
|2003                                        |  | $                         | 340,575   |                                     | $ | 1,114,539 |       |  | $ | (50,000    | )(A) |                     
|2002                                        |  |                           | 381,944   |                                     |   | 35,757    |       |  |   | 62,750     | (B)  |                     
|2001                                        |  |                           | 113,282   |                                     |   | 99,044    |       |  |   | 209,588    | (C)  |                     
|Valuation allowance on deferred tax assets: |  |                           |           |                                     |   |           |       |  |   |            |      |                     
|Year ended March 31,                        |  |                           |           |                                     |   |           |       |  |   |            |      |                     
|2003                                        |  | $                         |          |                                     | $ | 580,100   | (D)   |  | $ |           |      |                     
|2002                                        |  |                           | 1,458,500 |                                     |   |          |       |  |   |           |      |                     
|2001                                        |  |                           | 717,495   |                                     |   | 741,005   | (D)   |  |   |           |      |                     



|(A) |  | Provision for other receivable included in bad debt expense.
|--- |  | ------------------------------------------------------------

|(B) |  | Recovery of debt previously written off.
|--- |  | ----------------------------------------

|(C) |  | Represents allowance for doubtful accounts for accounts receivable.
|--- |  | -------------------------------------------------------------------

|(D) |  | Increase in amount of deferred income tax assets for which realization is not more likely than not.
|--- |  | ---------------------------------------------------------------------------------------------------



|     |  |                                                                                                                                                                                                                                  
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |  | 3.                                                                                                                                                                                                                               
|     | 
|2.1  |  | Agreement and Plan of Merger by and between NuMed Surgical, Inc. and
Nutriceuticals.com Corporation, dated as of January 15, 1999. (1)                                                                                           
|     | 
|2.2  |  | Agreement and Plan of Reorganization dated September 8, 1999 by and between
Nutriceuticals.com Corporation and Dynamic Health Products, Inc. (2)                                                                                 
|     | 
|2.3  |  | Agreement and Plan of Reorganization between DrugMax.com, Inc., Jimmy L. Fagala,
K. Sterling Miller, and HCT Capital Corp. dated as of March 20, 2000. (3)                                                                       
|     | 
|2.4  |  | Stock Purchase Agreement between DrugMax.com, Inc. and W.A. Butler Company dated
as of March 20, 2000. (3)                                                                                                                       
|     | 
|2.5  |  | Merger Purchase Agreement between DrugMax.com, Inc., DrugMax Acquisition
Corporation, and Valley Drug Company, Ronald J. Patrick and Ralph A. Blundo dated as of April 19, 2000.
(4)                                             
|     | 
|2.6  |  | Agreement for Purchase and Sale of Assets by and between Discount Rx, Inc., and
Penner & Welsch, Inc., dated October 12, 2001. (11)                                                                                              
|     | 
|3.1  |  | Articles of Incorporation of NuMed Surgical, Inc., filed October 18, 1993. (1)                                                                                                                                                   
|     | 
|3.2  |  | Articles of Amendment to the Articles of Incorporation of NuMed Surgical, Inc.,
filed March 18, 1999. (1)                                                                                                                        
|     | 
|3.3  |  | Articles of Merger of NuMed Surgical, Inc. and Nutriceuticals.com Corporation,
filed March 18, 1999. (1)                                                                                                                         
|     | 
|3.4  |  | Certificate of Decrease in Number of Authorized Shares of Common Stock of Nutriceuticals.comCorporation, filed October 29, 1999. (5)                                                                                             
|     | 
|3.5  |  | Articles of Amendment to Articles of Incorporation of Nutriceuticals.com Corporation, filed January11, 2000. (8)                                                                                                                 
|     | 
|3.6  |  | Articles and Plan of Merger of Becan Distributors, Inc. and DrugMax.com, Inc., filed March 29, 2000.(8)                                                                                                                          
|     | 
|3.7  |  | Amended and Restated Bylaws, dated November 11, 1999. (5)                                                                                                                                                                        
|     | 
|4.2  |  | Specimen of Stock Certificate. (8)                                                                                                                                                                                               
|     | 
|10.1 |  | Employment Agreement by and between Nutriceuticals.com Corporation and William L. LaGambadated January 1, 2000. (7)                                                                                                              
|     | 
|10.2 |  | Employment Agreement by and between Valley Drug Company and Ronald J. Patrick dated April 19,2000 (8)                                                                                                                            
|     | 
|10.3 |  | Employment Agreement by and between DrugMax, Inc. and Jugal K. Taneja, dated October 1, 2001.(12)                                                                                                                                
|     | 
|10.4 |  | Consulting Agreement by and between DrugMax.com, Inc. and Stephen M. Watters dated August 10,2000. (9)                                                                                                                           
|     | 
|10.5 |  | DrugMax.com, Inc. 1999 Incentive and Non-Statutory Stock Option Plan. (8)                                                                                                                                                        
|     | 
|10.6 |  | Amendment No. 1 to DrugMax, Inc. 1999 Incentive and Non-Statutory Stock Option Plan, dated June5, 2002. (14)                                                                                                                     
|     | 
|10.7 |  | Fourth Amendment and Modification to Loan and Security Agreement among DrugMax, Inc., ValleyDrug Company, Discount Rx, Inc., Valley Drug Company South and Standard
Federal Bank NationalAssociation dated October 28, 2002. (15)
|     | 
|10.8 |  | Loan and Security Agreement by an between Congress Financial Corporation and DrugMax, Inc.,Valley Drug Company, Valley Drug Company South and Discount Rx, Inc.,
dated April 15, 2003. *                                         
|     | 
|16.1 |  | Letter of Deloitte & Touche, LLP addressed to the Securities and Exchange Commission. (16)                                                                                                                                       
|     | 
|21.0 |  | Subsidiaries of DrugMax.com, Inc. (9)                                                                                                                                                                                            
|     | 
|99.1 |  | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *                                                                                                        
|     | 
|99.2 |  | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *                                                                                                        

---

|* |  | Filed herewith.
|- |  | ---------------

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

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

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

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

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

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

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

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

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

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



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##### Table of Contents

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

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

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

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

|(15) |  | Incorporated by reference to the Companys Form 10-Q, filed October 17, 2002.
|---- |  | -----------------------------------------------------------------------------

|(16) |  | Incorporated by reference to the Companys Form 8-K/A, filed February 28, 2003.
|---- |  | -------------------------------------------------------------------------------



(b) Reports on Form 8-K.



During the three months ended March 31, 2003, the Company filed the following reports on Form 8-K:



Form 8-K dated February 5, 2003, with respect to the Companys change in
independent accountants.

Form 8-K/A dated February 27, 2003, with respect to the Companys change in independent accountants.



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##### Table of Contents

SIGNATURES



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





|                     |  | DRUGMAX, INC.                                                                          
|-------------------- |  | ---------------------------------------------------------------------------------------
|                     | 
|Dated: July 15, 2003 |  | By /s/Jugal K. TanejaJugal K. Taneja, Chief Executive Officer and Chairman of the Board
|                     | 
|Dated: July 15, 2003 |  | By /s/William L. LaGambaWilliam L. LaGamba, President and Chief Operating Officer      
|                     | 
|Dated: July 15, 2003 |  | By /s/Ronald J. PatrickRonald J. Patrick, Chief Financial Officer                      



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





|Signatures                                                |  | Title                                                       |  | Date         
|--------------------------------------------------------- |  | ----------------------------------------------------------- |  | -------------
|                                                          |  |                                                            
|By: /s/Jugal K. TanejaJugal K. Taneja                     |  | Chairman of the Board, Chief Executive Officer and Director |  | July 15, 2003
|                                                          |  |                                                            
|By: /s/William LaGambaWilliam L. LaGamba                  |  | President, Chief Operating Officer and Director             |  | July 15, 2003
|                                                          |  |                                                            
|By: /s/Ronald J. PatrickRonald J. Patrick                 |  | Chief Financial Officer and Director                        |  | July 15, 2003
|                                                          |  |                                                            
|By: /s/Dr. Howard L. Howell,
DDSDr. Howard L. Howell, DDS |  | Director                                                    |  | July 15, 2003
|                                                          |  |                                                            
|By: /s/ Robert G. LoughreyRobert G. Loughrey              |  | Director                                                    |  | July 15, 2003
|                                                          |  |                                                            
|By: /s/Martin SperberMartin Sperber                       |  | Director                                                    |  | July 15, 2003
|                                                          |  |                                                            
|By: /s/Sushil SuriSushil Suri                             |  | Director                                                    |  | July 15, 2003



59



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##### Table of Contents

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002



I,
Jugal K. Taneja, certify that:



1. I have reviewed this annual
report on Form 10-K of DrugMax, Inc.;



2. Based on my
knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this annual report;



3. Based
on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;



4. The
registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and we have:



a) designed such disclosure controls and procedures to
ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others, particularly during the period in which this annual report is being prepared;



b) evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the Evaluation Date); and



c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;



5. The
registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent function):



a) all significant deficiencies in the design
or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls;
and



b) any fraud, whether or not material,
that involves management or other employees who have a significant role in the registrants internal controls; and



6. The registrants other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.



|Dated: July 15, 2003 |  | By: |  | /s/ Jugal K. Taneja    
|-------------------- |  | --- |  | -----------------------
|                     |  |     |  | Jugal K. Taneja        
|                     |  |     |  | Chief Executive Officer





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##### Table of Contents

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002



I,
Ronald J. Patrick, certify that:



1. I have reviewed this
annual report on Form 10-K of DrugMax, Inc.;



2. Based on my
knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this annual report;



3. Based
on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;



4. The
registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



a) designed such disclosure controls and procedures to
ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others, particularly during the period in which this annual report is being prepared;



b) evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the Evaluation Date); and



c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;



5. The
registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent function):



a) all significant deficiencies in the design
or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls;
and



b) any fraud, whether or not material,
that involves management or other employees who have a significant role in the registrants internal controls; and



6. The registrants other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.



|Dated: July 15, 2003 |  | By: |  | /s/Ronald J. Patrick   
|-------------------- |  | --- |  | -----------------------
|                     |  |     |  | Ronald J. Patrick      
|                     |  |     |  | Chief Financial Officer





61