ADVANCEPCS - 10-Q Quarterly Report

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes þ No ¨

As of January 31, 2004, the registrant had (1) 80,681,432 shares of Class A common stock, $.01 par value outstanding, (2) 12,913,334 shares of Class B-1 common stock, $.01 par value, outstanding and (3) 200 shares of Class B-2 common stock, $.01 par value, outstanding.

This Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, (forward-looking statements). We have based these forward-looking statements on our current expectations and projections about future events. These statements relate to business plans or strategies, projected or anticipated benefits or other consequences of such plans or strategies or projections involving anticipated revenues, earnings, level of capital expenditures or other aspects of operating results and the underlying assumptions including internal growth as well as general economic and financial market conditions. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results and performance to be materially different from any future results or performance expressed or implied by these forward-looking statements. These factors include, among other things, those matters set forth in our Annual Report on Form 10-K for the fiscal year ended March 31, 2003, as it may be amended from time to time, under the caption “Risk Factors,” as well as the following:

Although we believe that our forward-looking statements are based upon reasonable assumptions, we can give no assurance that these forward-looking statements will be achieved. Given these uncertainties, prospective investors are cautioned not to place undue reliance on these forward-looking statements. These forward-looking statements speak only as of the date made. Except as required by law, we are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results.

The accompanying notes are an integral part of these consolidated financial statements.

AdvancePCS, a Delaware corporation, and its subsidiaries (the Company or AdvancePCS) provide a wide range of health improvement services designed to manage costs and improve the quality of care delivered to health plan members. Services include integrated mail service and retail pharmacy networks, formulary development and management, rebate negotiation and management, specialty pharmacy, disease management, clinical trials, outcomes research, information management, prescription drug services for the uninsured and online health information. The Company markets its services to managed care organizations, third-party health plan administrators, insurance companies, government agencies, employer groups and labor union-based trusts.

In September 2003, AdvancePCS entered into an Agreement and Plan of Merger (Merger Agreement) with Caremark Rx, Inc. (Caremark), to combine the two companies. Pursuant to the Merger Agreement and subject to the terms and conditions set forth therein, at the effective time of the merger (Effective Time), the Company will become a wholly-owned subsidiary of Caremark. Also at the Effective Time, each outstanding share of common stock of the Company will be converted into the right to receive (i) shares of Caremark common stock equal to the product of 2.15 (Exchange Ratio) and 90%, which is equal to 1.935 shares, and (ii) an amount in cash equal to 10% of the product of the Exchange Ratio and the average of the per share closing sales prices of shares of Caremark common stock as reported on the New York Stock Exchange during the five consecutive trading day period ending on (and including) the fifth trading day immediately prior to the Effective Time. Consummation of the transaction is subject to various conditions, including stockholder and regulatory approvals.

The accompanying unaudited consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States for the interim financial information in the form prescribed by the Securities and Exchange Commission (SEC) in instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements. In the opinion of the Company’s management, all adjustments, which include normal recurring adjustments, necessary for a fair presentation of financial position, results of operations and cash flows at the dates and for the periods presented have been included. In the opinion of the Company’s management, the disclosures contained in this Form 10-Q are adequate to make the information presented not misleading when read in conjunction with the Company’s Annual Report on Form 10-K for the year ended March 31, 2003, as amended. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year or for any future period. Certain prior year amounts have been reclassified to conform to the current year presentation.

The Company follows the disclosure provisions as provided by Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” (SFAS 123) and SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an Amendment of FASB Statement No. 123” (SFAS 148) but continues to account for stock options using the intrinsic value method under Accounting Principals Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees”. Under this method, compensation expense is recorded over the related service period when the market price exceeds the option price at the measurement date, which is the grant date for the options. For the three months ended December 31, 2003 and 2002, compensation expense of $302,000 and $206,000, respectively, and for the nine months ended December 31, 2003 and 2002, compensation expense of $925,000 and $618,000, respectively, was recorded for certain options granted in fiscal year 2001. The Company has elected to continue applying the intrinsic value method under APB 25. Had compensation expense for these plans been determined in accordance with SFAS 123 and 148, the Company’s net income and net income per share would have been reduced to the following pro forma amounts (in thousands):

For options granted during the three months and nine months ended December 31, 2003 and 2002, the fair value of each option grant was estimated using the Black-Scholes option-pricing model and the following assumptions: expected life of 3-5 years, risk-free interest rate of 1.77% and 2.68%, respectively, expected volatility of 58% and no expected dividend yield.

During each reporting period, fully diluted earnings per share are calculated by assuming that “in-the-money” options are exercised and the exercise proceeds are used to repurchase shares in the marketplace. When options are actually exercised, option proceeds are credited to equity and issued shares are included in the computation of earnings per common share, with no effect on reported earnings. Equity is also increased by the tax benefit that the Company will receive in its tax return for income reported by the optionees in their individual tax returns.

In May 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002” (SFAS 145). This Statement rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, and an amendment of that Statement, and FASB Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. SFAS 145 restricts the classification of gains and losses from extinguishment of debt to only those transactions that are unusual and infrequent in nature as defined by APB No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (APB 30) as extraordinary. The Company adopted SFAS 145 in the first quarter of fiscal 2004. In connection with the Term B note repayments made in June 2002, the Company recorded a loss associated with the early retirement of debt. The loss was attributable to a non-cash charge to write-off a portion of the deferred financing fees related to the secured bank agreement in the amount of $2.4 million (excluding taxes of $953,000, included in provision for income taxes) and was previously reflected as an extraordinary item. Accordingly, the pre-tax extraordinary loss of $2.4 million for the nine months ended December 31, 2002, was reclassified to income before income taxes to conform to the requirements of SFAS 145.

to support its activities without additional subordinated financial support from other parties. The revised interpretation adds the requirement for consolidating an entity where the equity investors’ voting rights are not proportionate to their economic interests and where the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest. This revised interpretation is effective for all entities no later than the end of the first reporting period that ends after March 15, 2004. However, for reporting periods ending after December 15, 2003, a company must apply either the original or this revised interpretation to those entities that are considered to be special-purpose entities. A company that has already applied the original FIN 46 to an entity may continue to do so until the effective date of the revised interpretation. The Company has a variable interest entity that has been and will continue to be included in the Company’s consolidated financial statements, and therefore, management believes that adoption of FIN 46 (revised December 2003) will not have a material impact on its financial position or results of operations.

In May 2003, the EITF released Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables” (EITF 00-21). EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue generating activities. Specifically, EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. It also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. EITF 00-21 applies to all deliverables within contractually binding arrangements in all industries under which a vendor will perform multiple revenue-generating activities, with some exceptions noted. EITF 00-21 is effective for revenue generating arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. The Company does not expect the adoption of EITF 00-21 to have a material impact on its financial position or results of operations.

In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition” (SAB 104). SAB 104 updates portions of the interpretive guidance included in Topic 13 of the codification of Staff Accounting Bulletins in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The Company believes it is following the guidance of SAB 104.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (SFAS 132). This revised statement retains the disclosures required by the original SFAS 132, which standardized employers’ disclosures about pensions and other postretirement benefits, and requires additional disclosures concerning the economic resources and obligations related to pension plans and other postretirement benefits. The provisions of the original SFAS 132 remain in effect until the provisions of this revised statement are adopted. This revised statement is effective for fiscal years ending after December 15, 2003. The Company will revise its disclosures to meet the requirements under this revised standard in the financial statements for the fiscal year ended March 31, 2004.

Basic net income per share is computed using the weighted average number of common shares (including both Class A common stock and Class B common stock) outstanding during the periods presented. Diluted net income per share is computed giving effect to all potentially dilutive common shares, assuming that such shares were outstanding during the periods presented. The weighted average diluted common shares outstanding were calculated under the “treasury stock” method in accordance with SFAS No. 128, “Earnings Per Share.”

Below is a reconciliation of basic weighted average shares outstanding to diluted weighted average shares outstanding (in thousands). Options to purchase 2.7 million shares of common stock were outstanding at December 31, 2002 but were excluded from the computation of diluted earnings per share for the three month and nine month periods, because the options’ exercise prices were greater than the average market price of the Company’s common stock during the applicable period (antidilutive). No antidilutive options were outstanding at December 31, 2003.

SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142) requires that goodwill no longer be amortized. Instead, all goodwill (including goodwill associated with acquisitions consummated prior to the adoption of SFAS 142) is to be evaluated for impairment at least annually or when events or circumstances occur indicating that goodwill might be impaired.

The Company completed its annual impairment test during the fourth quarter of fiscal year 2003, which did not result in an impairment charge.

The following is a summary of goodwill activity for the dates indicated (in thousands):

The following is a summary of intangible assets at the dates indicated (in thousands):

The Company recorded a $4.7 million decrease in amortizable intangible assets during the first quarter of fiscal 2004, which represents the reallocation of Accordant intangibles based on the final valuation analysis. The weighted average amortization period for amortizable intangible assets is 25.3 years (26.3 years—customer base and 6.7 years—other).

Amortization expense of amortizable intangible assets was $3.3 million and $2.9 million for the three months ended December 31, 2003 and 2002, respectively, and $9.9 million and $8.7 million for the nine months ended December 31, 2003 and 2002, respectively.

The Company determined that the $105.3 million and $2.6 million in trade names, acquired with the acquisition of PCS and Accordant, respectively, had indefinite useful lives. Current circumstances and conditions continue to support that determination.

During the nine months ended December 31, 2003, the Company repaid approximately $260 million on the Asset Securitization Facility.

In March 2001, the Company issued $200 million of Senior Notes due 2008 (Senior Notes). In the second quarter of fiscal year 2003, the Company repurchased a portion of the Senior Notes with a face value of approximately $12.2 million in open market transactions.

The Senior Notes are guaranteed until the due date or when repaid, if sooner, for the outstanding balance, by all of the Company’s existing and future domestic subsidiaries (Guarantors), other than receivables subsidiaries, as defined in the Senior Notes indenture, and certain other subsidiaries not otherwise required to be guarantors under the terms of the indenture. After issuance of the Senior Notes, the Company created subsidiaries that are not required to guarantee the Senior Notes. All of the subsidiaries that have guaranteed the Senior Notes are 100% owned, directly or indirectly by AdvancePCS. Each of the Guarantors jointly and severally, unconditionally guarantees that the principal, and interest, as well as, penalties, fees, indemnifications, reimbursements and damages, if any, payable under the Senior Notes will be promptly paid in full when due, whether at maturity, by acceleration, redemption or otherwise. The Senior Notes contain covenants that are typical for this type of debt including, among others, fixed charge ratio, payment of dividends and sales of assets. There are no restrictions on the ability of the guarantors to pay dividends, make loans or advances to the parent. The Company is in compliance with all covenants.

The Revolving Credit Facility contains covenants that are typical for this type of debt, including limitations on capital expenditures, minimum fixed charge, interest coverage and total leverage ratios. The Company is in compliance with all covenants.

In November 2000, the Company entered into an interest rate protection agreement (swap) that had a fixed LIBOR rate of 6.60% for $400 million of the Company’s variable rate debt under the credit facility. The notional amount was reduced by $100 million in October 2001 and 2002. The swap expired in October 2003. The Company had accounted for the swap as a cash flow hedge in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS 137 and 138.

In March 2001, the Company issued $200 million of Senior Notes, which were unconditionally guaranteed, jointly and severally, by all of the existing and future domestic subsidiaries, other than subsidiaries treated as unrestricted subsidiaries or receivables subsidiaries, each as defined in the indenture governing the Senior Notes. Presented below are condensed consolidating balance sheets as of December 31, 2003 and March 31, 2003, condensed consolidating statements of operations for the three months and nine months ended December 31, 2003 and 2002, and condensed consolidating statements of cash flows for the nine months ended December 31, 2003 and 2002 of AdvancePCS (Parent and Issuer), guarantor subsidiaries (Guarantor Subsidiaries) and the subsidiaries which are not guarantors (Non-guarantor Subsidiaries) (in thousands):

On June 6, 2002, the Company filed a Form 8-K announcing the authorization from the board of directors of a stock repurchase program of up to $150 million of the Company’s outstanding shares of Class A common stock in the open market or private transactions. Purchases of stock under this repurchase program are included in treasury stock and offset by the issuance of shares for the employee stock purchase plan (ESPP) program.

During the three month and nine month periods ended December 31, 2002, the Company purchased 0.7 million and 4.0 million shares at a cost of $15.9 million and $87.7 million, respectively, under this repurchase program. There were no shares issued under the ESPP program during the three and nine month periods ended December 31, 2002. During the three month and nine month periods ended December 31, 2003, no shares were purchased under this

repurchase program, however, previous treasury purchases were offset by the issuance of 137,545 shares for the ESPP program. Since inception, the Company has purchased 5.6 million shares at a cost of $111.5 million, offset by 271,050 shares issued for the ESPP program. In the Merger Agreement, the Company has agreed not to repurchase any additional shares without the consent of Caremark.

In August 2001, the Company completed the acquisition of 100% of the equity of Dresing-Lierman, Inc. and its wholly-owned subsidiary, TheraCom Inc. (collectively, TheraCom), a specialty pharmacy and distribution company located in Bethesda, Maryland. At the time of the acquisition, in addition to the payment of other consideration, 217,050 shares of common stock issued to the former TheraCom stockholders were held in escrow to satisfy any indemnification claims the Company may have arising out of the acquisition, including those related to the settlement of certain TheraCom litigation outstanding at the time of the acquisition. All shares held in escrow were included in the Company’s calculation of basic earnings per share beginning with the quarter ended September 30, 2002.

In January 2003, 34,188 shares were withdrawn from the indemnification claims escrow and returned to the Company to satisfy its indemnification claim arising from the settlement of litigation between TheraCom and one of its former stockholders. These shares returned to the Company are held in treasury. In August 2003, further litigation was settled between TheraCom and one of its former employees. Pursuant to this settlement, TheraCom paid the former employee $2 million. The former stockholders of TheraCom then indemnified and reimbursed the Company $2 million in cash. Upon receipt of this indemnification payment and in accordance with the terms of the acquisition, all of the 182,862 shares then held in the indemnification escrow were released to the former TheraCom stockholders.

The Company has entered into long-term employment and noncompete agreements with certain management employees. These employment agreements provide for certain minimum payments should the agreements be terminated.

In November 1999, PCS Health Systems, Inc. (PCS), a subsidiary of PCS Holding Corporation, which was acquired by the Company in October 2000, received a subpoena from the Department of Health and Human Services OIG requesting that PCS produce documents in connection with an industry-wide investigation. The investigation is ongoing and being pursued under the direction of the United States Attorney’s Office for the Eastern District of Pennsylvania. Based on public statements from that office, the investigation appears to involve a review of the practices of pharmacy benefit management companies (PBMs) under federal anti-kickback statutes and other laws and regulations. Specifically, the focus of the investigation appears to be PBMs’ relationships with pharmaceutical manufacturers and retail pharmacies and PBMs’ programs relating to drug formulary compliance, including rebate and other payments made by pharmaceutical manufacturers to PBMs, and payments made by PBMs to retail pharmacies in connection with therapeutic intervention activity. The Company provided documents responsive to the subpoena. The United States Attorney’s Office also contacted some of the pharmaceutical manufacturers with which the Company has agreements and has asked them to provide copies of documents relating to their agreements with the Company. The United States Attorney General also issued Civil Investigative Demands (CIDs) seeking to compel the depositions of eight of the Company’s current and former employees.

On September 17, 2002, the United States District Court for the Eastern District of Pennsylvania entered an order holding in abeyance both the Company’s dispute with the OIG regarding the scope and enforcement of the subpoena for documents and employee e-mails as well as the issuance of the CIDs, pending the good faith efforts to reach a mutual resolution of the outstanding discovery issues. As a result of such order, AdvancePCS does not have to comply with the subpoena issued by the OIG. Since entry of that order, the Company has reached agreement with the United States Attorney’s office regarding the scope of its document requests and facilitated interviews of certain employees in lieu of the CIDs. The government has continued to request the production of additional documents and interviews, including information relating to the activities of the former Advance Paradigm (which was the name of AdvancePCS prior to the acquisition of PCS) and the activities of AdvancePCS subsequent to the PCS acquisition, as well as additional information regarding the Company’s arrangements with retail pharmacies and health plans.

The Company continues to cooperate with the OIG. The Company already has produced certain requested materials and intends to continue to work with the OIG to facilitate the production of further documents and arrange the requested interviews.

It is not possible to predict the outcome of this investigation or whether the government will commence any action challenging any of the Company’s programs and practices. The Company believes that its programs, including those prior to the PCS acquisition, are in compliance with the requirements of the anti-kickback and false claims statutes and other applicable laws and regulations. Moreover, other than those actions filed in connection with the enforcement of the subpoena, neither the OIG nor the United States Attorney has filed any actions or claims against AdvancePCS nor have they indicated their intention to do so. Nevertheless, as a result of this investigation, the Company could be subject to scrutiny, further investigation or challenge under federal or state anti-kickback and false claims statutes or other laws and regulations which could cause the Company’s business, profitability and growth prospects to suffer materially.

In March 1998, a class action lawsuit captioned Mulder v. PCS Health Systems, Inc., case number 98-1003, was filed in the United States District Court of the District of New Jersey. This action alleges that PCS is a fiduciary, as that term is defined in the Employee Retirement Income Security Act (ERISA), and that the Company has breached its fiduciary obligations under ERISA in connection with its development and implementation of formularies, preferred drug listings and intervention programs for its sponsors of ERISA health plans. In particular, the plaintiff alleges that the Company’s therapeutic interchange programs and negotiation of formulary rebates and discounts from pharmaceutical manufacturers violate fiduciary obligations. The plaintiff is seeking injunctive relief and monetary damages in an unspecified amount. AdvancePCS believes that it does not assume any of the plan fiduciary responsibilities that would subject it to regulation under ERISA as alleged in the complaint, has denied all allegations of wrongdoing and is vigorously defending this suit. The plaintiff purported to represent a nation-wide class consisting of all members of all ERISA plans for which PCS provided PBM services during the class period. AdvancePCS opposed certification of this class and on July 17, 2003, the District Court entered an order certifying a more limited class comprised only of members of those ERISA plans for which PCS provided services under its contract with a single plan administrator. The Company will continue to vigorously defend this suit. Although the ultimate outcome is uncertain, an adverse determination could potentially cause the Company to change its business practices with respect to formularies, preferred drug listings, intervention programs, and rebates, potentially reducing its profitability and growth prospects.

AdvancePCS is also a party to Marantz v. AdvancePCS, case number CIV-01-2413PHX EHC, a class action filed on or about December 17, 2001 in the United States District Court in Arizona that alleges that AdvancePCS acts as an ERISA fiduciary and that its has breached certain fiduciary obligations under ERISA. The plaintiff withdrew the class action allegations in April 2002. In March 2003, the court dismissed the plaintiff’s apparent effort to reassert possible class action claims. In May 2003, the Marantz case was dismissed based on inadequacies in the plaintiff’s pleadings and subsequently the plaintiff filed an amended complaint purporting to address these inadequacies. Currently, the case is proceeding as a single plaintiff seeking to represent one health plan. However, the plaintiff is again attempting to broaden the scope of the case to a class action. The Company will oppose any effort to certify a class.

The Company also was party to a class action, Glanton v. AdvancePCS, case number CIV-02-0507 PHX SRB, previously referred to as Lewis v. AdvancePCS, filed by the same counsel that had filed the Marantz case described above. This class action was served on or about April 19, 2002 and purported to be brought on behalf of a class of self-funded health plans. On or about March 31, 2003, the Company was served with another complaint (Mackner v. AdvancePCS, case number CIV-03-0607 PHX MHM) in which the plaintiff, a purported participant in a self-funded plan/customer of AdvancePCS, sought to bring action on behalf of that plan. Because the Glanton case purported to be brought as a class action on behalf of self-funded plans, on May 14, 2003, the United States District Court consolidated Mackner into Glanton. On November 7, 2003, the Federal District Court dismissed and terminated both the Glanton and Mackner cases on the pleadings, finding that the plaintiffs lacked standing to bring the actions under ERISA. The plaintiffs are entitled to appeal these dismissals to the United States Ninth Circuit Court of Appeals.

As to all of the ERISA cases, the Company believes that it does not act as an ERISA fiduciary or assume the ERISA fiduciary responsibilities as alleged in the complaints. AdvancePCS believes that, in any event, its business practices are in compliance with ERISA. The ERISA lawsuits seek unspecified monetary damages and injunctive relief.

The Company was served as a defendant in two California state court cases in 2003, one of which was brought by the same plaintiff’s counsel that represents the plaintiffs in the dismissed and pending Arizona ERISA cases. One was filed on or about March 17, 2003 in Los Angeles County Superior Court (American Federation of State, County & Municipal Employees (“AFSCME”) v. AdvancePCS, et al., case number BC292227) against AdvancePCS and other leading PBMs. The other was filed on or about March 26, 2003 in Alameda County Superior Court against AdvancePCS and several other defendants (Irwin v. AdvancePCS, et al., case number RG03088693) and is styled as a class action brought on behalf of a class of all public employees that participate in non-ERISA prescription drug benefit plans; however, a class has not been certified and the Company will oppose such certification. These two California cases allegedly involve non-ERISA plans and make the same general allegations of wrongdoing as made in the Arizona ERISA actions but are brought under California’s Unfair Competition Law rather than ERISA. Since the two California actions are related, the Company and the other PBM defendants secured an order requiring that the cases be coordinated in the Los Angeles Superior Court.

Although the ultimate outcome in these Arizona ERISA and California non-ERISA cases is uncertain, an adverse determination could potentially cause the Company to change its business practices with respect to formularies, preferred drug listings, rebates, and intervention programs, potentially reducing the Company’s profitability and growth prospects. The Company has denied all allegations of wrongdoing and is vigorously defending these suits.

On December 17, 2001, AARP and United Healthcare Insurance Co. (United) filed a multi-count complaint against AdvancePCS in federal court in Minneapolis, Minnesota in a matter captioned United Healthcare Insurance Co. and AARP v. AdvancePCS, Civ. No. 01-CV-2320 (D. Minn.). AARP and United have asserted claims against the Company for violation of Minnesota’s deceptive trade practices act, tortious interference with prospective economic advantage and unjust enrichment. Specifically, AARP and United claim that the Company created confusion among certain AARP members and pharmacists through the launch of its prescription drug discount program. AARP and United requested preliminary and permanent injunctive relief. The Company moved to dismiss the complaint. Without holding an evidentiary hearing, the district court granted AARP and United’s request for preliminary injunctive relief. The Company appealed the district court’s order and on November 1, 2002, the Eighth Circuit Federal Court of Appeals affirmed the district court’s order. In addition to the injunctive relief requested, AARP and United have asserted monetary damages of $24 million, including attorneys’ fees and costs. In September 2003, the District Court rejected, without prejudice, AARP’s and United’s attempt to amend their complaint to include a punitive damages allegation. The Company has denied AARP and United’s allegations, moved to dismiss the complaint and are vigorously defending this matter. In addition, in May 2003 the Company amended its answer to include a cross-complaint against both AARP and United for monetary damages arising out of asserted inappropriate activities by AARP and United that interfered with the operation of its prescription drug discount program. Discovery in connection with these claims is ongoing.

The Company is a defendant in a purported class action (Bellevue Drug Co. et al., on behalf of themselves and all others similarly situated, and The Pharmacy Freedom Fund and The National Community Pharmacists Association v. AdvancePCS, Civ. No. 03-473) filed in the United States District Court for the Eastern District of Pennsylvania in August 2003. The plaintiff alleges antitrust violations under Section 1 of the Sherman Act by the Company allegedly participating in a conspiracy to fix retail pharmacy reimbursement rates at sub-competitive levels. The plaintiffs are attempting to certify a nationwide class of all pharmacies that, at any time during the period commencing four years before the filing of the litigation through the present, contracted with the Company to dispense and sell brand name and generic prescription drugs for any prescription drug benefit plan(s). The plaintiffs are seeking damages and injunctive relief. The Company will vigorously defend this suit.

The Company is also a defendant in similar anti-trust class action (North Jackson Pharmacy, Inc., et al. v. AdvancePCS, et al.) filed in the United States District Court for the Northern District of Alabama in October 2003. The plaintiffs are pharmacies who seek to represent a nationwide class of pharmacies. The plaintiffs have made generally similar allegations as the plaintiffs in the Bellevue Drug Co. litigation described above. The Company will vigorously defend this suit.

In addition, the Company is a party to routine legal and administrative proceedings arising in the ordinary course of its business. The proceedings currently pending are not, in management’s opinion, material either individually or in the aggregate.

The Company cannot presently determine the ultimate resolution of these investigations and lawsuits. Accordingly, the likelihood of a loss, if any, and the amount of a loss, if any, cannot be reasonably estimated and the Company has not recognized in the accompanying consolidated financial statements any liability arising from these matters. If adversely determined, the outcome of these matters could have a material adverse effect on the Company’s liquidity, financial position and results of operations.

Various aspects of the Company’s businesses are governed by federal and state laws and regulations and compliance is a significant operational requirement for the Company. Management believes that the Company is in substantial compliance with all existing legal requirements material to the operation of its business; however, the application of complex standards to the detailed operation of the business always creates areas of uncertainty. Moreover, regulation of the field is in a state of flux. Numerous health care laws and regulations have been proposed at the state and federal level, many of which could affect the Company’s business. Management cannot predict what additional federal or state legislation or regulatory initiatives may be enacted in the future regarding health care, or the business of pharmacy benefit management. It is possible that federal or state governments might impose additional restrictions or adopt interpretations of existing laws that could have a material adverse affect on the Company’s business or financial position.

The components of the ending balances of accumulated other comprehensive loss, net of taxes, as reflected in stockholders’ equity are shown as follows (in thousands):

The components of total comprehensive income, net of taxes, are shown as follows (in thousands):

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires that management establish accounting policies and make estimates that affect both the amounts and timing of the recording of assets, liabilities, revenues and expenses. Some of these estimates require judgments about matters that are inherently uncertain. While judgments and estimates made by us are based on historical experience and other assumptions that we believe are appropriate and reasonable under current circumstances, actual resolution of these matters may differ from recorded estimated amounts, resulting in charges or credits that could materially affect future financial statements. The following are accounting policies and use of estimates applied in the preparation of our financial statements as well as the residual accounting risk inherent for these areas that should be considered. Residual accounting risk is defined as the inherent risk that remains after the application of our policies and processes and is generally outside of our control.

Our revenues are derived principally from sales of prescription drugs to members of our customers, either through our mail and specialty service pharmacies (Mail Services) or our networks of contractually affiliated retail pharmacies (Data Services). We also provide clinical and other services as part of our overall health improvement service offerings.

We adopted Emerging Issues Task Force (EITF) Issue No. 02-16, “Accounting by a Reseller for Cash Consideration Received from a Vendor” (EITF 02-16) in the fourth quarter of fiscal 2003 by retroactively reclassifying all prior years to conform with the presentation for fiscal 2003. When we provide formulary management services to a customer in conjunction with claims processing, we record rebates and administrative fees received from pharmaceutical manufacturers as a reduction of cost of revenues and the portion of the rebate payable to customers is treated as a reduction of revenue.

We evaluate our plan sponsor customer contracts using the indicators of EITF No. 99-19, “Reporting Gross Revenue as a Principal vs. Net as an Agent” (EITF 99-19) to determine whether we act as a principal or an agent in the fulfillment of prescriptions through the retail pharmacy network.

Revenues are recorded gross when we adjudicate claims for plan sponsor customers that have contractually agreed to use our contracted pharmacy network. We act as principal under EITF 99-19 when adjudicating claims for plan sponsors through our contracted pharmacy network for the following reasons:

When adjudicated claims are recorded gross, the plan sponsor’s aggregate pharmacy benefit claim payment to us is recorded as revenue and our payment to the pharmacy provider is recorded as cost of revenue in our consolidated statement of operations. In contrast, when we adjudicate prescriptions at pharmacies that are under contract directly with our plan sponsor customer and there are no financial risks to us, we record only our claims processing fees as revenues and do not include prescription costs in revenues or cost of revenues, which is referred to as net reporting.

We do not have responsibility to collect co-payments to be made by members to the retail pharmacy. Accordingly, we do not record member co-payments collected in the retail pharmacy as either revenue or cost of sales. As has been widely reported, the Securities and Exchange Commission (SEC) is in the process of reviewing the topic of co-payments and whether co-payments should or should not be included as a component of revenues and cost of sales in the prescription benefit management (PBM) industry and other related industries, including insurance companies. If the SEC should ultimately decide that co-payments should be included in revenues and cost of sales, it would result in an increase in reported revenue and a corresponding increase in cost of revenues. Thus, our consolidated results of operations, including gross profit and net income, and the consolidated balance sheets and consolidated statements of cash flows would not be affected.

Certain implementation and other fees paid to customers upon the initiation of a contractual agreement are considered an integral part of overall contract pricing and are capitalized and amortized as a reduction of revenue on a straight-line basis over the life of the contract.

We contract directly with plan sponsor customers to provide home delivery of prescription drugs to their members. We are contractually committed to specific turn around times, which is the time it takes to ship the prescription after receiving the written order. We also assume the credit and inventory risk and collect co-payments from members. Therefore, for prescriptions dispensed through our own mail service pharmacies, we recognize the total amounts paid by both the customer and the member (in the form of a co-payment) as revenue. Revenues from the dispensing of pharmaceuticals from our mail service pharmacies are recognized when each prescription is shipped.

When we earn rebates and administrative fees in conjunction with formulary management services (formulary development and manufacturer contracting) for customers, but do not process the underlying claims (rebate utility), we record rebates and administrative fees received from pharmaceutical manufacturers, net of the portion payable to customers, in revenue. In contrast, when we provide formulary management services and process the claims, we record rebates and administrative fees received as a reduction of cost of revenues and the portion deliverable to the customer as a reduction of revenue.

We recognize rebates and administrative fees receivable from pharmaceutical manufacturers and the corresponding amounts payable to customers when the prescriptions covered under the contractual agreements with the manufacturers are dispensed. We estimate the amount of rebates to be delivered to customers based on historical rates of rebates received as well as estimates of current rebates receivable from pharmaceutical manufacturers. These estimates are adjusted to actual when amounts are received from manufacturers and the portion deliverable to the customer is disbursed.

We also earn other revenue from pharmaceutical manufacturers for services such as formulary support services, outcomes studies and clinical trials. These services are negotiated separately with each pharmaceutical manufacturer and specify the services we are to perform and the revenues and fees we are to earn based on the delivery or completion of the services. We also earn revenues from our customers (primarily managed care organizations) for disease management services provided by Accordant Health Services, Inc. (Accordant), our wholly owned subsidiary acquired in November 2002. Accordant focuses on helping patients with complex, chronic and progressive diseases. The revenues of Accordant have been included in Clinical and Other Services revenue since the date of acquisition.

Cost of revenues includes prescription drug costs, labor, call center operations, information technology and other costs associated with the sale and/or dispensing of prescription drugs and providing clinical and other services.

Rebates collected from pharmaceutical manufacturers on behalf of our health plan sponsor customers are recognized as a reduction of cost of revenues in accordance with EITF 02-16.

Accounts receivable balances represent customer trade receivables generated from our Data and Mail Services. Also included in accounts receivable are receivables from vendors for our Clinical and Other Services whereby we recognize rebates and administrative fees receivable from pharmaceutical manufacturers. Based on our revenue recognition policies, certain claims at the end of the period are unbilled. Revenue and unbilled receivables for those claims are estimated each period based on the amount to be paid to the pharmacies and historical gross margin. Estimates are adjusted to actual at the time of billing. In addition, revenue and unbilled receivables for rebates are calculated quarterly based on an estimate of rebatable prescriptions and rebate per prescription. These estimates are adjusted to actual when the number of rebatable prescriptions and rebate per prescription have been determined and the billings to the pharmaceutical manufacturers have been completed. As of December 31, 2003 and March 31, 2003, unbilled receivables were $749.9 million and $883.5 million, respectively. Corresponding amounts payable to retail pharmacies (for claims) or to plan sponsor customers (for rebates) are recorded at the time the unbilled receivables are recorded. Unbilled receivables from plan sponsor customers are typically billed within 15 days and unbilled receivables from manufacturers are typically billed within 90 days, based on the respective contractual billing schedules.

To reduce the potential for credit risk, we evaluate the collectibility of customer balances based on a combination of factors but do not generally require significant collateral. We regularly analyze significant customer balances, and, when it becomes evident a specific customer will be unable to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position, a specific allowance for doubtful account is recorded to reduce the related receivable to the amount that is believed reasonably collectible. We also record allowances for doubtful accounts for all other customers based on a variety of factors including the length of time the receivables are past due, the financial health of the customer and historical experiences. If circumstances related to specific customers change, our estimates of the recoverability of receivables could be further adjusted.

Agreements with certain health plan sponsor customers contain provisions that require us to obtain a minimum rebate per claim from pharmaceutical manufacturers in order to generate additional savings for health plan sponsor customers. Failure to achieve the minimum rebate per claim results in an obligation by us to the health plan sponsor customer. The obligation is equivalent to the difference between the actual rebate per claim obtained and the minimum stated in the health plan sponsor customer agreement, which is then multiplied by the number of claims processed in a specified period. We continually monitor the health plan sponsor customers’ rebate per claim and recognize a liability when it appears unlikely the average rebate per claim will meet or exceed the stated minimum.

If circumstances related to collectibility assumptions of pharmaceutical manufacturers rebates change, including changes in market conditions (e.g., drug patent expiration) or member quantity, that materially alter drug utilization patterns and adversely affect the pharmaceutical manufacturers rebates obtained, rebate guarantee obligations could increase, resulting in a charge to earnings.

Agreements with certain health plan sponsor customers contain plan performance guarantees that require us to meet various operational standards, including items such as customer service wait time, abandoned customer service calls and mail pharmacy turn around time, as well as guaranteed savings for using our retail networks. Certain contracts require 100% guarantee in achieving various operational standards. Failure to achieve the operational standards results in penalty payments to the health plan sponsors by us. We continually monitor our operational performance

against the standards outlined in health plan sponsor customer contracts. A loss is recorded as a liability. If we experience changes in events or circumstances that adversely impact operations, performance guarantee obligations could increase, resulting in a charge to earnings.

Agreements with certain health plan sponsor customers contain guarantees relating to an efficient and effective transition into our services (implementations). Failure to achieve an efficient and effective transition on our part results in an obligation to health plan sponsor customers. Obligations are estimated based on the success of recently transitioned health plan sponsor customers. If we experience changes in events or circumstances that adversely impact the transition of new health plan sponsor customers to our products and services, a charge to earnings may result.

Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will exceed the recorded provision. Contingent liabilities are often resolved over extended time periods. We evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial position or results of operations. Estimating probable losses requires varying levels of analysis that often depend on judgments about potential actions by third parties such as arbitrators.

The following table sets forth certain consolidated, unaudited historical financial data of AdvancePCS.

During fiscal year 2003, we adopted EITF 02-16. Under this pronouncement, any consideration received from a vendor is presumed to be a reduction of the prices of the vendor’s products and should, therefore, be characterized as a reduction of cost of revenues. This EITF applies to rebates and administrative fees received from pharmaceutical manufacturers. We had previously recorded rebates, net of the amount distributed to our customers, and administrative fees as components of Clinical Services revenue. Prior period reclassification is allowed to the extent there is no impact on net income. The application of EITF 02-16 did not change our net income, gross profit or cash flows.

Three Months Ended December 31, 2003 Compared to Three Months Ended December 31, 2002

Data Services – Data services revenue increased $10.6 million, or 0.3%, for the three months ended December 31, 2003 compared to the same period one year ago. Increases in the Average Wholesale Price index for drug ingredient costs drove revenue up by $90.8 million. The increase in the Average Wholesale Price index, which is used to establish the price of a prescription at the point of sale, was due to higher costs for newly introduced drugs, as well as price increases for existing drugs. Higher average generic dispensing rates reduced revenue per claim processed. Our generic dispensing rate increased 3.8% for the three months ended December 31, 2003 as compared to the same quarter in fiscal 2003.

Mail Services – Mail services revenue increased $123.4 million, or 20%, compared to the three months ended December 31, 2002. Of this increase, approximately $58.9 million resulted from a 10% increase in the number of mail prescriptions dispensed, which was driven principally by increased utilization of our mail services by existing members. The number of mail pharmacy prescriptions dispensed increased from 4.0 million for the three months ended December 31, 2002 to 4.5 million for the three months ended December 31, 2003. Also contributing to the increase in mail revenue was the combined impact of an increase in the Average Wholesale Price index for drug ingredient cost, offset by a 4.2% increase in our mail order generic dispensing rate for the three months ended December 31, 2003 as compared to the same quarter in fiscal 2003. The remaining increase in mail revenue was due to the growth of specialty pharmacy services revenue, with revenues of $121.5 million for the three months ended December 31, 2003 compared to $68.8 million for the same period in the prior year, which was primarily as a result of increased volumes.

Clinical and Other Services – Clinical and other services revenue increased $14.0 million, or 29%, compared to the three months ended December 31, 2002. The majority of this increase is attributable to the inclusion of a full quarter of revenues generated by Accordant, a disease management company focusing on patients with complex, chronic and progressive diseases, which was acquired in November 2002. The remaining increase was attributable to improved contract rates and greater formulary compliance by our rebate utility customers as well as increased utilization of our clinical programs.

Overall cost of revenues increased $120.9 million, or 3%, compared to the three months ended December 31, 2002. Of this increase, drug ingredient costs grew by $125.2 million to $3.6 billion. This increase was driven primarily by the increase in the Average Wholesale Price index of pharmaceuticals, which in turn was driven by higher costs for newly introduced drugs, as well as price increases for existing drugs and increases in mail services. Cost of revenues, excluding drug ingredient costs, decreased $4.3 million, or 3%, as compared to the three months ended December 31, 2002. The majority of the period over period decrease was attributable to the elimination of expenses incurred in connection with the opening of our third mail order facility in Wilkes-Barre, Pennsylvania in the quarter ended December 31, 2002; and the elimination of non-pharmaceutical cost of revenues associated with both the ramp up of our specialty pharmacy operations and Accordant in the quarter ended December 31, 2002.

Our selling, general and administrative expenses, excluding merger-related charges, for the three months ended December 31, 2003 increased by $9.5 million compared to the same period in 2002. This increase was primarily attributable to the growth in our mail and specialty business and increased administration costs associated with outside legal fees, increased insurance premiums and employee benefits costs, offset by the elimination of expenses related to our acquisition and integration of Accordant in the quarter ended December 31, 2002. Selling, general and administrative expenses as a percentage of revenues increased from 1.5% for the three months ended December 31, 2002 to 1.7% for the three months ended December 31, 2003.

During the three months ended December 31, 2003, we incurred charges of approximately $6.0 million in legal, accounting and other expenses related to the proposed merger with Caremark. We expect to incur continuing costs up until the closing of this transaction, including costs associated with our responding to requests by the Federal Trade Commission.

Interest expense, net of interest income, for the three months ended December 31, 2003 decreased $4.1 million, or 46%, compared to the same period in 2002. The decrease in interest expense resulted from: (1) the increased net repayment of debt with excess cash and (2) the expiration of the $200 million of the interest rate swap in October 2003.

In February 2001, we entered into an agreement with Express Scripts and Medco Health Solutions (formally Merck-Medco Managed Care), to form RxHub, LLC (RxHub) to develop electronic prescribing technology. We own one-third of the equity of RxHub. We have recorded our investment in RxHub under the equity method of accounting and record our percentage interest in RxHub’s results in our consolidated statements of operations. Our proportionate share of RxHub’s loss for the three months ended December 31, 2003 was $1.1 million compared to $1.3 million for the same period in 2002.

For the three months ended December 31, 2003 and 2002, our effective tax rate was approximately 39.5%.

We reported diluted net income of $0.55 per share for the three months ended December 31, 2003 compared to $0.46 per share for the same period in 2002. The weighted average shares outstanding were 99.6 million and 97.4 million for the three-month periods ending December 31, 2003 and 2002, respectively. The weighted average shares outstanding at December 31, 2003 include reductions due to share repurchases, offset by shares issued through the employee stock purchase plan (ESPP) program, since June 2002.

Nine Months Ended December 31, 2003 Compared to Nine Months Ended December 31, 2002

Data Services – Data services revenue increased $454.6 million, or 5%, for the nine months ended December 31, 2003 compared to the same period one year ago. Increases in the Average Wholesale Price index for drug ingredient costs drove up revenue by approximately $468.0 million. The increase in the Average Wholesale Price index was attributable to higher costs for newly introduced drugs, as well as price increases for existing drugs. In addition, the increase was due to a 3.0 million increase in retail claims processed, compared to the nine months ended December

31, 2002. Higher average generic dispensing rates reduced revenue per claim processed. Our retail generic dispensing rate increased 5.3% for the nine months ended December 31, 2003 as compared to the same period in fiscal 2003.

Mail Services – Mail services revenue increased $411.8 million, or 25%, compared to the nine months ended December 31, 2002. Of this increase, approximately $217.1 million resulted from a 13% increase in the number of mail prescriptions dispensed which was driven by the addition of several customers whose members are high mail utilizers and increased utilization of our mail services by existing members. The number of mail pharmacy prescriptions dispensed increased from 11.4 million for the nine months ended December 31, 2002 to 12.9 million for the nine months ended December 31, 2003. Also contributing to the increase in mail revenue was the impact of an increase in the Average Wholesale Price index for drug ingredient cost, which was partially offset by higher brand discounts and a 7.2% increase in our mail order average generic dispensing rates. The remaining increase in mail revenue was due to the growth of specialty pharmacy services revenue, with revenues of $321.2 million for the nine months ended December 31, 2003 compared to $165.2 million for the same period in the prior year, which growth was primarily as a result of increased volumes.

Clinical and Other Services – Clinical and other services revenue increased $39.8 million, or 28%, compared to the nine months ended December 31, 2002. A significant portion of this increase is attributable to the inclusion of revenues generated by Accordant, which was acquired in November 2002. The remaining increase was attributable to new customers, which use our clinical services, and improved contract rates and greater formulary compliance by our rebate utility customers.

Overall cost of revenues increased $822.6 million, or 8%, compared to the nine months ended December 31, 2002. Of this increase, drug ingredient costs grew by $817.7 million to $10.5 billion. This increase was driven primarily by the increase in the Average Wholesale Price index of pharmaceuticals, which in turn was driven by higher costs for newly introduced drugs, as well as price increases for existing drugs and increases in mail services. This increase in Average Wholesale Price was partially offset by the benefits of forward purchasing of inventory and increased generic dispensing rates. Adjusted claims grew 7.6 million or 1.9% as compared to the comparable nine-month period in the prior fiscal year. Adjusted claims are calculated as pharmacy network claims processed plus mail pharmacy prescriptions multiplied by three, as mail claims typically represent a three-month supply, while pharmacy network claims typically represent a one-month supply. Cost of revenues, excluding drug ingredient costs, increased $4.9 million or 1% as compared to the nine months ended December 31, 2002. The majority of the increase was attributable to non-ingredient costs associated with filling a greater number of mail order prescriptions; the opening of our third mail order facility in Wilkes-Barre, Pennsylvania in the third quarter of fiscal 2003; increased call center operations to handle the increased volume of calls associated with implementing new mail utilizing members and promoting the use of our mail services to existing members; and non-pharmaceutical cost of revenues associated with both the ramp up of our specialty pharmacy operations and the inclusion of Accordant, which was acquired in November 2002.

Our selling, general and administrative expenses, excluding merger-related charges, for the nine months ended December 31, 2003 increased by $31.0 million compared to the same period in 2002. This increase was primarily attributable to increased costs associated with information systems technology; increased administration costs associated with greater outside legal fees, insurance premiums and employee benefits costs; and the acquisition and integration of Accordant in November 2002. We also increased our on-going costs of operations supporting the Wilkes-Barre mail order facility, which was opened in the third fiscal quarter of 2003. Selling, general and administrative expenses as a percentage of revenues increased from 1.6% for the nine months ended December 31, 2002 to 1.7% for the nine months ended December 31, 2003.

During the nine months ended December 31, 2003, we recognized charges of approximately $10.1 million in legal, accounting and other expenses related to the proposed merger with Caremark. We expect to incur continuing costs up until the closing of this transaction, including costs associated with our responding to requests by the Federal Trade Commission.

Interest expense, net of interest income, for the nine months ended December 31, 2003 decreased $7.9 million or 27% compared to the same period in 2002. The decrease in interest expense resulted from: (1) the increased net repayment of debt with excess cash, (2) the increased usage of the Asset Securitization Facility beginning in the first quarter of fiscal 2003, which incurs interest at a lower rate than the debt it replaced and (3) the expiration of $200 million and $100 million of the interest rate swap in October 2003 and October 2002, respectively.

During the nine months ended December 31, 2002, we recorded a loss associated with the early retirement of debt. The loss was attributable to a non-cash charge to write off a portion of the deferred financing fees related to the Term B note in the amount of $2.4 million (excluding taxes of $953,000, included in provision for income taxes). This amount was previously reported as an extraordinary loss but has been retroactively reclassified to pre-tax income in accordance with SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002” (SFAS 145), see Recently Adopted Accounting Policies, which the Company adopted in the first fiscal quarter of 2004.

In February 2001, we entered into an agreement with Express Scripts and Medco Health Solutions, to form RxHub to develop electronic prescribing technology. We own one third of the equity of RxHub. We have recorded our investment in RxHub under the equity method of accounting and record our percentage interest in RxHub’s results in our consolidated statement of operations. Our proportionate share of RxHub’s loss for the nine months ended December 31, 2003 was $4.1 million compared to $3.5 million for the same period in fiscal 2003.

For the nine months ended December 31, 2003 and 2002, our effective tax rate was approximately 39.5%.

We reported diluted net income of $1.57 per share for the nine months ended December 31, 2003 compared to $1.23 per share for the same period in 2002. The weighted average shares outstanding were 98.2 million and 99.3 million for the nine months ended December 31, 2003 and 2002, respectively. The decline in weighted average shares outstanding at December 31, 2003 represents reductions due to share repurchases, offset by shares issued through the ESPP program, since June 2002.

Net cash provided by operating activities was $267.6 million and $191.0 million for the nine months ended December 31, 2003 and 2002, respectively. The increase of $76.6 million for the nine months ended December 31, 2003 versus the same period in 2002 reflected increased earnings of $31.6 million and improvements in our working capital components. These increases were offset in part by increased period over period inventory purchases of $167.8 million, reflecting higher investment buying activities for our mail service pharmacies, and include the additional inventory investment associated with the ramping up of our Wilkes-Barre, Pennsylvania mail facility through 2003. Although we had a working capital deficit of $266.9 million as of December 31, 2003, the majority of our current obligations are not due until cash is collected from our customers. We use our excess cash balances to reduce debt under our credit facilities, which results in a net deficit in our working capital. Our net cash provided by operating activities improved due to the timing of receivables and payables resulting from our claims processing cycle. A majority of our claims billings are processed on a fourteen-day cycle, beginning on Saturdays. As a result,

cash balances, accounts receivable and accounts payable reflected in our consolidated balance sheets may fluctuate period to period depending on the day of the week that the quarter actually ends in relationship to the timing of invoicing, receipt of cash from our customers and our payments to retail pharmacies. Therefore, we experience fluctuations in our cash balances depending upon the day of the cycle. We manage the effect of these fluctuations by borrowing on our Asset Securitization Facility and our Revolving Credit Facility during certain cycle days.

We anticipate cash flow from operations will continue to be used to support our current operations, debt service and currently anticipated capital expenditure requirements for the foreseeable future. Excess cash flow generated will continue to be invested according to our investment policy.

Net cash used in investing activities was $26.0 and $134.6 million for the nine months ended December 31, 2003 and 2002, respectively, and principally consisted of capital expenditures, as well as the Accordant acquisition in November 2002. Capital expenditures were $23.8 million and $58.7 million for the nine months ended December 31, 2003 and 2002, respectively, and primarily related to purchases of property and equipment; capitalized software associated with the growth and expansion of our systems and facilities, including our Wilkes-Barre, Pennsylvania mail order facility which was opened in the third fiscal quarter of 2003; leasehold improvements for the new TheraCom facility which was opened in January 2004; and software and systems upgrades for compliance with the Health Insurance Portability and Accountability Act of 1996.

In November 2002, we acquired 100% of the common stock of privately-held Accordant Health Services, Inc. (Accordant), a disease management company that focuses on helping patients with complex, chronic and progressive diseases. The aggregate purchase price of Accordant was $96.5 million, net of cash acquired, and includes the final determination of working capital adjustment, transaction costs and the $25.0 million purchase earn-out, in accordance with the purchase agreement. The results of Accordant have been included in our consolidated financial statements since the acquisition date.

Net cash used in financing activities was $222.5 million and $124.3 million for the nine months ended December 31, 2003 and 2002, respectively. The activity for the nine months ended December 31, 2003 consisted of net debt repayments of $260.1 million, primarily related to the Asset Securitization Facility, offset in part by proceeds from stock option exercises of $37.6 million. The activity for the nine months ended December 31, 2002 consisted primarily of 4.7 million shares purchased under our stock repurchase program at a cost of approximately $87.7 million and the repurchase of Senior Notes with a face value of approximately $12.2 million in open market transactions. In the Merger Agreement, we have agreed not to repurchase any additional shares without the consent of Caremark. Additionally, during the nine months ended December 31, 2002, we completed an increase to the Asset Securitization Facility of $150 million, which was used to repay the remaining Term B note under our senior credit facility. Additional debt reduction, if any, will be made in such amounts and at such times, as we deem appropriate based upon prevailing market and business conditions. However, during the reporting periods, we experience cash balance fluctuations and manage these fluctuations by borrowing against the Asset Securitization Facility and Revolving Credit Facility.

In September 2002, we amended our Senior Secured Credit Facility to increase the size of the revolver from $175 million to $275 million. No amounts were outstanding under the revolving facility at December 31, 2003. The credit facility contains covenants that are typical for this type of debt, including limitations on capital expenditures, minimum fixed charge, interest coverage and total leverage ratios. We are in compliance with all covenants.

In March 2001, we issued $200 million of Senior Notes due 2008. In the second quarter of fiscal year 2003, we repurchased a portion of the Senior Notes with a face value of approximately $12.2 million in open market transactions. The Senior Notes contain covenants that are typical for this type of debt including, among others, fixed charge ratio, payment of dividends and sales of assets. There are no restrictions on the ability of the guarantors to pay dividends, make loans or advances to the parent. We are in compliance with all covenants.

In December 2001, we securitized certain of our accounts receivable pursuant to the Asset Securitization Facility. We used the proceeds to repay $150 million of our Term B note that had a balance outstanding of approximately $300 million at that time. In June 2002, we increased the Asset Securitization Facility to $300 million. We used the proceeds to pay the remaining $150 million of our Term B note. The Asset Securitization Facility is included in our debt balance as of December 31, 2003 and March 31, 2003 and will continue to be reflected “on-balance sheet”. As of December 31, 2003, there was no outstanding amount under the Asset Securitization Facility.

In October 2003, our interest rate swap fully expired. Since we have no balance outstanding under our Revolving Credit Facility and our Asset Securitization Facility, we do not anticipate lower interest expense in future quarters as compared to the quarter ended December 31, 2003.

On June 6, 2002, we filed a Form 8-K announcing the authorization from the board of directors of a stock repurchase program of up to $150 million of our outstanding shares of Class A common stock in the open market or private transactions. Purchases of stock under this repurchase program are included in treasury and offset by the issuance of shares for the ESPP program.

During the three month and nine month periods ended December 31, 2002, we purchased 0.7 million and 4.0 million shares at a cost of $15.9 million and $87.7 million under this repurchase program. There were no shares issued under the ESPP program during the three and nine month periods ended December 31, 2002. During the three month and nine month periods ended December 31, 2003, no shares were purchased under this repurchase program, however, previous treasury purchases were offset by the issuance of 137,545 shares for the ESPP program. Since inception, we have purchased 5.6 million shares at a cost of $111.5 million, offset by 271,050 shares issued for the ESPP program. In the Merger Agreement, we have agreed not to repurchase any additional shares without the consent of Caremark.

In August 2001, the we completed the acquisition of 100% of the equity of Dresing-Lierman, Inc. and its wholly-owned subsidiary, TheraCom Inc. (collectively, TheraCom), a specialty pharmacy and distribution company located in Bethesda, Maryland. At the time of the acquisition, in addition to the payment of other consideration, 217,050 shares of common stock issued to the former TheraCom stockholders were held in escrow to satisfy any indemnification claims the we may have had arising out of the acquisition, including those related to the settlement of certain TheraCom litigation outstanding at the time of the acquisition. All shares held in escrow were included in our calculation of basic earnings per share beginning with the quarter ended September 30, 2002.

In January 2003, 34,188 shares were withdrawn from the indemnification claims escrow and returned to us to satisfy the indemnification claim arising from the settlement of litigation between TheraCom and one of its former stockholders. These shares returned to us are held in treasury. In August 2003, further litigation was settled between TheraCom and one of its former employees. Pursuant to this settlement, TheraCom paid the former employee $2 million. The former stockholders of TheraCom then indemnified us and reimbursed TheraCom for the $2 million in cash. Upon receipt of this indemnification payment and in accordance with the terms of the acquisition, all of the 182,862 shares then held in the indemnification escrow were released to the former TheraCom stockholders.

In November 1999, PCS Health Systems, Inc., or PCS, a subsidiary of PCS Holding Corporation, which was acquired by us in October 2000, received a subpoena from the Department of Health and Human Services OIG requesting that PCS produce documents in connection with an industry-wide investigation. The investigation is ongoing and being pursued under the direction of the United States Attorney’s Office for the Eastern District of Pennsylvania. Based on public statements from that office, the investigation appears to involve a review of the practices of pharmacy benefit management companies, or PBMs, under federal anti-kickback statutes and other laws and regulations. Specifically, the focus of the investigation appears to be PBMs’ relationships with pharmaceutical

manufacturers and retail pharmacies and PBMs’ programs relating to drug formulary compliance, including rebate and other payments made by pharmaceutical manufacturers to PBMs, and payments made by PBMs to retail pharmacies in connection with therapeutic intervention activity. We provided documents responsive to the subpoena. The United States Attorney’s Office also contacted some of the pharmaceutical manufacturers with which we have agreements and has asked them to provide copies of documents relating to their agreements with us. The United States Attorney General also issued Civil Investigative Demands, or CIDs, seeking to compel the depositions of eight of our current and former employees.

On September 17, 2002, the United States District Court for the Eastern District of Pennsylvania entered an order holding in abeyance, pending the good faith efforts to reach a mutual resolution of the outstanding discovery issues, both our dispute with the OIG regarding the scope and enforcement of the subpoena for documents and employee e-mail as well as the issuance of the CIDs. As a result of that order, AdvancePCS does not have to comply with the subpoena issued by the OIG. Since entry of that order, we have reached agreement with the United States Attorney’s office regarding the scope of its document requests and facilitated interviews of certain employees in lieu of the CIDs. The government has continued to request the production of additional documents and interviews, including information relating to the activities of the former Advance Paradigm (which was the name of AdvancePCS prior to the acquisition of PCS) and the activities of AdvancePCS subsequent to the PCS acquisition, as well as additional information regarding our arrangements with retail pharmacies and health plans. We continue to cooperate with the OIG. We already have produced certain requested materials and we intend to continue to work with the OIG to facilitate the production of further documents and arrange the requested interviews.

It is not possible to predict the outcome of this investigation or whether the government will commence any action challenging any of our programs and practices. We believe that our programs, including those prior to the PCS acquisition, are in compliance with the requirements of the anti-kickback and false claims statutes and other applicable laws and regulations. Moreover, other than those actions filed in connection with the enforcement of the subpoena, neither the OIG nor the United States Attorney has filed any actions or claims against us nor have they indicated their intention to do so. Nevertheless, as a result of this investigation, we could be subject to scrutiny, further investigation or challenge under federal or state anti-kickback and false claims statutes or other laws and regulations which could cause our business, profitability and growth prospects to suffer materially.

In March 1998, a class action lawsuit captioned Mulder v. PCS Health Systems, Inc., case number 98-1003, was filed in the United States District Court of the District of New Jersey. This action alleges that PCS is a fiduciary, as that term is defined in the Employee Retirement Income Security Act, or ERISA, and that we have breached our fiduciary obligations under ERISA in connection with our development and implementation of formularies, preferred drug listings and intervention programs for our sponsors of ERISA health plans. In particular, the plaintiff alleges that our therapeutic interchange programs and negotiation of formulary rebates and discounts from pharmaceutical manufacturers violate fiduciary obligations. The plaintiff is seeking injunctive relief and monetary damages in an unspecified amount. We believe that we do not assume any of the plan fiduciary responsibilities that would subject us to regulation under ERISA as alleged in the complaint, have denied all allegations of wrongdoing and are vigorously defending this suit. The plaintiff purported to represent a nation-wide class consisting of all members of all ERISA plans for which PCS provided PBM services during the class period. We opposed certification of this class and on July 17, 2003, the District Court entered an order certifying a more limited class comprised only of members of those ERISA plans for which PCS provided services under its contract with a single plan administrator. We will continue to vigorously defend this suit. Although the ultimate outcome is uncertain, an adverse determination could potentially cause us to change our business practices with respect to formularies, preferred drug listings, intervention programs, and rebates, potentially reducing our profitability and growth prospects.

We are also a party to Marantz v. AdvancePCS, case number CIV-01-2413PHX EHC, a class action filed on or about December 17, 2001 in the United States District Court in Arizona that alleges that we act as an ERISA fiduciary and that we have breached certain fiduciary obligations under ERISA. The plaintiff withdrew the class action allegations in April 2002. In March 2003, the court dismissed the plaintiff’s apparent effort to reassert possible class action claims. In May 2003, the Marantz case was dismissed based on inadequacies in the plaintiff’s pleadings and subsequently the plaintiff filed an amended complaint purporting to address these inadequacies. Currently, the case is proceeding as a single plaintiff seeking to represent one health plan. However, the plaintiff is again attempting to broaden the scope of the case to a class action. We will oppose any effort to certify a class.

We also were party to a class action, Glanton v. AdvancePCS, case number CIV-02-0507 PHX SRB, previously referred to as Lewis v. AdvancePCS, filed by the same counsel that had filed the Marantz case described above. This class action was served on or about April 19, 2002 and purported to be brought on behalf of a class of self-funded health plans. On or about March 31, 2003, we were served with another complaint (Mackner v. AdvancePCS, case number CIV-03-0607 PHX MHM) in which the plaintiff, a purported participant in a self-funded plan/customer of ours, sought to bring action on behalf of that plan. Because the Glanton case purported to be brought as a class action on behalf of self-funded plans, on May 14, 2003, the United States District Court consolidated Mackner into Glanton. On November 7, 2003, the Federal District Court dismissed and terminated both the Glanton and Mackner cases on the pleadings, finding that the plaintiffs lacked standing to bring the actions under ERISA. The plaintiffs are entitled to appeal these dismissals to the United States Ninth Circuit Court of Appeals.

As to all of the ERISA cases, we believe that we do not act as an ERISA fiduciary or assume the ERISA fiduciary responsibilities as alleged in the complaints. We believe that, in any event, our business practices are in compliance with ERISA. The ERISA lawsuits seek unspecified monetary damages and injunctive relief.

We were served as a defendant in two California state court cases in 2003, one of which was brought by the same plaintiff’s counsel that represents the plaintiffs in the dismissed and pending Arizona ERISA cases. One was filed on or about March 17, 2003 in Los Angeles County Superior Court (American Federation of State, County & Municipal Employees (“AFSCME”) v. AdvancePCS, et al., case number BC292227) against us and other leading PBMs. The other was filed on or about March 26, 2003 in Alameda County Superior Court against us and several other defendants (Irwin v. AdvancePCS, et al., case number RG03088693) and is styled as a class action brought on behalf of a class of all public employees that participate in non-ERISA prescription drug benefit plans; however, a class has not been certified and we will oppose such certification. These two California cases allegedly involve non-ERISA plans and make the same general allegations of wrongdoing as made in the Arizona ERISA actions but are brought under California’s Unfair Competition Law rather than ERISA. Since the two California actions are related, we and the other PBM defendants secured an order requiring that the cases be coordinated in the Los Angeles Superior Court.

Although the ultimate outcome in these Arizona ERISA and California non-ERISA cases is uncertain, an adverse determination could potentially cause us to change our business practices with respect to formularies, preferred drug listings, rebates, and intervention programs, potentially reducing our profitability and growth prospects. We have denied all allegations of wrongdoing and are vigorously defending these suits.

On December 17, 2001, AARP and United Healthcare Insurance Co., or United, filed a multi-count complaint against us in federal court in Minneapolis, Minnesota in a matter captioned United Healthcare Insurance Co. and AARP v. AdvancePCS, Civ. No. 01-CV-2320 (D. Minn.). AARP and United have asserted claims against us for violation of Minnesota’s deceptive trade practices act, tortious interference with prospective economic advantage and unjust enrichment. Specifically, AARP and United claim that we created confusion among certain AARP members and pharmacists through the launch of our prescription drug discount program. AARP and United requested preliminary and permanent injunctive relief. We moved to dismiss the complaint. Without holding an evidentiary hearing, the district court granted AARP and United’s request for preliminary injunctive relief. We appealed the district court’s order and on November 1, 2002, the Eighth Circuit Federal Court of Appeals affirmed the district court’s order. In addition to the injunctive relief requested, AARP and United have asserted monetary damages of $24 million, including attorneys’ fees and costs. In September 2003, the District Court rejected, without prejudice, AARP’s and United’s attempt to amend their complaint to include a punitive damages allegation. We have denied AARP and United’s allegations, moved to dismiss the complaint and are vigorously defending this matter. In addition, in May 2003 we amended our answer to include a cross-complaint against both AARP and United for monetary damages arising out of asserted inappropriate activities by AARP and United that interfered with the operation of our prescription drug discount program. Discovery in connection with these claims is ongoing.

We are a defendant in a purported class action (Bellevue Drug Co. et al., on behalf of themselves and all others similarly situated, and The Pharmacy Freedom Fund and The National Community Pharmacists Association v. AdvancePCS, Civ. No. 03-473) filed in the United States District Court for the Eastern District of Pennsylvania in August 2003. The plaintiff alleges antitrust violations under Section 1 of the Sherman Act by us allegedly participating in a conspiracy to fix retail pharmacy reimbursement rates at sub-competitive levels. The plaintiffs are attempting to certify a nationwide class of all pharmacies that, at any time during the period commencing four years before the filing of the litigation through the present, contracted with us to dispense and sell brand name and generic prescription drugs for any prescription drug benefit plan(s). The plaintiffs are seeking damages and injunctive relief. We will vigorously defend this suit.

We are also a defendant in similar anti-trust class action (North Jackson Pharmacy, Inc., et al. v. AdvancePCS, et al.,) filed in the United States District Court for the Northern District of Alabama in October 2003. The plaintiffs are pharmacies who seek to represent a nationwide class of pharmacies. The plaintiffs have made generally similar allegations as the plaintiffs in the Bellevue Drug Co. litigation described above. We will vigorously defend this suit.

In addition, we are a party to routine legal and administrative proceedings arising in the ordinary course of our business. The proceedings currently pending are not, in our opinion, material either individually or in the aggregate.

We cannot presently determine the ultimate resolution of these investigations and lawsuits. Accordingly, the likelihood of a loss, if any, and the amount of a loss, if any, cannot be reasonably estimated and we have not recognized in the accompanying consolidated financial statements any liability arising from these matters. If adversely determined, the outcome of these matters could have a material adverse effect on our liquidity, financial position and results of operations.

Various aspects of our businesses are governed by federal and state laws and regulations and compliance is a significant operational requirement for us. We believe that we are in substantial compliance with all existing legal requirements material to the operation of our business; however, the application of complex standards to the detailed operation of the business always creates areas of uncertainty. Moreover, regulation of the field is in a state of flux. Numerous health care laws and regulations have been proposed at the state and federal level, many of which could affect our business. We cannot predict what additional federal or state legislation or regulatory initiatives may be enacted in the future regarding health care, or the business of pharmacy benefit management. It is possible that federal or state governments might impose additional restrictions or adopt interpretations of existing laws that could have a material adverse affect on our business or financial position.

In May 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002” (SFAS 145). This Statement rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, and an amendment of that Statement, and FASB Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. SFAS 145 restricts the classification of gains and losses from extinguishment of debt to only those transactions that are unusual and infrequent in nature as defined by APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (APB 30) as extraordinary. We adopted SFAS 145 in the first quarter of fiscal 2004. In connection with the Term B note repayments made in June 2002, we recorded a loss associated with the early retirement of debt. The loss was attributable to a non-cash charge to write-off a portion of the deferred financing fees related to the secured bank agreement in the amount of $2.4 million (excluding taxes of $953,000, included in the provision for income taxes) and was previously reflected as an extraordinary item. Accordingly, the pre-tax extraordinary loss of $2.4 million for the nine months ended December 31, 2002, was reclassified to income before income taxes to conform to the requirements of SFAS 145.

In January 2003, the FASB issued FASB Interpretation (FIN) No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (FIN 46), which clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”. This revised interpretation retains the original FIN 46 requirements for consolidating variable interest entities by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not provide sufficient equity at risk for the entity to support its activities without additional subordinated financial support from other parties. The revised interpretation adds the requirement for consolidating an entity where the equity investors’ voting rights are not proportionate to their economic interests and where the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest. This revised interpretation is effective for all entities no later than the end of the first reporting period that ends after March 15, 2004. However, for reporting periods ending after December 15, 2003, a company must apply either the original or this revised interpretation to those entities that

are considered to be special-purpose entities. A company that has already applied the original FIN 46 to an entity may continue to do so until the effective date of the revised interpretation. We have a variable interest entity that has been and will continue to be included in our consolidated financial statements, and therefore, management believes that adoption of FIN 46 (revised December 2003) will not have a material impact on our financial position or results of operations.

In May 2003, the EITF released Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables” (EITF 00-21). EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue generating activities. Specifically, EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. It also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. EITF 00-21 applies to all deliverables within contractually binding arrangements in all industries under which a vendor will perform multiple revenue-generating activities, with some exceptions noted. EITF 00-21 is effective for revenue generating arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. We do not expect the adoption of EITF 00-21 to have a material impact on our financial position or results of operations.

In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition” (SAB 104). SAB 104 updates portions of the interpretive guidance included in Topic 13 of the codification of Staff Accounting Bulletins in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. We believe we are following the guidance of SAB 104.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (SFAS 132). This revised statement retains the disclosures required by the original SFAS 132, which standardized employers’ disclosures about pensions and other postretirement benefits, and requires additional disclosures concerning the economic resources and obligations related to pension plans and other postretirement benefits. The provisions of the original SFAS 132 remain in effect until the provisions of this revised statement are adopted. This revised statement is effective for fiscal years ending after December 15, 2003. We will revise our disclosures to meet the requirements under this revised standard in the financial statements for the fiscal year ended March 31, 2004.

Changes in prices charged by manufacturers and wholesalers for pharmaceuticals we dispense affect our cost of revenues. Historically, we have been able to pass the effect of such price changes to our customers under the terms of our agreements. As a result, changes in pharmaceutical prices due to inflation have not adversely affected us. There can be no guarantee that we will be able to pass on the effect of such future price changes to our customers.

We have not entered into derivatives or other financial instruments for trading purposes. We did enter into interest rate protection agreements that had fixed the LIBOR rate as of November 7, 2000 at 6.60% for $400 million of our variable rate debt under our credit facility. The notional amount was reduced by $100 million in October 2001 and 2002. The swap expired in October 2003. As of December 31, 2003, our outstanding variable rate debt was zero.

Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, or the Exchange Act, such as this Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Internal controls are procedures which are designed with the objective of providing reasonable assurance

that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with generally accepted accounting principles.

The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the quarterly period covered by this quarterly report. Based on such evaluation, such officers have concluded that, as of the end of the quarterly period covered by this quarterly report, the Company’s disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s reports filed or submitted under the Exchange Act and that our internal controls are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with generally accepted accounting principles.

Since the end of the quarterly period covered by this quarterly report, there have not been any significant changes in the Company’s internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) or in other factors that could significantly affect such controls. There were no significant deficiencies or material weaknesses and therefore there were no corrective actions taken.

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

which the Company has agreements and has asked them to provide copies of documents relating to their agreements with the Company. The United States Attorney General also issued Civil Investigative Demands (CIDs) seeking to compel the depositions of eight of the Company’s current and former employees.

On September 17, 2002, the United States District Court for the Eastern District of Pennsylvania entered an order holding in abeyance, pending the good faith efforts to reach a mutual resolution of the outstanding discovery issues, both the Company’s dispute with the OIG regarding the scope and enforcement of the subpoena for documents and employee e-mails as well as the issuance of the CIDs. As a result of such order, AdvancePCS does not have to comply with the subpoena issued by the OIG. Since entry of that order, the Company has reached agreement with the United States Attorney’s office regarding the scope of its document requests and facilitated interviews of certain employees in lieu of the CIDs. The government has continued to request the production of additional documents and interviews, including information relating to the activities of the former Advance Paradigm (which was the name of AdvancePCS prior to the acquisition of PCS) and the activities of AdvancePCS subsequent to the PCS acquisition, as well as additional information regarding the Company’s arrangements with retail pharmacies and health plans. The Company continues to cooperate with the OIG. The Company already has produced certain requested materials and intends to continue to work with the OIG to facilitate the production of further documents and arrange the requested interviews.

attempting to certify a nationwide class of all pharmacies that, at any time during the period commencing four years before the filing of the litigation through the present, contracted with the Company to dispense and sell brand name and generic prescription drugs for any prescription drug benefit plan(s). The plaintiffs are seeking damages and injunctive relief. The Company will vigorously defend this suit.

The Company is also a defendant in similar anti-trust class action (North Jackson Pharmacy, Inc., et al. v. AdvancePCS, et al.,) filed in the United States District Court for the Northern District of Alabama in October 2003. The plaintiffs are pharmacies who seek to represent a nationwide class of pharmacies. The plaintiffs have made generally similar allegations as the plaintiffs in the Bellevue Drug Co. litigation described above. The Company will vigorously defend this suit.

Various aspects of the Company’s businesses are governed by federal and state laws and regulations and compliance is a significant operational requirement for the Company. Management believes that the Company is in substantial compliance with all existing legal requirements material to the operation of the Company’s business; however, the application of complex standards to the detailed operation of the business always creates areas of uncertainty. Moreover, regulation of the field is in a state of flux. Numerous health care laws and regulations have been proposed at the state and federal level, many of which could affect the Company’s business. Management cannot predict what additional federal or state legislation or regulatory initiatives may be enacted in the future regarding health care, or the business of pharmacy benefit management. It is possible that federal or state governments might impose additional restrictions or adopt interpretations of existing laws that could have a material adverse affect on the Company’s business or financial position.


Exhibit No.		Exhibits

3.		Articles of Incorporation and By-Laws

3.1		Certificate of Amendment to the Second Amended and Restated Certificate of Incorporation of AdvancePCS (incorporated by reference to exhibit 99.1 of AdvancePCS’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on November 9, 2001).

3.2		Second Amended and Restated Certificate of Incorporation of AdvancePCS (incorporated by reference to Exhibit 99.1 of AdvancePCS’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on December 11, 2000).

3.3		Second Amended and Restated Bylaws of AdvancePCS (incorporated by reference to Exhibit 3.1 of AdvancePCS’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on October 16, 2000).

10.		Material Contracts

10.1*		Omnibus Amendment No. 2 to Receivables Purchase and Contribution Agreement, Receivables Sale and Contribution Agreement, and Receivables Purchase and Servicing Agreement entered into as of July 1, 2003, by and among AdvancePCS, AdvancePCS Health L.P., AFC Receivables Holding Corporation, Advance Funding Corporation, ADVP Management L.P., Redwood Receivables Corporation, and General Electric Capital Corporation.

10.2*		Omnibus Amendment No. 3 to Receivables Purchase and Contribution Agreement, Receivables Sale and Contribution Agreement, and Receivables Purchase and Servicing



		Agreement entered into as of February 11, 2004, by and among AdvancePCS, AdvancePCS Health L.P., AFC Receivables Holding Corporation, Advance Funding Corporation, ADVP Management L.P., Redwood Receivables Corporation, and General Electric Capital Corporation.

31.		Section 302 Certifications

31.1*		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

31.2*		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

32.		Section 1350 Certifications

32.1*		Certification Pursuant To 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002.

The Company filed a Current Report on Form 8-K on October 14, 2003, on which information was reported under Item 5 and 7 announcing a joint press release between Caremark Rx, Inc. and AdvancePCS.

The Company filed a Current Report of Form 8-K on October 27, 2003, on which information was reported under Item 12 announcing our press release reporting financial results for the fiscal quarter ended September 30, 2003.

Pursuant to the requirements 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.


Delaware		75-2493381
(State of Incorporation)		(IRS Employer Identification Number)


				Page
Part I.	Financial Information

	Item 1.	Financial Statements

		A.	Consolidated Balance Sheets as of December 31, 2003 and March 31, 2003 (Unaudited)	1

		B.	Consolidated Statements of Operations for the Three and Nine Months Ended December 31, 2003 and 2002 (Unaudited)	2

		C.	Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2003 and 2002 (Unaudited)	3

		D.	Notes to Consolidated Financial Statements (Unaudited)	4 – 15

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16 – 29

	Item 3.	Qualitative and Quantitative Disclosures About Market Risk		29

	Item 4.	Controls and Procedures		29 – 30

Part II.	Other Information

	Item 1.	Legal Proceedings		30 – 33

	Item 6.	Exhibits and Reports on Form 8-K		33 – 34

Signatures				35


	December 31, 2003			March 31, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	130,316		$	111,247
Accounts receivable, net of allowance for doubtful accounts of $12,909 and $15,586, respectively		1,416,584			1,627,931
Inventories		326,874			99,429
Prepaid expenses and other		40,797			25,647

Total current assets		1,914,571			1,864,254
Noncurrent assets:
Property and equipment, net of accumulated depreciation and amortization of $131,791 and $100,641, respectively		143,097			151,200
Goodwill		1,274,320			1,248,514
Intangible assets, net		368,818			380,806
Other noncurrent assets		58,824			67,970

Total assets	$	3,759,630		$	3,712,744

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	46		$	188
Claims and accounts payable		2,060,465			2,005,306
Accrued salaries and benefits		43,560			46,960
Other accrued expenses		77,398			60,088

Total current liabilities		2,181,469			2,112,542
Noncurrent liabilities:
Long-term debt, less current portion		187,825			447,823
Deferred income taxes		145,222			147,803
Other noncurrent liabilities		47,338			34,102

Total liabilities		2,561,854			2,742,270

Commitments and contingencies

Stockholders’ equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized; Convertible preferred stock, $.01 par value; no shares issued and outstanding		—			—
Common stock, $.01 par value; 200,000,000 shares authorized:
Class A common stock, $.01 par value; 85,847,264 and 82,502,362 shares issued, respectively		858			825
Class B-1 common stock, $.01 par value; 12,913,334 shares issued and outstanding		130			130
Class B-2 common stock, $.01 par value; 200 shares issued and outstanding		—			—
Additional paid-in capital		817,763			750,446
Accumulated other comprehensive loss		(8,154	)		(11,596	)
Accumulated earnings		494,667			340,520
Treasury stock, at cost:
Class A common stock; 5,322,028 and 5,459,573 shares		(107,488	)		(109,851	)

Total stockholders’ equity		1,197,776			970,474

Total liabilities and stockholders’ equity	$	3,759,630		$	3,712,744


	Three Months Ended December 31,						Nine Months Ended December 31,
	2003			2002			2003			2002
Revenues	$	3,905,598		$	3,757,689		$	11,401,970		$	10,495,728
Cost of revenues		3,737,632			3,616,732			10,916,566			10,093,962

Gross profit		167,966			140,957			485,404			401,766
Selling, general and administrative expenses		65,898			56,387			194,816			163,834
Merger-related charges		6,030			—			10,095			—

Operating income		96,038			84,570			280,493			237,932
Interest income		1,068			1,266			3,299			3,947
Interest expense		(5,961	)		(10,249	)		(24,885	)		(33,386	)
Loss on early retirement of debt		—			—			—			(2,444	)
Loss from joint venture		(1,123	)		(1,253	)		(4,119	)		(3,510	)

Income before provision for income taxes		90,022			74,334			254,788			202,539
Provision for income taxes		(35,558	)		(29,362	)		(100,641	)		(80,016	)

Net income	$	54,464		$	44,972		$	154,147		$	122,523

Basic
Net income per share	$	0.59		$	0.50		$	1.68		$	1.34

Weighted average shares outstanding		92,990			89,983			91,967			91,540

Diluted
Net income per share	$	0.55		$	0.46		$	1.57		$	1.23

Weighted average shares outstanding		99,564			97,394			98,228			99,302


	Nine Months Ended December 31,
	2003			2002
Cash flows from operating activities:

Net income	$	154,147		$	122,523

Adjustments to reconcile net income to net cash provided by operating activities –
Depreciation and amortization		41,628			33,469
Provision for doubtful accounts		1,021			12,977
Deferred income taxes		10,886			2,816
Change in operating assets and liabilities –
Accounts receivable		210,326			(412,734	)
Inventories		(227,445	)		(59,679	)
Prepaid expenses and other noncurrent assets		(28,819	)		12,445
Claims and accounts payable, accrued expenses and other noncurrent liabilities		105,820			479,141

Net cash provided by operating activities		267,564			190,958

Cash flows from investing activities:

Purchase of property and equipment		(23,778	)		(58,670	)
Acquisition, net of cash acquired, joint venture and other		(2,213	)		(75,883	)

Net cash used in investing activities		(25,991	)		(134,553	)

Cash flows from financing activities:

Net proceeds from issuance of Common Stock		37,636			8,102
Purchase of Class A Common Stock – Treasury Stock		—			(87,739	)
Deferred financing costs		—			(1,655	)
Repayment of debt		(142	)		(163,022	)
Net activity on asset securitization facility		(259,998	)		120,000

Net cash used in financing activities		(222,504	)		(124,314	)

Net increase (decrease) in cash and cash equivalents		19,069			(67,909	)

Cash and cash equivalents, beginning of period		111,247			139,145

Cash and cash equivalents, end of period	$	130,316		$	71,236

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March 31, 2003	$	1,248,514
Finalization of Accordant purchase price		794
Accordant purchase earn-out		25,012

December 31, 2003	$	1,274,320


	December 31, 2003			March 31, 2003
Amortizable intangible assets, gross:
Customer base	$	278,380		$	285,600
Other		21,675			19,130

		300,055			304,730

Accumulated amortization of amortizable intangible assets:
Customer base		(30,347	)		(22,881	)
Other		(8,727	)		(6,310	)

		(39,074	)		(29,191	)

Amortizable intangible assets, net		260,981			275,539

Non-amortizable intangible assets:
Trade name - PCS		105,267			105,267
Trade name - Accordant		2,570			—

Total intangible assets, net	$	368,818		$	380,806


	December 31, 2003			March 31, 2003
Asset Securitization Facility, with interest at funding agent’s A-1+/P-1 commercial paper rate of 1.05% plus 1.00% and 1.33% plus .85%, respectively, due December, 2006	$	—		$	259,998
Senior Notes, with interest at 8.50%, due March, 2008		187,825			187,825
Other		46			188
Revolving Credit Facility, with interest at LIBOR plus 2%, due October, 2005		—			—

Total debt		187,871			448,011
Less current portion		(46	)		(188	)

Total long term debt	$	187,825		$	447,823


	Parent			Guarantor Subsidiaries			Non-guarantor Subsidiaries			Eliminations			Consolidated
As of December 31, 2003
Cash and cash equivalents	$	52,551		$	—		$	77,765		$	—		$	130,316
Accounts receivable, net		—			999,191			417,393			—			1,416,584
Inventories		—			326,874			—			—			326,874
Prepaid expenses and other		—			40,797			—			—			40,797

Current assets		52,551			1,366,862			495,158			—			1,914,571
Property and equipment, net		—			142,574			523			—			143,097
Equity investment		583,238			—			—			(583,238	)		—
Intercompany		744,755			(327,432	)		(417,323	)		—			—
Goodwill and intangible assets, net		—			1,642,495			643			—			1,643,138
Other assets		9,103			49,721			—			—			58,824

Total assets	$	1,389,647		$	2,874,220		$	79,001		$	(583,238	)	$	3,759,630

Current liabilities	$	4,046		$	2,149,800		$	27,623		$	—		$	2,181,469
Long-term debt, less current portion		187,825			—			—			—			187,825
Deferred income taxes		—			145,222			—			—			145,222
Other liabilities		—			47,353			(15	)		—			47,338

Total liabilities		191,871			2,342,375			27,608			—			2,561,854

Common stock		988			—			—			—			988
Additional paid in capital		817,763			(1,275	)		1,275			—			817,763
Other comprehensive income		(8,154	)		—			—			—			(8,154	)
Equity earnings		583,238			—			—			(583,238	)		—
Accumulated earnings		(88,571	)		533,120			50,118			—			494,667
Treasury stock		(107,488	)		—			—			—			(107,488	)

Stockholders’ equity		1,197,776			531,845			51,393			(583,238	)		1,197,776

Total liabilities and stockholders’ equity	$	1,389,647		$	2,874,220		$	79,001		$	(583,238	)	$	3,759,630

As of March 31, 2003
Cash and cash equivalents	$	96,490		$	—		$	14,757		$	—		$	111,247
Accounts receivable, net		—			1,087,425			540,506			—			1,627,931
Inventories		—			95,756			3,673			—			99,429
Prepaid expenses and other		—			25,647			—			—			25,647

Current assets		96,490			1,208,828			558,936			—			1,864,254
Property and equipment, net		—			150,543			657			—			151,200
Equity investment		413,829			—			—			(413,829	)		—
Intercompany		649,175			(398,569	)		(250,606	)		—			—
Goodwill and intangible assets, net		—			1,628,677			643			—			1,629,320
Other assets		14,899			53,069			2			—			67,970

Total assets	$	1,174,393		$	2,642,548		$	309,632		$	(413,829	)	$	3,712,744

Current liabilities	$	10,446		$	2,081,692		$	20,404		$	—		$	2,112,542
Long-term debt, less current portion		187,825			—			259,998			—			447,823
Deferred income taxes		—			147,739			64			—			147,803
Other liabilities		5,648			25,711			2,743			—			34,102

Total liabilities		203,919			2,255,142			283,209			—			2,742,270

Common stock		955			—			—			—			955
Additional paid in capital		750,446			(1,275	)		1,275			—			750,446
Other comprehensive income		(11,596	)		—			—			—			(11,596	)
Equity earnings		413,829			—			—			(413,829	)		—
Accumulated earnings		(73,309	)		388,681			25,148			—			340,520
Treasury stock		(109,851	)		—			—			—			(109,851	)

Stockholders’ equity		970,474			387,406			26,423			(413,829	)		970,474

Total liabilities and stockholders’ equity	$	1,174,393		$	2,642,548		$	309,632		$	(413,829	)	$	3,712,744


	December 31, 2003			March 31, 2003
Mark to market interest rate swap, net of taxes	$	—		$	(3,442	)
Pension liability adjustment, net of taxes		(8,154	)		(8,154	)

Accumulated other comprehensive loss	$	(8,154	)	$	(11,596	)


	AdvancePCS
	(Registrant)

Date: February 11, 2004	By:	/s/ DAVID D. HALBERT
		David D. Halbert, Chairman of the Board, President and Chief Executive Officer

Date: February 11, 2004	By:	/s/ YON Y. JORDEN
		Yon Y. Jorden, Chief Financial Officer and Executive Vice President (Principal Financial and Accounting Officer)